Income tax expense is the amount of income tax that a company or an individual owes to the government in a given period. It is one of the most important items on the income statement, as it affects the net income and the earnings per share of the company. In this blog post, we will explain what income tax expense is, how to calculate it, and why it matters for financial decision-making.

How to Calculate Income Tax Expense

Income tax expense can be calculated by multiplying the taxable income by the effective tax rate. The taxable income is the income that is subject to taxation, after deducting all the allowable expenses, deductions, exemptions, and credits. The effective tax rate is the average rate of tax that is paid on the taxable income, taking into account the different tax brackets and rates that apply to different levels of income.

The formula for income tax expense is:

Income Tax Expense=Taxable Income×Effective Tax Rate

For example, let’s say that a company has $500,000 in revenue, $300,000 in expenses, and $50,000 in depreciation. The company also has a tax loss carryforward of $100,000 from the previous year, and a tax credit of $10,000 for research and development. The company’s taxable income is:

Taxable Income=500,000−300,000−50,000−100,000+10,000=60,000

Assume that the company’s effective tax rate is 25%. The company’s income tax expense is:

Income Tax Expense=60,000×0.25=15,000

Why Income Tax Expense Matters

Income tax expense is a crucial measure of a company’s profitability and performance, as it reduces the amount of income that is available to the shareholders. A high income tax expense indicates that the company has a high taxable income, which may be a sign of a successful and profitable business. However, it also means that the company has to pay a large portion of its income to the government, which may reduce its cash flow and growth potential. A low income tax expense indicates that the company has a low taxable income, which may be a sign of a struggling or unprofitable business. However, it also means that the company has to pay a small portion of its income to the government, which may increase its cash flow and growth potential.

Income tax expense is also an essential input for many financial analysis tools and techniques, such as:

• Income statement: Income tax expense is the fourth and final line item on the income statement, as it determines the net income and the earnings per share of the company.
• Financial ratios: Income tax expense is used to calculate various financial ratios that measure the profitability, efficiency, and performance of the company, such as net margin, return on sales, return on assets, and return on equity.
• Financial forecasting: Income tax expense is the starting point for projecting the future income and cash flows of the company, based on historical trends, market conditions, and growth assumptions.

Conclusion

Income tax expense is the amount of income tax that a company or an individual owes to the government in a given period. It is calculated by multiplying the taxable income by the effective tax rate. Income tax expense matters for financial decision-making, as it affects the net income and the earnings per share of the company, and influences the income and cash flows of the company.