Answer
The reserve overstates the total loss before it is incurred. Consequently, the amount that is provided for as loss is not taxed. In other words, the amount of loss that is reserved is greater than the actual loss suffered. In the context of the time value of money, the value of the loss today (the one reserved) is greater than the loss to be incurred in the future. Therefore, the IRS would prefer the loss be declared once it is incurred instead of reserving it five years beforehand, which results in the loss of tax.
Work Step by Step
The reserve overstates the total loss before it is incurred. Consequently, the amount that is provided for as loss is not taxed. In other words, the amount of loss that is reserved is greater than the actual loss suffered. In the context of the time value of money, the value of the loss today (the one reserved) is greater than the loss to be incurred in the future. Therefore, the IRS would prefer the loss be declared once it is incurred instead of reserving it five years beforehand, which results in the loss of tax.
