How to calculate the provision for income taxes in an income statement


The provision for income taxes in an income statement is the amount of income taxes that a company believes it has to pay in a given year. Typically, this is shown quarterly with each income report on the company’s income statement. Income taxes are paid annually, but businesses will generally pay their estimated tax quarterly.

The final and exact amount of income tax is calculated each year, and the company’s final tax bill may be slightly more or less than the estimated payments made throughout the year. This is similar to the estimated tax deductions paid from an individual’s paycheck each month. At tax time in April, the individual will write a final check or receive a refund to balance the withholdings with the actual income taxes owed.

How companies are doing it versus what matters to investors
The process of calculating estimated income taxes can be quite complex and require a team of accountants. The GAAP accounting rules that dictate how a business should present its financial statements to investors differ from the tax accounting rules required to calculate taxable income. For this reason – and the overwhelming complexity of corporate accounting rules, in general – the typical investor should not be concerned with the methods and processes that accountants use to establish the provision for income taxes.

Instead, investors should focus on how much the company actually pays each year and how that amount compares to that of the company’s competitors. Company management has a fiduciary responsibility to maximize shareholder value; in this case, it means paying the appropriate taxes owed to the government without paying too much.

Investors can find tax information at the bottom of the income statement each quarter and in the annual report. Typically, the “Management Discussion and Analysis” section will also include one or two paragraphs explaining the company’s effective tax rate and taxes paid.

You might not like them, but corporate tax loopholes are legal and businesses should at least consider them
Every now and then a business will make a business decision that is largely driven by a tax strategy. A tech giant may have run a significant portion of its business through a shell company located in Ireland in order to take advantage of that country’s low tax rate. Companies can be incorporated abroad. A company can acquire a rival and move its head office as part of the deal, all in an effort to take advantage of lower tax rates in the rival’s country. This strategy is called a “fiscal reversal”.

The government has cracked down on many of these techniques – Ireland closed the so-called ‘Irish double loophole’ in 2014 – but businesses are going and should consider finding new legal ways to lower their tax rates. The key is for management to maintain an open, honest, and ethical relationship with the IRS, obey the law, and then implement tactics and strategies to minimize taxes. Every dollar saved in taxes is another dollar in profits.

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