Understanding "Income Before Tax" on an Income Statement
And How Corporate Income Taxes Come Into Play
One of the most important lines to understand on an income statement is "income before tax." After deducting interest payments, and depending on the business and other expenses, you are left with the profit a company made before paying its income tax bill. This figure allows you to see what the business would have earned if it did not have to pay taxes.
The Utility of Income Before Tax
Over time, income before tax can be a particularly useful metric, especially if you examine it not in isolation by looking at a single year, but rather throughout the entire business cycle when compared to either total sales, tangible assets, or shareholders' equity. This is because income tax laws change from time to time depending on many economic, social, and political factors, which can cause after-tax income to fluctuate in a way that does not always indicate the economic engine a business has going under the hood.
Income before taxes, on the other hand, should be much more consistent. You will want to look at a firm's long-term income before taxes figure relative to those three items and put it side by side with other companies in the same sector or industry to fully understand its performance, because certain industries tend to outperform other industries by this metric, so making an apples-to-apples comparison is of particular importance for this type of analysis.
Income Tax Expense on the Income Statement
The income tax expense is the total amount the company paid in taxes. This figure is frequently broken out by source (federal, state, local, etc.) either on the income statement or somewhere in the annual report or Form 10-K filing.
You should be familiar with the tax laws affecting specific companies and/or business transactions. For instance, say the business you were analyzing purchased $100 million worth of preferred stock that, at the time of acquisition, boasted a dividend yield of 9 percent. You could rightly assume the company would receive $9 million a year in dividends on that preferred stock. If the company had a tax rate of, for example, 35 percent, you may assume that $3.15 million of these dividends are going to be paid to Uncle Sam.
In truth, corporations get an exemption on 70 percent of the dividends they receive from preferred stock, an advantage that individual investors do not enjoy. Because of this advantage, only $2.7 million of the $9 million in dividends would be subject to taxation.
While corporate tax rates in the United States have varied greatly over time, and were most often progressive taxes (tax "brackets" in which tax rates go up as a corporation's taxable income rises), as of January 1, 2018, the corporate tax rate is now a flat tax with a rate of 21 percent on all earnings of one dollar or more. Keep in mind that certain businesses risk triggering additional, special taxes, such as those levied on holding companies organized as classic C-corporations.