Is income tax an operating expense?
Income tax is a non-operating expense because it’s based on profit, not business activity. It’s recorded below operating income and is not deductible as a business expense on the company’s own tax return.
What is income tax in accounting?
Income tax represents the amount a business owes to federal, state, or local governments based on its taxable income. It’s calculated after accounting for all revenue, operating expenses, and non-operating items. Because it depends on profitability rather than business activity, it’s excluded from operating costs, which reflect ongoing operational performance.
How to categorize income tax
- Record as a Non-Operating Expense on the income statement.
- Use an “Income Tax Expense” account separate from “Operating Expenses.”
- Include federal, state, and local income taxes owed by the business.
- Do not include payroll taxes, property taxes, or sales taxes (those are operating expenses.)
- Record deferred tax liabilities or assets on the balance sheet if income is recognized in different periods for accounting vs. tax purposes.
Examples of income tax expenses
- Federal corporate income tax.
- State or local business income tax.
- Estimated tax payments made during the year.
- Deferred income tax adjustments.
- Franchise taxes based on net income.
Tax implications for income tax expenses
- Business income tax payments are not deductible on the business’s own income tax return; they represent the company’s tax liability, not an expense that reduces taxable income.
- Other business-related taxes (e.g., payroll tax, property tax, sales tax) are deductible as operating expenses.
- For pass-through entities (sole proprietorships, partnerships, S-corps), income tax is paid by the owners personally, not by the business.
- Track estimated and final tax payments separately from other expenses for accurate financial reporting.
- Include all income tax activity in the Non-Operating section of your financial statements
