Buffco began operations in 20X1, and although it has grown steadily, the company reported accumulated operating losses of $530,000 in its first four years in business. In the most recent year, 20X5, Buffco appears to have turned the corner and reported modest taxable income of $40,000. In addition to a deferred tax asset related to its net operating loss, Buffco has recorded a deferred tax asset related to product warranties and a deferred tax liability related to accelerated depreciation.

Given its past operating results, Buffco has established a full valuation allowance for its deferred tax assets. However, given its improved performance in 20X5, Buffco management would like to know if they can reduce or eliminate the valuation allowance.

Required: Assume you are Buffco’s CPA and write a one to two-page memorandum which discusses the following issues as they relate to Buffco and provide the specific FASB ASC references. Create a clear and organized memo that accomplishes the goals of the assignment, employs appropriate tools (FASB ASC), and demonstrates good composition skills, effective organization, and effective writing style.

• The importance of future taxable income as it relates to the valuation allowance for deferred tax assets.

• The sources of income that may be relied upon to remove the need for a valuation allowance.

• Possible tax-planning strategies for the purpose of reducing a valuation allowance.

• From the information provided above, discuss whether or not it appears that Buffco could employ a tax-planning strategy to support reducing its valuation allowance?

• Given its improved performance in 20X5 and the information gained from your research, should Buffco management reduce or eliminate the valuation allowance? Explain your conclusion. Keep in mind this relates to accounting for income taxes on the financial statements (not on the tax return).