How to Determine the Tax Rate From an Income Statement

how to make pro forma income statement

An income statement is a documentation of a company's revenue, expenses and profit during a specified time period. An income statement helps managers evaluate sales, keep track of various costs and evaluate the company's overall profitability during the year. A company's tax rate isn't specifically listed on the income statement, but you can calculate it using the figures available.

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Marginal Rate Versus Effective Rate

Companies have both a marginal tax rate and an effective tax rate. A company's marginal tax rate represents what tax bracket it falls in. For example, a company may have net income that falls in the 25 percent tax bracket. However, that doesn't mean that the company paid tax on 25 percent of its net income. Because tax rates are graduated, it paid only 15 percent on a portion of the net income. The effective tax rate evens out the brackets and represents the company's average tax rate.

Pre-Tax Income

To estimate a company's tax rate from the income statement, you need to know the company's pre-tax income and income tax expense. Pre-tax income is usually labelled as "income before taxes," "profit before tax" or "earnings before taxes." It's

listed after revenue and expenses but before income from discontinued operations. It's generally about halfway or three-quarters of the way down the income statement.

Income Tax Expense

Income tax expense is the second piece to the tax rate puzzle. Companies with substantial earnings usually can't just wait until the end of the year to pay their income tax bills. Instead, they estimate their income tax based on earnings and make quarterly tax payments to the IRS. You can find this income tax expense on the income statement; it's usually labelled "income tax" or "income tax expense." It's listed directly after pre-tax income. Don't confuse this with a company's provision for income taxes, which is a balance sheet account.

Calculate the Tax Rate

Once you know pre-tax income, you may be tempted to calculate income tax rate using corporate tax rate tables. Don't do this. Although you know income for financial purposes, there's often a significant difference between a company's book income and taxable income. Instead, calcualte the company's effective tax rate by dividing income tax expense by pre-tax income. For example, if income tax is $40,000 and pre-tax income is $150,000 the effective tax rate is 26.7 percent.

Source: ehow.com

Category: Forex

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