SFAS 96 generally requires a rigid and mechanical approach to computing deferred taxes. Many of the complexities encountered result from the changing tax laws. The FASB, however, complicated matters by requiring the use of tax-planning strategies "for purposes of estimating the years in which temporary differences will result in taxable or deductible amounts." Conceptual Basis and Criteria for Tax-Planning Strategies

The use of tax-planning in calculating deferred taxes represents one of the FASB's concessions to practicality in SFAS 96. After scheduling the reversals of temporary differences, the aggregate net deductible temporary difference for any future year is treated as a net operating loss (NOL) of that year. The benefit of that NOL can be recognized only when, under the tax law, it can be: 1) carried back from the year of reversal to offset taxable income or net taxable temporary differences reversing in the carryback period; or 2) carried forward from the reversal year to offset net taxable temporary differences reversing in the carryforward period. Application of these carryback and carryforward rules may leave a company with: 1) net taxable amounts in some years and net deductions in other years; or 2) loss carryforwards exceeding net taxable amounts scheduled to reverse during the carryforward years, combined with net taxable income for years beyond the carryforward period. If either of these income patterns actually existed for a company, it would engage in taxplanning to minimize the amount of unused deductions and credits. The objective of such planning is to accelerate or delay the reversal of the company's temporary differences. It is this realism that the SFAS 96 tax-planning provisions are intended to capture. Conceptual Basis

SFAS 96 identifies three broad principles underlying the accounting for income taxes:

1. A current or deferred tax asset or liability is recognized for the current or deferred tax consequences of all events that have been recognized in the financial statements.

2. The current or deferred tax consequences of an event are measured on the basis of enacted tax law to determine the amount of taxes payable or refundable currently or in future years.

3. Recognition and measurement of a deferred tax liability or asset do not anticipate the tax consequences of earning income or incurring losses or expenses in future years, or the future enactment of a change in tax laws.

The only exceptions in applying these principles are that SFAS 96: 1) continues to permit the exceptions to comprehensive tax allocation allowed by APB Opinion 23, Accounting for Income Taxes-Special Areas, and for deposits in statutory reserve funds by U.S. steamship enterprises; 2) does not change the accounting for leveraged leases provided for in SFAS 13, Accounting for Leases, and FASB Interpretation 21, Accounting for Leases in a Business Combination; and 3) prohibits recognition of a deferred tax liability or asset related to goodwill.

The tax-planning strategies contemplated by SFAS 96 are consistent with the principles underlying the entire statement. The strategies may not anticipate or consider the earning of income or the incurring of losses or expenses that will result from events or transactions that will be reported in future financial statements. This also means that a company may not use a strategy that "avoids" a reversal of temporary differences. The FASB's measurement approach rests on the inherent assumption of accrual basis financial statements that a company will recover recorded assets and settle recorded liabilities at their recorded amounts. The recovery or settlement may be delayed or accelerated, but to assume that the recorded amounts will never be recovered or settled is inconsistent with this assumption.

The tax-planning strategies must be developed within the context of existing tax law for each applicable tax jurisdiction. If the tax law does not permit flexibility in the timing of the reversal of a particular temporary difference, a company may not assume flexibility in its tax-planning strategy. Criteria for Strategies

Besides consistency with the conceptual underpinnings of SFAS 96, a tax-planning strategy used in the deferred tax calculation must meet two other criteria. First, it must be a prudent and feasible strategy over which management has discretion and control. The terms prudent," feasible," discretion," and "control" are not specifically defined in SFAS 96, but Appendix B (Basis for Conclusions) provides the following insight:

"If an action is not prudent, management probably

would not do it. If an action is not feasible, management

does not have the ability to do it. Without

discretion and control, management cannot unilaterally

employ a particular strategy." The Statement (paragraph 19a) further states that management must have both the ability and intent to implement the strategy, if necessary, to reduce taxes. Management's ability to implement a strategy may be affected by debt covenants restricting the use of assets that would be involved in the strategy. For example, if an asset has been pledged as collateral for a loan, management may not be able to sell the asset or sell it and lease it back. Thus, a sale-leaseback strategy for SFAS 96 purposes could not be assumed. Actual implementation, however, is not required if subsequent transactions or events negate the need for the strategy. By the same token, the intent requirement does not mean that management is given total discretion in the selection of strategies (see management responsibility discussions later).

