Tax expense

From Wikipedia, the free encyclopedia

Tax expense was computed in earlier years by multiplying the income before tax number, as reported to shareholders, by the appropriate tax rate. The computation was made more complex by the range of tax rates applicable to various levels of income. This approach used the revenue-expense method in which the income statement was seen as primary and the balance sheet as secondary. Today, as described below, tax expense is the result of computing current and deferred tax payable using the asset-liability method in which the balance sheet is seen as primary and the income statement as secondary. The new approach in the United States was codified in SFAS 96 published in December 1987.

Current tax payable is computed by multiplying the taxable income number, as reported to the tax authorities, by the appropriate tax rate. As with tax expense, the computation is made more complex by the range of tax rates that are applicable to various levels of income and the various deductions and adjustments that the tax authorities allow.

In the United States and elswhere, companies are permitted to report one pre-tax income number called income before tax to shareholders and another called taxable income to the tax authorities, the IRS in the case of the US. The result is a gap between tax expense computed using income before tax and current tax payable computed using taxable income. This gap is known as deferred tax. If the tax expense exceeds the current tax payable then there is a deferred tax payable; if the current tax payable exceeds the tax expense then there is a deferred tax receivable.

In the long run, income before tax and taxable income are equal. If the one is less in earlier years, then it will be greater in later years. Deferred taxes will reverse themselves in the long run and in total will zero out. A deferred tax payable results from a tax break in the early years and will reverse itself in later years; a deferred tax receivable results from more taxes being paid in early years than the tax expense reported to shareholders and will again reverse itself in later years. The deferred tax amount is computed by estimating the amount and the timing of the reversal and multiplying that by the appropriate tax rates. Again, the computation is made more complex by the range of tax rates applicable to varoius levels of income.