Income Tax Expense: What It Is and How It Works

income tax expenseThere are some words in the English language that just aren’t fun. Tax is one of them. Have you ever seen anyone get excited about paying taxes? We didn’t think so.

One of the reasons for this is because tax tends to bring a few negative things to mind. When tax season rolls around, there’s tons of paperwork, the processes are complicated, and there’s a whole bunch of jargon for different situations.

Fun or not, at the end of it all everyone has to pay them. From the Latin word taxo, meaning “rate”, taxes are charges that the state imposes. If you don’t pay them, it’s punishable by law. Since you can’t avoid them, then why not understand them a bit better? This article goes through the basics of taxation and helps you better understand the income tax expense.

And if you need help preparing your taxes, this income tax course is a great option.

Why Do We Even Have Taxes?

The government has to pay for a lot of things. The armed forces, public schools, roads, and hospitals are all funded by the taxes we pay to them. The government takes funds from its people so they have enough money and resources to run the country well.

Not every government does it the same way, as there are many different kinds of tax methods they can use. The most common method is what we will focus on here. Practically every government uses it — they deduct a percentage of everyone’s income to fill up the country’s coffers. This is called the income tax.

The Income Tax Expense

Everyone who earns is subject to the income tax. Whether we like it or not, we all have to report and give part of our income to the government. Some organizations like churches and charities are exempt from this type of tax, but they still have to file a record of their income each year.

The income tax expense is the amount that a company or person owes the government, based on standard business rules. For companies, this is slightly tougher to calculate, and they have to report this expense on their income statement. The general way to get it is simply by multiplying the right tax rate by your taxable income.

Most countries have a progressive income tax system, which means that as your income grows, you’ve got to pay a higher percentage of tax. Income includes wages, dividends, investment profits and rent, but gifts or inheritances aren’t part of it. Don’t worry, you don’t have to pay for every little thing that you own!

The GAAP and Taxable Income

You’ll know which tax rate applies to you through the methods that your country’s internal revenue department details. The GAAP, or Generally Accepted Accounting Principles, also helps. These are accounting standards that tell you how to present your financial information, and how much of your income is actually taxable.

Yes, there’s a reason for all the complex forms we have to go through come tax season. It’s important to know exactly which things are taxable, because otherwise you might end up paying more than you should.

The amount the government can take from is called your taxable income. For businesses, taxable income is usually the profits related to operations. Interest income, capital gains from selling long term assets, and dividend income are taxable as well.

Tax Deductions: Smaller Pizza, Smaller Tax

Sometimes, if you make specific types of expenses, you get to remove a tax deduction from your pre-tax income. These expenses are the ones with societal benefits, like charitable donations and expenses that improve the environment. Tax deductions make the final expense smaller, because you’re multiplying the tax rate to a smaller gross income.

Think of it like this: every time you eat a pizza, you have to give 2 slices to the government as tax. If the pizza you ordered is extra large, the 2 slices that the government gets is pretty big. If the pizza’s just a medium, you still give 2 slices, but they’re smaller than if you got an 18-inch.

Learn about how your kids can earn you a deduction by taking this course. Or you have your own business, see how to turn your business expenses into a tax break.

Information is Power

Every region has it’s own Tax Code that details how to calculate your income tax, which tax deductible expenses they recognize, etc. Most people who don’t know their own Tax Code end up paying more than they should, and can be taken advantage of by unscrupulous “accountants”. If you’re Canadian, use this course to get up to speed on how your income tax works.

At the end of the day, if you understand the reason behind the government collecting taxes, it’ll be easy for you to recognize what’s actually valid and what isn’t. Remember, information is power. This blog post will give you even more helpful tax advice, so make sure you give it a read.