Second, the strategy cannot involve a significant cost to the enterprise. The term "significant cost" is not defined in SFAS 96, but it states that the tax benefit arising from a strategy may not be viewed as a reduction of the cost for this purpose. Appendix B gives the following example of a failure to meet the significant cost criterion:

". . . a strategy to accelerate recovery of the reported

amount of an asset that involves incurring four dollars

of legal expense for every five dollars of tax savings

might be a prudent and reasonable action for management

to take. Nevertheless, the strategy would not

meet the second criterion because the costs of implementing

a tax strategy must be of a minor, incidental

nature. Otherwise, the strategy anticipates "significant"

future events that are not inherent in financial

accounting assumptions for the current year." This requirement is consistent with the basic recognition principle underlying SFAS 96, i.e., future events that are not inherent in the financial statements for the current year may not be anticipated for the purpose of deferred taxes. Additional Requirements

In evaluating the effects of tax-planning strategies, companies must assume that assets will be recovered and liabilities settled at the amounts recorded in the financial statements. In other words, SFAS 96 tax-planning strategies cannot assume financial statement gains or losses even though the actual amounts expected to be recovered or settled differ from the recorded amounts. For example, in an assumed sale of an asset where the sales value is more than book value, the gain cannot be assumed; only the difference between the book and tax basis of the asset is considered. The tax consequences of the gain will be recognized when, and if, the actual gain is recognized. Similarly, in a sale-leaseback strategy, only the effects of the sale on the reversal of existing, temporary differences-not any future temporary differences arising from the leaseback or any gain expected to be realized on the sale-can be assumed. If the asset considered for the sale or the sale- leaseback strategy has an expected sales value less than its book value at the sale or sale-leaseback date, the strategy does not satisfy the SFAS 96 requirements because the strategy does not result in recovery of the asset's book value.

SFAS 96 (paragraph 48) also requires companies to use the same tax- planning strategies for accelerating or delaying the reversal of any temporary difference that exists under both the regular tax system and the alternative minimum tax (AMT) system. For example, if a strategy for regular tax purposes assumes the sale of an asset in two years, the strategy for AMT purposes must be the same. Similar consistency for federal and state purposes would seem reasonable, but is not specifically covered by SFAS 96.

The FASB staff has taken the position that a strategy requiring IRS approval for implementation generally cannot be used for SFAS 96 purposes. If a company secures a ruling approving the strategy, however, it may be so used. Management's Responsibility in Finding and Selecting Tax-Planning Strategies

The use of tax-planning strategies under SFAS 96 is not elective. Strategies that meet the SFAS 96 criteria and have the effect of reducing a deferred tax liability or increasing a deferred tax asset must be incorporated in the calculation.

Since the use of tax-planning strategies is mandatory, questions arise as to: 1) management's responsibility in searching for suitable strategies; 2) the effect of the intent criterion in light of the mandatory-use requirement; and 3) the reporting of a strategy discovered subsequent to the publication of the financial statements. These issues are not specifically addressed in SFAS 96, but the FASB staff addresses the first two questions in a special report: A Guide to Implementation of Statement 96 on Accounting for Income Taxes, issued earlier this year. The report, commonly referred to as the Implementation Guide, provides guidance in a question and answer format for approximately 70 implementation issues. Responsibility in Searching for Strategies

In response to question number 62 in the Implementation Guide, the FASB staff provides the following regarding management's responsibility in searching for tax-planning strategies:

"Management should make a reasonable effort to identify

those qualifying tax-planning strategies that are

significant. Management's obligation to apply qualifying

tax-planning strategies in determining the amount

of a deferred tax liability or asset is the same as its

obligation to apply the requirements of other standards

for financial accounting and reporting."

What is a reasonable effort?" The scope of management's search effort in discharging its responsibility will depend on the particular facts and circumstances facing each company. Some generalizations, however, can be made about the circumstances prompting a search. If any of the conditions in Exhibit 1 exist, it seems reasonable to expect management to seek a strategy to alleviate it. This may require the testing of a number of scenarios with a variety of strategies under both the regular tax and the AMT systems.

