- Writing a Business Plan
- Financial Statements
- Business Forecasting
- Business Checklist
BUDGET 14 - DEVELOPING YOUR INCOME TAX RATE & BUDGET
Businesses, like individuals, must pay Income Taxes based on their Taxable Income (IE Earnings Before Tax). Recall from our discussion on the Income Statement, Taxable Income is calculated by subtracting a company's Sales from its Cost of Goods Sold and its Operating Expenses. The Income Tax a company pays is made up of state/provincial tax & federal tax, and is calculated by applying an Income Tax Rate or percentage (%) to a company's Earnings Before Taxes.
Most existing businesses have an accountant calculate their income tax obligation. Individuals not owning a business and who are preparing forecasted financial statements, on the other hand, find it difficult to decide on a tax percentage to apply to their Forecasted Earnings Before Taxes. Since these people are not accountants or tax experts, this seems to be a legitimate concern. However, when preparing forecasted financial statements, many people assume an income tax rate of 30% or 40% if the Forecasted Earnings Before Tax is positive. A 0% tax rate is used if the Forecasted Earnings Before Tax is Zero or negative.
Estimating an Income Tax Rate (tax percentage) and an Income Tax Budget before knowing a company's forecasted taxable income is similar to putting the 'Cart Before The Horse". But that's OK because we are only forecasting. The truth of the matter is, the Income Tax Budget must await preparation of your Forecasted Income Statement, at which time your taxable income and your income tax obligation can be estimated. Therefore, Murray can NOT determine his 200X Income Tax obligation until he has developed his 200X Forecasted Income Statement. Similarly, Murray can NOT determine his 200Y Income Tax obligation until he has developed his 200Y Forecasted Income Statement.
At this stage, however, lets assume Murray decides to apply an Income Tax Rate of 30% if his Earnings Before Taxes turns out to be a Positive value. If Murray's Earnings Before Taxes turns out to be ZERO or a Negative value, he plans to apply an Income Tax Rate of 0%. This is the only requirement for Murray in this Budget. By the way, make sure you decide on WHEN the income taxes will be paid. This is important for your Forecasted Cash Flow Statement (IE a Cash Outflow, illustrating "Payment on Income Taxes").
But as you will later see in Murray's 200X Forecasted Income Statement, his Earnings Before Taxes on December 31, 200X are expected to be a positive $7,829. Therefore, his company's expected Income Tax obligation for 200X would be $2,349 (IE $7,829 Earning Before Taxes x 30% tax rate = $2,349). And as you will also see later in Murray's 200Y Forecasted Income Statement, his Earnings Before Taxes on December 31, 200Y are expected to be a positive $24,761. Therefore, his company's expected Income Tax obligation for 200Y would be $7,428 (IE $24,761 Earning Before Taxes x 30% tax rate = $7,428).
Murray must now decide when he will pay his Company's Income Taxes. Lets assume, Murray plans to pay these taxes in April - the same month in which he pays his personal income taxes. Using this assumption, Murray will pay his 200X Income Tax obligation in April of 200Y. Therefore, Murray's 200Y Forecasted Cash Flow Statement will show a Cash Outflow in April of $2,349 for payment on his 200X's Income Taxes. But until the Income Taxes are paid (in April of 200X), Murray will owe these funds to the Government. Therefore, this money owed (income taxes) to the government is considered a corporate liability and must be recorded as an "Income Tax Payable" on his December 31, 200X Forecasted Balance Sheet.
At the same token, Murray will pay his 200Y Income Tax obligation in April of 200Z. Therefore, Murray's 200Z Forecasted Cash Flow Statement will show a Cash Outflow in April of $7,428 for payment on Income Taxes. But until the 200Y Income Taxes are paid (in April of 200Z), Murray will owe these funds to the Government. Therefore, this money owed (income taxes) to the government is considered a corporate liability and must be recorded as an "Income Tax Payable" on his December 31, 200Y Forecasted Balance Sheet.
Please Note: Murray's 200X Forecasted Cash Flow Statement will NOT show any payment on Income Tax, since his anticipated business start date is July 1, 200X and his scheduled tax payment date is April.
In summary, Income Taxes usually effect three statements; namely, the Income Statement, the Cash Flow Statement, and the Balance Sheet.