Income Tax Payable

Income tax payable is a financial accounting term used to describe the amount of tax liability on the income a company has towards the government. But, of course, this income cannot be calculated without measuring the business's profitability. 

It is determined using the company's profits and applicable tax rates. The rate of taxation is found by the prevailing corporate tax rate in the nation of operation.

"But why do they have to get a chunk of their earnings and pay them as taxes?"

The profits and earnings a corporation pays in taxes are a way to give back to the government, helping it facilitate operations and provide goods, services, and funds to the nation's people.

It is classified as a current liability on the balance sheet since it is usually due to the government within 12 months. However, if it were due more than a year away, it would be classified as a long-term liability.

Once the tax is paid, the liability found in the balance sheet is gone. These taxes can be paid to the government in numerous ways. They are generally paid to the applicable federal, state, or municipal governments where the company is located. 

Nevertheless, to calculate the taxes that need to be paid, the reported earnings found in the financial statements are not the only thing to look out for. With the help of some adjustments due to tax law, your total tax liability can be reduced. 

Benefits of paying

Paying one's income tax payable provides numerous benefits such as avoiding penalties, facilitating the option to apply for any financial help, and increasing social security payments.

It is also with the help of the taxes paid that a government can help fund infrastructure projects and even business subsidies. Not to mention launching public welfare schemes that can benefit a person's health, education, and housing, improving the economy overall.

How to calculate

Formula

The tax to be paid out of the income earned is the amount of money owed to the government. Therefore, the amount is present under the current liability category on the balance sheet rather than the income statement.

Although there is no definite formula for income tax payable, based on accounting standards, the income tax expense is:

Income Tax Expense = Taxable Income x Tax Rate

There is still a set path to follow to figure out the income tax payable on the balance sheet.

1. Add all the values of the different taxes to be paid, such as income and social security taxes.
2. Ensure that the employer's contribution is included in those balances.
3. Add the total amount to the sales tax payable account, other local taxes, and state income tax.

Example

To further illustrate an example of how to calculate income tax payable, suppose a company in 2022 reported the following:

• Revenue for the year is $96000
• Expenses are $40000

→ Pre-tax income = Revenue - Expenses = $96000 - $40000 = $56000

• The tax rate is 20%

→ Income tax expense = pre-tax income * tax rate = $56000 * 20% = $11200

Suppose an additional month of revenue of $8000 got added to the total revenue:

• Revenue would then be $104000
• Expenses stay the same at $40000

→ Pre-tax income = Revenue - Expenses = $104000 - $40000 = $64000

• The tax rate is 20%

→ The income tax payable would then be $12800

To record the journal entries, the company must:

• Debit the income tax expense account with $12800
  • Credit the income tax payable account with $12800

When the company later pays the tax, it must:

• Debit the income tax payable account with $12800
  • Credit the cash account with $12800

Income Tax Payable vs. Income Tax Expense

While they may seem similar and confusing, they differ in multiple ways.

Income tax payable means a liability that has yet to be paid to the government. Hence, it appears on the balance sheet under the liabilities section and is counted as a current liability due within 12 months. 

Once this tax is paid, the liability is gone from the balance, and the journal entry is recorded as debit income tax payable and credit cash.

Income tax expense, however, is classified in a different sense. Income tax expenses show the amount the company pays in taxes based on its calculations during a specific accounting period. 

These expenses are present in the income statement between the pretax income and net income. They are used to get the net income by performing the following calculation: 

Pretax Income - Taxes = Net Income

Furthermore, these expenses should be shown directly in the period they were incurred, meaning they must be recorded on the date the transaction takes place rather than the date the transaction was paid.

Hence, income tax expense is the tax charged against taxable income in the current period.

Written and researched by Jad Shamseddine | Linkedin

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accounts Receivable Turnover Ratio
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• Nash Equilibrium
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