A company engaged in foreign operations will find its search for federal tax strategies more complicated and, thus, more difficult to ensure that it has conducted an adequate search. Likewise, a company subject to tax in more than one jurisdiction compounds management's responsibility. Tax-planning strategies must be applied to taxes in each jurisdiction. Plus, it is entirely possible that the strategies will conflict, e.g., a strategy that reduces federal taxes may increase state taxes.

Who makes the search" effort? The search effort is managements responsibility; but who within the management ranks will be involved in discharging the responsibility? Traditionally, the calculation of deferred taxes has been a financial accounting responsibility. The strategies to be considered in implementing SFAS 96, however, probably will cut across a number of aspects of managerial decision-making. Most companies will find it advantageous to form a task force comprising financial accounting, tax, and other management personnel to develop their strategies. Because of SFAS 96's dependence on the tax laws, however, the tax personnel will be essential.

While searching for strategies, the task force must keep in mind the need to ensure that the data for calculating deferred taxes is gathered efficiently. For example, since changes in the laws have an immediate, direct effect on the deferred tax provision under SFAS 96, a procedure for monitoring and evaluating proposed or enacted changes in each tax jurisdiction may be needed. Similarly, for temporary differences whose reversal periods cannot be determined objectively (e.g., warranties, bad debts), procedures for building an experience base that will guide the allocation of amounts to future periods may be necessary.

The task force also must keep in mind that the strategies devised for SFAS 96 are hypothetical strategies developed in an artificial environment, i.e., the only future taxable income or loss assumed is that which results from the reversal of temporary differences. Tax experts may find this environment particularly difficult to adjust to, since they are accustomed to planning in an environment that assumes future income or loss. Effect of intent Criterion

Management must intend to use a strategy for it to be incorporated in the deferred tax calculation, but it is doubtful that management can justify its failure to use a particular strategy on the basis of a lack of intent. SFAS 96 makes it clear that the tax-planning strategies for deferred tax purposes are hypothetical strategies used only in the calculation of deferred taxes. The company may use a strategy for deferred tax purposes that would not even be considered on the basis of the company's actual projected tax position. The strategy is selected for SFAS 96 purposes because it places the company in a tax position that management can prudently and feasibly achieve if the only future taxable results are those resulting from the reversal of temporary differences.

If those circumstances were to actually occur, it would not be prudent for management to allow the tax benefit of a net deductible amount to expire rather than implement a tax-planning strategy that would permit the company to realize the benefit. Additionally, the SEC staff has indicated that, in its view, intent or lack of intent should not be allowed to justify the management of reported results. Reporting of Omitted Strategies

The third issue stemming from mandatory use of tax-planning strategies is the reporting of a strategy discovered after publication of the financial statements in which it could have been incorporated. If the facts for the strategy existed before the statements were published, it probably should be viewed as the detection of an error requiring retroactive restatement, if material. If, however, the facts were not available when the statements were published, retroactive restatement would seem inappropriate. Potential Tax-Planning Strategies

Exhibit 2 presents a number of tax-planning strategies that will accelerate or delay the reversal of a company's temporary differences. In the discussion of these strategies, however, remember that they are only hypothetical (i.e., for SFAS 96 purposes) and cannot be used unless they meet the SFAS 96 requirements previously discussed. Sale-Leaseback of Operating Assets

The assumed sale of an operating asset win reverse any temporary differences accumulated to the date of sale. The sale of significant operating assets alone, however, probably will not meet the prudent and feasible tests of SFAS 96 since it raises major additional considerations, such as whether the company intends to continue certain products and business lines or to market its products. Such considerations generally extend beyond those involved in actual tax- planning strategies.

A concurrent long-term operating leaseback of the assets avoids the additional considerations entailed by the sale alone. Since a tax- planning strategy cannot give rise to financial statement gain or loss, the assumed proceeds for the sale-leaseback are equal to the net book value of the asset at the date of sale. As previously discussed, if the sales value of the asset is less than its book value, the transaction does not meet the requirements of SFAS 96. No temporary differences for the asset exist after the sale date because the rent expense and deductible rent payments are equal for the operating leaseback.

