Cost of Income Taxes

Cost of Income Taxes: Every corporation or company incurs an expense for income tax in every fiscal year depending on the federal or statutory laws established for the income it generates from selling goods and services.

A company’s liability for income tax expenses results from the yearly profits generated by its operations. Federal, central, or both governments may impose income tax expenses. Both business and personal incomes are taxed for these kinds of expenses.

Formula for Income Tax Expense – Cost of Income Taxes

On the income upon which they are levied, income tax expenses may be computed. Businesses must pay income taxes on their profits after subtracting their operational, finance, salary, and marketing expenses. In other words, you may figure out your income tax expense by multiplying your taxable income by the income tax rate. It can therefore be calculated as:

Income Tax Expense = Revenue – Cost of Goods Sold – Salary Expenses – Operating Expenses – Finance Costs

An expanded picture of income tax expense is provided by the formula above. Therefore, depending on the nature of the business and legal needs, it can vary and more items can be added to or removed from the above equation.

Alternatively, income tax expense = Total taxable income x income tax rate.

How to Calculate Income Tax Expense?

The steps to figure out income tax costs for a business are as follows.

• To calculate gross profit, subtract the cost of revenue (manufacturing costs) from the total revenue.
• To obtain operating income, also known as earnings before interest and taxes, subtract operating costs from the gross profit, including wage costs, administrative costs, marketing and advertising costs, etc.
• To obtain earnings before taxes, subtract all financing costs, including interest expenditures, and make adjustments for any interest income earned, gains or losses on the sale of a business, etc.
• Lastly, based on the current interest rates, subtract the income tax expenses from the earnings before taxes or EBT.

The steps to figure out an individual’s income tax liability are as follows (employed person):

1. Determine the person’s total income, which may come from one or more sources.
2. Determine the tax bracket that the whole income belongs to.

Determine the income tax for each tax bracket. For instance, the applicable income tax slabs are 10%, 12%, and 22% if the total income is $80,000. The income taxes levied under these slabs are thus:

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

• A hospitality company made $10 million before taxes. On this income, the corporation records an effective tax rate of 35%. Determine the business’s net income and income tax expense (earnings).

  Earnings before taxes multiplied by an effective tax rate can be used to compute income tax expenses.

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

• John Smith makes $140,000 a year and resides in New York. What are his income tax costs taking into account the enumerated tax rates?

The marginal tax rate for those who are employed in the United States is provided. John Smith’s annual income will be taxable if it falls between the following schedule’s tax slabs of 10%, 12%, 22%, and 24%.

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

MERITS OF COST OF INCOME TAXES

Below are a few of the benefits:

1. Income tax expenses are imposed by the federal government and other governments on both people and businesses/firms. These costs are incurred by the governments for a variety of welfare programmes, including social security, pensions, unemployment compensation, medical assistance, etc. Contrarily, corporate income tax charges are used for larger expenditures such social upliftment programmes, engineering and construction projects, budgetary projects, etc.
2. Because of the responsibility that businesses have to society and the economy, income tax expenses are especially important. Companies who pay income tax bills on time and in full are seen as being responsible and accountable.

DRAWBACKS OF COST OF INCOME TAXES

The following are a few drawbacks:

1. Deferrals and tax evasion are significant problems for the economy. Investors and stakeholders, however, do not value businesses that avoid paying taxes or postpone paying taxes for prolonged periods of time.
2. The net income that can be attributed to the company’s shareholders is lessened by income tax expenses. Additionally, taxes on international corporations vary depending on the country. This can occasionally lead to unequal rivalry between companies in various regions.

CONCLUSION

For a given accounting period, such as an annual, quarterly, or monthly term, income tax expenses are recorded. Tax expenses for both individuals and small enterprises can be calculated with ease. However, due to the complexity of taxation, it can occasionally be challenging to compute corporate taxes, necessitating the use of taxation specialists by businesses.

Income taxes are classified as expenses on a company’s income statement, but unpaid income taxes are shown as income tax payable on the balance sheet. For instance, let’s say a business deducts $500,000 from EBT for taxes that need to be paid even though the real amount owed is just $475,000. In this scenario, the business will report a deferred tax liability of $25,000.