Hi, I have a technical question related to the impact on taxes when adjusting historical financials for non-recurring/extraordinary items and I was wondering if anyone more experienced could help me with it. Just for disclosure, I'm studying to break into the IB industry, so that's the reason for the question.
Ok, Let's take a generic example:
EBIT ------> $ 300 Interest ------> ($ 1000) Pre-Tax income ---> ($ 700) Taxes ------> $ 200 Net Income ------> ($ 500)
Suppose we have to adjust EBIT for two non-recurring items (pre-tax): (1). $ 400 one-time lawsuit expense; (2). $ 200 one-time restructuring expense.
Now, the Pre-Tax income should be ($ 100) - once we added back $ 600 to EBIT. So, with those ajustments (reducing losses from -$700 to -$100), how would we adjust the positive $ 200 on the Tax line to reflect the tax impact due to normalization adjustments? Let's assume a marginal tax rate of 35%.
I appreciate your help. Thanks in advance
Well how do you have taxes to pay to begin with if your pretax income (with or without non-recurring items) is negative?
You do not have taxes to pay actually. You do have a tax benefit in the tax line. And my question is: as you adjust for normalization, you should change your tax figure as a result of those adjustments (even if it is a tax benefit - it is not the same figure as you adjust the above the line items). How would you do to adjust the tax line in such case?
Well the pretax income has increased by 600 through normalizing, so therefore the taxes should increase by 6000.35, and Net Income should increase by 600(1-0.35).
This is based on the assumption that all of these nonrecurring items were originally deductible for tax purposes to begin with. In some jurisdictions restructuring expenses may/must be capitalized for tax purposes.
Another factor to considers is could be entirely possible the company also has a one-time tax benefit which itself could be considered a non recurring item. So if you're looking for a normalized figure to forecast future years, then you might want to dig for more information.
paradox715, that's the issue: you see that adjusting for the non-recurring items, the pre-tax income is still negative (-$100). And adjusting the tax line to reflect the $600*0.35 would result in a tax paid now (from a positive tax line of $200 to a negative tax of -$10). And that is my point: it does not make sense to have a negative pre-tax income of -$100 and a tax paid of -$10, after the adjustments. Did you get what I'm saying?
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