This post provides a brief overview of computing the effective tax rate and how certain business deductions/credits can significantly reduce the Effective Tax Rate to maximize business tax incentives. For a complete overview, tune in to the NSA Webinar Tomorrow.
How to Compute the Effective Tax Rate:
The Effective Tax Rate (ETR) demonstrates how a corporation’s actual tax rate relates to a “hypothetical tax rate” which is the tax the company would pay if there were no permanent differences.
A multinational corporation reduces its effective tax rate when a portion of its world-wide income is taxed in non-US tax jurisdictions.
Note: “Permanent Investment” exception: Income not taxed until it is repatriated as dividend income.
A domestic corporation can reduce its effective tax rate by excluding certain types of income from taxation, such as tax-exempt interest income, by deducting non-cash expenses, such as the dividends received deduction and the domestic production activities deduction, and by claiming business tax credits, such as the research activities tax credit.
Tax Rate Reconciliation
Computation and Reconciliation of the Income Tax Provision with a Company’s Hypothetical Tax Provision, ASC 740 requires a company to reconcile its:
- Reported income tax provision attributable to continuing operations with
- Amount of income tax expense that would result from applying its U.S. statutory tax rate to its pretax net income or loss from continuing operations.
The tax rate that backs out one-time and nonrecurring (discrete) events is referred to as the company’s structural tax rate. It is often is viewed as more representative of the company’s effective tax rate from its normal (recurring) operations.
The cash tax rate is used by analysts to compute a company’s tax status excluding deferred taxes. Computed by adjusting the Tax Expense on the Financial Statements by changes in taxes payable.
See example below:
For more information on tax minimization strategies, including a full overview of major deductions/credits, tune in for tomorrow’s NSA Webinar:
Maximizing Business Tax Incentives to Reduce the Effective Tax Rate
Wednesday, Sept. 21, 2:00pm – 4:00pm EST
IRS CE: 2 Hours Federal Tax Law / NASBA CE: 2 Hours Taxes
In this course, we will cover:
- Understanding the difference between a tax deduction and a tax credit.
- How to compute the effective tax rate and how certain business deductions/credits can significantly reduce the ETR
- How the Domestic Production Activities Deduction can reduce your ETR by up to three percentage points.
- You will be given a summary of the various business tax credits and will learn which credits can significantly reduce your ETR.
- Research & Experimentation Credit
- Work Opportunity Credit
- Credits targeted to specific business investment activities.
- Learn about the documentation required by the IRS to claim these tax incentives.
- Get a better understanding of what questions you should be asking of your Tax Director
More information can be found here.