What is a tax charge?
A tax liability is a liability owed to federal, state/provincial, and/or municipal governments over a period of time, typically within a year.
Tax charges are calculated by multiplying an individual or company’s appropriate tax rate by the income received or generated before taxes, after taking into account variables such as non-deductible items, tax assets and tax liabilities.
Tax expenditure = effective tax rate x taxable income
Key points to remember
- Tax charges are the total amount of taxes owed by an individual, company or other entity to a taxing authority.
- The income tax expense is obtained by multiplying the taxable income by the effective tax rate.
- Other taxes may be levied on the value of an asset, such as property or estate taxes.
Understanding the tax burden
The calculation of the tax burden can be complex since different types of income are subject to certain levels of taxation. For example, a company must pay payroll tax on wages paid to employees, sales tax on certain asset purchases, and excise tax on certain goods.
In addition to the range of tax rates applicable to different levels of income, the different tax rates in different jurisdictions and the multiple levels of income taxation also add to the complexity of determining an entity’s tax liability. . Determining the appropriate tax rate and identifying the correct accounting policies for items affecting one’s tax burden are carefully described by tax authorities such as the Internal Revenue Service (IRS) and GAAP/IFRS.
Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) provide for a certain treatment of income and expense items which may differ from the provision authorized by the applicable tax code.
This means that the amount of tax expense recognized is unlikely to exactly match the standard income tax percentage applied to business income. In other words, differences in financial accounting and tax code may result in a different tax charge than the actual tax bill.
For example, many companies use straight-line depreciation to calculate the depreciation reported in their financial statements, but are permitted to employ a form of accelerated depreciation derive their taxable profit; the result is a lower taxable income figure than the reported income figure.
Tax expense affects a company’s net profit since it is a liability that must be paid to a federal or state government. The expense reduces the amount of profits to be distributed to shareholders as dividends.
This is even more disadvantageous for the shareholders of C-Corporations who again has to pay taxes on the dividend received. However, a tax expense is only recognized when a company has taxable income. If a loss is recognized, the company can carry forward its losses to future years to offset or reduce future tax expenses.
Tax expenditure vs tax payable
Tax expense is what an entity has determined to be owed in taxes based on the company’s standard accounting rules. This charge is declared on the income statement. The tax payable is the actual amount due in taxes according to the rules of the tax code. The amount payable is recorded on the balance sheet as a liability until the company settles the tax bill.
If the tax expense is greater than the tax payable, the difference creates another liability, called deferred tax liability, which will have to be paid at some point in the future. On the other hand, if the tax payable is greater than the tax expense, the difference creates an asset class, called deferred tax asset, which can be used to settle any future tax liability.