Nelson Inc. purchased machinery at the beginning of 20X1 for $90,000. Management used the straight-line method to depreciate the cost for financial reporting purposes and the sum-of-theyears’ digits method to depreciate the cost for tax purposes. The life of the machinery was estimated to be three years, and the salvage value was estimated at zero. Revenues less expenses other than depreciation expense and goodwill impairment equaled $500,000 for 20X1, 20X2, and 20X3. Nelson pays income tax at the rate of 21% of taxable income. The goodwill impairment equaled $50,000 for 20X1 and 20X2. There was no impairment in 20X3.

Required:

1. Compute Nelson’s taxable income and financial reporting income (before tax) for all three years.

2. What are permanent and temporary differences? Give an example of each for Nelson.

3. For 20X1, 20X2, and 20X3, determine Nelson’s income tax due, income tax expense for the year, and deferred tax asset or liability at December 31. For the last item, be sure to specify whether the item is a deferred tax asset or liability. 

4. Assume that at the beginning of 20X2, the federal government changes the tax rate to 18%, effective immediately. Determine the amount of income tax due for 20X2 and the income tax expense for 20X2.