What is Income Tax Expense?
Income tax expense is the amount of tax that a company owes on its taxable income for a given period. It is calculated by applying the applicable tax rate to the company’s taxable income.
Income tax expense is a significant expense for many businesses, and it is important to accurately calculate and record it in the company’s financial statements. The income tax expense is reported on the income statement and is used to determine the company’s net income (or net loss) for the period. The income tax expense is also used to calculate the company’s effective tax rate, which is the overall rate of tax that the company pays on its taxable income. This information is useful for both internal decision-making and external reporting to stakeholders such as shareholders and investors.
Income tax expense is typically recorded in an accrual accounting system, which means that the expense is recognized in the period in which it is earned or incurred, rather than in the period in which it is paid. This is because the income tax expense reflects the company’s liability to the government, rather than the actual cash outflow.
Journal Entries for Income Tax Expense
To record income tax expense, you will need to make a journal entry that includes a debit to income tax expense and a credit to income tax payable. The income tax expense represents the amount of tax that the company owes for the current period, based on its taxable income. The income tax payable account represents the amount of tax that the company has not yet paid to the government.
The income tax expense and income tax payable accounts will be reported on the income statement and balance sheet, respectively. The income tax expense will reduce the company’s net income for the period, while the income tax payable will increase the company’s liabilities.
Example: ABC Corp. earned net income of $500,000 before tax during its fiscal year. With an effective income tax rate of 25%, ABC Corp. will recognize $125,000 of income tax expense.
| Account | ||
|---|---|---|
| Income tax expense | $125,000 | |
| Income tax payable | $125,000 |
Journal Entries for Income Tax Payments
Income tax installments, also known as prepaid taxes, are payments made by individuals or companies to the government in advance to cover their estimated income tax liability for the current fiscal year. These installments are usually mandatory for companies that expect to owe a certain amount of tax for the year. They are based on the estimated tax liability for the year, and are typically paid quarterly or as otherwise specified by the tax authority. Failing to make adequate tax installments throughout the year can result in penalties and interest charges.
When the taxpayer files their tax return, their actual tax liability is calculated based on their income, deductions, credits, and other relevant factors. The total amount of tax installments paid over the year is compared to the actual tax liability to determine whether the taxpayer has overpaid or underpaid their taxes.
Example: ABC Corp. makes a $50,000 tax installment payment each quarter, paid to the central taxation authority.
| Account | ||
|---|---|---|
| Income tax payable | $50,000 | |
| Income tax cash | $50,000 |