The sale-leaseback strategy may be used to accelerate the reversal of taxable temporary differences so that taxable income for utilizing an NOL carryforward, an excess deduction carryforward, or a tax credit carryforward that would otherwise be lost, is generated. The following example illustrates the benefit with an NOL carryforward:

XYZ company has an operating asset with a tax basis of

$3,000,000 and a book value of 4,000,000. This temporary

difference of $1,000,000 has produced a deferred

tax liability that will reverse at a rate of $100,000

over the next 10 years. XYZ also has a $500,000 NOL

carryforward scheduled to expire next year. Without a

tax-planning strategy, the company will recognize only

$100,000 of benefit from the NOL carryforward in its

scheduling process. An assumed sale and leaseback of

the asset in the year the NOL carryforward is scheduled

to expire, however, will produce taxable income

equal to the temporary difference in that year. XYZ,

therefore, will be able to recognize the entire benefit of

the NOL carryforward. Sale of installment Receivables

An assumed sale of installment receivables win accelerate taxable amounts equal to the gains on the installment sales deferred for tax purposes. Consistent with the SFAS 96 prohibition against gain or loss recognition, the sale price must not be less than the remaining balance of the reported amount of the receivable at the sale date. Consider the following example.

ABC Company's only temporary difference arises from

deferring $3,000,000 of profit on installment sales that

will reverse over the next three years at $1,000,000 per

year. ABC also has a $1,600,000 NOL carryforward

expiring next year. Absent a tax-planning strategy, the

company will recognize only the benefit of $1,000,000

of the NOL carryforward in scheduling process. The

assumed sale of the receivables in the next year,

however, will accelerate the reversal of the entire

$3,000,000 temporary difference. Sale of Obsolete Inventories

Disposal of obsolete inventory that is reported on the books at net realizable value may be used to either accelerate or delay a deduction equal to the amount by which the tax basis exceeds the net realizable value of the inventory. This acceleration or delay may be used to offset reversing taxable temporary differences or to recognize a loss carryback of taxes paid in a current or prior year. Election to File a Consolidated Return

The election to file a consolidated tax return may be a viable tax strategy under SFAS 96 if the tax law permits such an election. The tax law generally extends this privilege to any affiliated group of corporations whose individual member corporations (even those affiliated for only part of the year) consent to all the consolidated return regulations. The term "affiliated group" includes one or more chains of includable corporations (most corporations except tax-exempts, insurance companies, foreign entities, companies for which possession tax credits are in effect, regulated investment companies, real estate investment trusts, and domestic international sales corporations) connected through stock ownership with a common parent corporation.

To qualify for the election, the common parent must own directly at least 80% of the stock of at least one of the other includable corporations. Additionally, 80% of the other includable corporations must be owned directly by one or more of the includable corporations. For both of these requirements, 80% ownership means: 1) 80% of the voting power of the corporation's stock; and 2) 80% of the total value of the corporation's stock.

Tar advantages and disadvantages. Since management's decision to file a consolidated return involves considering both the advantages and disadvantages of the election, they also must be considered in assuming the election for SFAS 96 purposes.

SFAS 96 advantages of consolidated return strategy. For SFAS 96 purposes, the election to file a consolidated return may allow an NOL or tax credit carryforward of either the parent corporation or one of the other includable corporations to be off set against the other corporations' deferred tax liabilities at the date of assumed election. Recognition of an NOL or tax credit carryforward in this manner is acceptable only to the extent permitted by the tax laws. Federal tax law limits the use of purchased NOL carryforwards according to the form of the purchase transaction and the amount of an NOL used each year. Such restrictions must be reflected in the calculation of deferred taxes when the consolidated return election is assumed.

Life insurance companies: a special case. The strategy of electing to file a consolidated return for a life insurance company introduces an additional complexity. The company first must decide whether it expects to be taxed as a non-life insurance company in a consolidated return or a fife insurance company under special tax rules. Life insurance companies generally are not considered includable corporations of affiliated groups under the tax law because they receive special tax benefits (e.g., insurance reserves excludable from gross income). A domestic life insurance company, however, may be treated as an includable corporation if: 1) the common parent elects to treat it as an includable corporation; and 2) it has been a member of the affiliated group for the five years immediately preceding the tax year for which the consolidated return is filed. This type of consolidation is referred to as a "life/non-life consolidation," the federal income tax regulations provide for a subgroup method of computing the group's consolidated taxable income. Generally, non-life members and life members are treated as separate groups, with certain exceptions such as intercompany transactions.

