# Taxable Income

### Types of Income Calculations The terms revenue, income, and profit have distinct meanings within the accounting profession; calculating these figures is the basis for determining taxable income.

Income taxes are calculated based on income. There are a variety of types of income; therefore, the accounting profession uses a variety of synonyms for the term income. The terms revenue, profit, and income are often used interchangeably by laypeople, but tax accountants see these as very different quantities. When a business earns money from sales, this money is entered as revenue, or net sales or total receipts. Profit is the amount left over from total receipts or revenue once total cost (however defined) is subtracted. Some calculations include gross profit, sales minus the cost of goods sold, or gross margin, the total amount received from gross profit divided by sales.

From gross profit, other expenses are subtracted, such as all the expenses that are not direct business costs. Expenses include operating expenses to cover fixed and overhead costs and may include costs for financing and investments. If the expenses, except for interest expenses and taxes are used, the calculation results in the earnings before interest and taxes (EBIT), or the profit associated with operations. The EBIT is considered an important calculation for investors and business managers.

Gross profit minus expenses results in the net income before taxes. Net income is the receipts remaining after all expenses have been deducted. For many businesses, this is also the taxable income, or revenue minus deductible expenses, which is the amount on which the tax liability will be calculated. In its simplest form, the tax liability is calculated based on net income before taxes. Subtracting the tax liability from the taxable net income produces a net profit, or earnings after taxes. This figure is also popularly called profit or the bottom line.

### Calculating Tax Base The tax base will define how much money a company will need to pay, and it is linked to the information found on the income statement.

The tax base is the total income and assets on which the tax rate will be applied to determine the tax liability. A company's tax liability is the tax base times the tax rate. In the income tax context, taxable income is the tax base. In the United States, at the federal level, the Internal Revenue Service (IRS) is the taxing authority. Not all of the taxes levied are income taxes. The IRS is also responsible for many other types of taxes, such as gift taxes, estate taxes, and excise taxes. All of these tax forms require the calculation of the tax base. For a corporation, the form is 1120. There are varied tax rates that are levied against taxable income and the tax base for the various types of taxes. It is imperative that companies apply the correct IRS tax rate from these various tax categories to ensure that all tax liabilities are captured. This can be done by conducting research within IRS guidelines and laws.

As an example for income tax rates, the most straightforward way to calculate effective tax rates is to divide the income tax expenses by the earnings (or income earned) before taxes. If a company earned $250,000 and paid$50,000 in taxes, the effective tax rate can be calculated by dividing the taxes by the company earnings. In this situation the tax rate is calculated to be 20 percent.
$\frac{\50{,}000}{\250{,}000}=\;0.20\;{\text{or}}\;20\%$
Focusing solely on income, the tax base is calculated starting with gross receipts. From the gross receipts, any allowances or returns are deducted. Cost of goods sold is subtracted and results in the gross profit. Atypical income, or income that is not expected from year to year, is added to this figure. Some examples of atypical income are interest earned, rent, and royalties. The result is total income.

Next, after the income, tax deductions are listed. A tax deduction is a reduction to taxable income, which in turn reduces the tax base. Tax deductions include expenses broken down into approximately a dozen inclusive categories. The total income minus the total deductions results in the taxable income, which is the tax base.