Updated July 10, 2023
Definition of Income Tax Expense
Every business/company pays income tax as an expense in every financial year, based on the federal or statutory laws laid down for the income it earns through selling products and services.
Income tax expense is a company’s liability arising from the income earned yearly by doing business. Federal governments, central governments, or both levy income tax expenses. These types of expenses are levied on both businesses and individual incomes.
Formula for Income Tax Expense
Income tax expenses can be calculated on the earnings they are imposed. For businesses, income taxes are levied on the earnings after removing manufacturing, marketing, salary, operating, and finance costs. In other words, income tax expense can be calculated by multiplying the income tax rate by the taxable income. Thus, It can be calculated as
The above calculation is a broader representation of income tax expense. Therefore, it can vary, and more items can be included or excluded from the above equation depending on the nature of the business and regulatory requirements.
Alternatively, income tax expense = Total taxable income x income tax rate
How to Calculate Income Tax Expense?
Following are the steps to calculate income tax expenses for a company
- Deduct the cost of revenue (manufacturing costs) from the total revenue generated to obtain gross profit
- Deduct operating expenses such as salary expenses, administration expenses, marketing, and advertising expenses, etc., from the gross profit to get operating income or earnings before interest and taxes
- Deduct all the costs associated with financing, such as interest expenses, adjust for any interest income earned, gains or losses on the sale of a business, etc., to get earnings before taxes
- Finally, deduct the income tax expenses from the earnings before taxes or EBT based on the applicable interest rates
Following are the steps to calculate income tax expense for an individual (employed person)
- Calculate the total income of the individual, which can be from one or more sources
- Identify the tax slab under which the total income falls
Marginal Tax Rate
|Single Taxable Income||
Married Filing Jointly or Qualified Widow(er) Taxable Income
|10%||$0 to $9,525||$0 to $19,050|
|12%||$9,526 to $38,700||$19,051 to $77,400|
|22%||$38,701 to $82,500||$77,401 to $165,000|
|24%||$82,501 to $157,500||$165,001 to $315,000|
Calculate the income tax under each slab. For example, if the total income is $80,000, the applicable income tax slabs are 10%, 12%, and 22%. Hence, the income taxes under these slabs are:
10% of $9,525 = $952.5
12% of ($38,700 – $9,526) = $3501
22% of ($82,500 – $38,701) = $9,636
Total income tax expense = $952.5 + $3501 + $9,636 = $14,090
Examples of Income Tax Expenses
1. A hospitality business has earnings before taxes of $10 million. The company marks an effective tax rate of 35% on this income. Calculate the income tax expense and the business’s net income (earnings).
Income tax expense can be calculated as Earnings before taxes times an effective tax rate.
Income tax expense = $10 million x 35% = $3.5 million
Net earnings can be calculated as Earnings before taxes less net earnings
Net earnings = $10 million – $3.5 million = $6.5 million
2. John Smith lives in New York and has an annual income of $140,000. What are his income tax expenses considering the tax rates given below?
Marginal Tax Rate
Single Taxable Income
|10%||$0 to $9,700|
|12%||$9,701 to $39,475|
|22%||$39,476 to $84,200|
|24%||$84,201 to $160,725|
|32%||$160,726 to $204,100|
|35%||$204,101 to $510,300|
|37%||$510,301 or more|
The given gives the marginal tax rate for the United States employed persons. According to the following schedule, John Smith’s annual income falls in the 10%, 12%, 22%, and 24% tax slabs and will be taxable.
10% of The First Tax Slab + 12% of The Second Tax Slab + 22% of The Third Tax Slab + 24% of The Fourth Tax Slab = Total Taxes
Total taxes = $970 + $3,573 + $9,839.3 + $18,366 = $32,748
- Federal and other governments levy income tax expenses on individuals, businesses/firms. The governments use these expenses for different welfare schemes such as social security, pensions, unemployment benefits, medical welfare, etc. On the other hand, corporate income tax expenses are used for bigger spending such as social upliftment projects, construction and engineering works, budgetary works, etc.
- Income tax expenses are also significant from business accountability toward society and the economy. Companies paying income tax expenses without deferrals or postponements are considered responsible and accountable.
- Tax evasion and deferrals are important issues in the economy. However, investors and stakeholders do not appreciate companies that avoid income taxes or defer taxes for longer periods.
- Income tax expenses reduce the net income attributable to the company’s shareholders. In addition, multinational companies are taxed differently in different geographies. This can sometimes generate uneven competition among businesses in different geographies.
Income tax expenses are recognized for a specific accounting period, i.e., annual, quarterly, or monthly. Income tax expenses are easily calculable, whether levied on individuals or small businesses. However, it sometimes becomes difficult to calculate corporate taxes become of the complexity of taxation, and it requires companies to hire professionals with expertise in taxation.
Income tax expenses are treated on a company’s income statement, whereas those income taxes due to be paid are reported on the balance sheet under income tax payable. For example, suppose a company takes out $500,000 from EBT as taxes due to be paid, but the actual payment is only 475,000 for the financial year. In such a case, the company will list $25,000 as deferred tax liability.
This is a guide to Income Tax Expenses. Here we also discuss the introduction, how to calculate income tax expenses, and advantages and disadvantages. You may also have a look at the following articles to learn more –