In deciding to use the consolidated return strategy for SFAS 96, the management of an affiliated group with life insurance companies must compare the benefits of having the life insurance companies taxed separately with the benefits of having them taxed as part of the group (i.e., via the consolidated return). Having the life insurance companies' temporary differences available for offsetting the nonlife companies' NOLs or tax credit carryforwards, even where limited by the tax law, is an important factor in favor of the consolidated return election. However, if the election is made, the life insurance companies' surplus reserves may trigger a tax-an effect that also must be scheduled. Acceleration of the Repatriation of Earnings from Foreign Subsidiaries

If deferred taxes are provided on the unremitted earnings of a foreign subsidiary, accelerating the repatriation of the foreign earnings is a possible strategy. The assumed form of the repatriation is important to the scheduling of the strategy. If the repatriation is assumed to be in the form of dividends, the dividends, as well as an appropriated provision for withholding taxes, are scheduled in the year that remittance is planned. If sale or liquidation of the subsidiary in a future period is part of the strategy, however, the remaining temporary differences are assumed to occur in that period. Election to Forego NOL Carryback

Since federal tax law permits a company to forego the carryback period and use only the carryforward period for NOLs, a company may adopt a similar strategy for SFAS 96 purposes. One situation in which this might be prudent and feasible is where the company has used foreign tax credits to reduce or eliminate taxes payable in the preceding three years. The NOL carryback benefit in this situation is simply the freeing up of the foreign tax credits. With only a five-year carryforward period for the foreign tax credits (i.e., in the U.S.), as well as other limitations on their use, the foreign tax credits may expire without benefit. By electing to forego the NOL carryback and to carry it forward instead, the company avoids this loss of benefits.

The election to forego the carryback in the scheduling process may be reversed in future years. Changing facts and circumstances may be such that the election no longer results in the minimum deferred tax liability or maximum deferred tax asset for the company. If either of these situations exists, the election will no longer qualify as an appropriate tax-planning strategy for SFAS 96 purposes. Making Larger Than Normal Pension Payments

An annual payment in excess of a company's normal annual payment to reduce its long-term pension obligation (recognized as liability in the balance sheet) may accelerate a tax deduction for pension expense to an earlier year than otherwise would have occurred. From a tax standpoint, however, there is a limitation on the deduction for amounts paid on or before the extended due date of the tax return. Actual contributions exceeding the maximum allowable deduction may be carried forward and deducted in a future year, but if the objective in the scheduling process is to accelerate the deduction, the benefit of the excess payment on the pension obligation is limited. Acceleration of Payout Under Deferred Compensation Arrangements

Because of the extended period elapsing between the inception of a deferred compensation contract and actual payout, taxable income from other reversals may not be available to offset the compensation deductions. Whether a tax-planning strategy accelerating the pattern of deductions can be used, however, is questionable. Management generally does not have complete control of the deferred compensation arrangement, and it may be difficult to implement such a strategy without incurring significant cost. The significant cost, of course, renders the strategy inappropriate for SFAS 96 purposes.

For individual deferred compensation contracts, it is possible to assume accelerated payout if: 1) the individuals are willing to accept taxable income before the contractual payout; and 2) the stockholders find the accelerated payout acceptable. For a plan covering a number of employees, on the other hand, management may be given more discretion by virtue of the contract. If management trustees have the contractual authority to change either the plan or the payout, the acceleration strategy becomes more viable. Early Settlement of Lawsuits

Where accruals for litigation have been made on the books, the reversals are, in part, governed by management's intentions regarding settlement. If management intends to contest a claim until the courts reach a verdict, the reversal may not be scheduled to occur for several years. The reversal may be accelerated by a tax-planning strategy that calls for management to settle the litigation before the process is complete. Management, however, must have the ability to effect this settlement, and its implementation must not involve a significant cost to the company. These criteria clearly will limit the number of situations where the early settlement strategy is appropriate, ate the will not prohibit the strategy in all cases.