Tax Expense

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Tax Expense

What Is a Tax Expense?

A tax expenditure is a responsibility owing to the federal, state/provincial, and/or local governments during a certain time period, often a year.

Tax costs are computed by multiplying an individual’s or business’s applicable tax rate by the income received or produced before taxes, after accounting for non-deductible items, tax assets, and tax liabilities.

Tax Expense = Effective Tax Rate x Taxable Income

Key Takeaways

  • Tax costs are the entire amount of taxes owing to a taxation body by a person, company, or other organization.
  • Taxable income is multiplied by the effective tax rate to calculate income tax expenditure.
  • Other taxes, such as property or estate taxes, may be imposed against the value of an asset.

Understanding Tax Expense

Because various sources of income are taxed at different rates, calculating tax expenditure may be difficult. For example, a company must pay payroll tax on employee salaries, sales tax on some asset acquisitions, and excise tax on certain commodities.

Aside from the variety of tax rates applicable to various amounts of revenue, the varying tax rates in different jurisdictions and the several layers of tax on income further complicate establishing an entity’s tax expenditure. Tax authorities such as the Internal Revenue Service (IRS) and GAAP/IFRS thoroughly detail determining the proper tax rate and defining the relevant accounting techniques for things impacting one’s tax expenditure.

The International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) provide for a certain treatment of income and costs that may vary from the provision authorized by the appropriate government tax legislation.

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This implies that the amount of tax cost realized is unlikely to match the usual income tax percentage applied on company revenue perfectly. In other words, inconsistencies in financial accounting and the tax law may result in a tax expenditure that is not the same as the real tax obligation.

Many businesses, for example, use straight-line depreciation to compute depreciation in their financial statements but are authorized to utilize an accelerated type of depreciation to calculate taxable profit, resulting in a taxable income number that is lower than the reported income figure.

Because tax cost is a liability that must be paid to the federal or state government, it has an impact on a company’s net profits. The expenditure limits the amount of earnings that may be given to shareholders as dividends.

This is considerably worse for C company shareholders, who must pay taxes on the dividend received twice. A tax cost, on the other hand, is only recorded when a corporation has taxable revenue. If a loss is realized, the company may carry it forward to future years to offset or decrease future tax expenditures.

Tax Expense vs. Tax Payable

The tax expenditure is the amount of taxes that an organization has calculated is payable based on typical company accounting procedures. This expense appears on the income statement. The tax due is the actual amount of taxes owing based on the tax code’s requirements. Until the corporation pays the tax obligation, the payable amount is recorded as a liability on the balance sheet.

If the tax expenditure exceeds the tax obligation, the difference generates a new liability known as a deferred tax liability, which must be paid at some time in the future. If, on the other hand, the tax payed exceeds the tax cost, the difference generates an asset category known as the deferred tax asset, which may be used to satisfy any future tax expense.

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