Between year-end and the tax filing deadline, a business might know it owes a certain amount of income taxes, even if it hasn’t sent the payment.
To keep track of this obligation, the company needs to record income tax payable on its balance sheet.
In this article, we’ll cover what income tax payable is, how to calculate it, and how it’s recorded on a company’s financial statements.
What is income tax payable?
Income tax payable is the tax that a business is obligated to pay based on the profits it has earned but has not yet paid.
Depending on where the business is located, it may owe income taxes at the local, state, and federal levels, impacting the total amount they need to pay.
The amount owed is recorded as a current liability on the balance sheet, since it is a debt that the company must pay in less than a year.
Of note, income taxes are separate from any self-employed taxes a sole proprietor or LLC member might owe.
How to calculate income tax payable
Calculating a company’s income tax payable depends on a number of factors, including where the business is located, how much taxable income it earns in a given period, and the effective tax rate it is subject to.
To help illustrate how it works, here’s a step-by-step process for calculating income tax payable, with some examples using sample data.
Step 1: Calculate the Earnings Before Tax (EBT)
First, find or calculate the company’s earnings before tax (EBT). It may be already listed on the company’s income statement, or it can be determined with the following series of calculations:
EBT = Revenue – COGS – SG&A Expenses – Dep. & Amort. Expenses – Int. Expense
Let’s say a company recorded the following for a given year:
- Revenue: $1,200,000
- COGS: $650,000
- SG&A Expenses: $250,000
- Depreciation & Amortization: $75,000
- Interest Expense: $25,000
In this case, its EBT would be $200,000.
Step 2: Determine the Tax Rate
Next, the company needs to assess the income tax treatment it will receive at the local, state, and federal levels.
If the company in the above example is a corporation in California, it would be subject to the following tax rates on its income:
- Federal corporate tax: 21%
- California corporate tax: 8.84%
Based on these figures, the company’s combined effective tax rate would be 29.84%.
Step 3: Calculate the Income Tax Payable
Using the tax rate identified in the previous step, calculate how much the company owes by multiplying this value by the EBT.
For the company in our example, the calculation would be as follows:
Tax expense = $200,000 * .2984
= $59,680
Until the company sends this payment to the tax authorities, it will be recorded as a liability (income tax payable) on the balance sheet.
Recording income tax payable in financial statements
Under accrual-based accounting, a company needs to record expenses when they are incurred, not necessarily when payment is made. This includes income tax expenses on a business’s income in the period that it’s earned.
Thus, even though the tax filing deadline for a given year isn’t until the following April, the company must still record the income tax expense they’ve incurred during that period. This is reflected on the income statement, impacting the company’s bottom line.
However, since the company won’t make the payment until a few months later, it will need to record this amount as a payable on the balance sheet.
Using the figures from the above example, here is how the company would record its income tax expense at the end of the year:
Then, when the company files its tax return and sends a payment to the IRS, the liability is reduced, along with the cash balance. This is the accompanying journal entry:
Payment options for income tax payable
Businesses must pay their income tax liability to relevant tax authorities by the filing deadline.
For annual tax returns, the deadline is typically April 15, unless it falls on a weekend or holiday.
The IRS accepts a few different payment methods for federal income taxes, including:
- Direct Pay from the business bank account
- Credit card
- Debit card
- Digital wallet
- Same-day bank wire
- Check
- Money order
- Cash
Acceptable payment methods for state income taxes can vary from state to state.
If the business misses the payment deadline, it may be subject to fines and penalties, on top of the taxes it owes.
Even if the company requests an extension for filing, it still must pay what it expects to owe by the federal deadline to avoid additional fines.
Common challenges with income tax payable
Calculating and managing income taxes payable can come with certain challenges. Here are some potential hurdles to be aware of:
Understanding income tax payable vs. deferred tax liability
Businesses may notice both income tax payables and deferred tax liability on the balance sheet, which can create some confusion.
While both are liabilities, there are some key differences between the two.
Tax payables are taxes that the business currently owes on its earnings, to be paid by the next filing deadline.
On the other hand, deferred tax liabilities stem from differences in income recognition between GAAP requirements and tax laws. It represents a tax liability that the company knows it will owe in the future, but not necessarily in the current year. As such, it may be a short-term or long-term liability.
Calculation errors
Another potential challenge is that the business unknowingly makes an error in its income tax calculations, resulting in a reporting error.
Maybe the team misunderstood its effective tax rate, or didn’t properly calculate its taxable income.
Either way, when it comes time to prepare and file the tax return, the company may notice the error, and need to make adjustments to its financial records.
Navigating deductions and credits
Businesses may be eager to maximize deductions and credits to minimize their tax liability.
However, it’s important for businesses to adhere to the tax code and IRS guidelines to stay compliant.
If its found that they were overzealous with deductions and underpaid taxes, they may owe the IRS back taxes, in addition to potential penalties and fines.
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Frequently asked questions
What are income taxes payable?
Income taxes payable are the taxes a company owes on its earnings for a given year, but has not yet paid to the government.
Is income tax payable a current liability?
Yes, income tax payable is considered a current liability, since it must typically be settled in one year or less. As such, it’s a short-term liability, not long-term.
How do you calculate income tax payable?
Income tax payable is calculated by multiplying the company’s taxable income for the year by its effective tax rate.
Is sales tax payable a current liability?
Similar to income tax payable, sales tax payable is also a current liability. It represents the amount of tax that the company has collected on transactions that are subject to sales tax, but has yet to remit to the relevant taxing authorities.
