Equity Method - Book to Tax Difference?

[Corduroy Frog]

Assume a company follows the "equity method" for accounting for investments - i.e. adjusting the balance sheet investment account for profits and losses of companies for which they own 20% or more.

Does this create a book-to-tax difference?

Example:  Company A owns 30% of Company Z.  It's initial investment in Company Z is $100,000, and is carried on the balance sheet of company A as such.  After one year, Company Z profits are $50,000.  I am told the "equity method" requires Company A to increase it's investment account by $15,000 (30% of $50K), and report the $15,000 as "investment income" for P&L purposes.

As far as I can tell, Company A's basis in Company Z is still only $100,000, and the $15,000 profit is recognized but not realized.  My question:  Is the $15,000 a book-to-tax difference?

 

[Lee B]

"Tax Impact

The dividends received under the cost method create taxable income. For example, if UVW Corp. pays out 2 percent a year in dividends, your income is 2 percent of $10 million, or $200,000. In the 24 percent tax bracket, you would incur a $48,000 tax liability.

The equity method has a larger potential effect on income and thus on income taxes. Suppose XYZ Corp routinely earns a 10 percent annual return on equity. In the first year, you would record income of 10 percent of $10 million, or $1 million. Your tax liability is $240,000. Since income is normally more volatile than dividend yield, the equity method has more potential to affect your company’s tax bill."

The way you phrase questions, I never know whether it's a real client question or a head scratching hypothetical question?

 

[Corduroy Frog]

Thank you Mr. Lee - you did answer the question.

And FWIW, there is usually a real client, but never with big round numbers that are used for a contrived example.