What is the Effective Tax Rate?
The Effective Tax Rate represents the share of a corporation ’ s pre-tax income that was actually paid out in the human body of taxes .
In This article
- What is the definition of the effective tax rate?
- Which formula calculates the effective tax rate?
- What is the difference between effective tax rate and marginal tax rate?
- Why are the effective tax rate and the marginal tax rates rarely the same?
effective Tax Rate Definition
The effective tax rate refers to the actual taxes paid by a corporate and is peer to the taxes paid divided by the pre-tax income.
Reading: Effective Tax Rate
Since there is a difference between the pre-tax income reported on the financials as train following accumulation account standards and the taxable income reported on tax filings, the effective tax rate much differs from the borderline tax rate .
The effective tax rate can be calculated for historic periods by dividing the taxes paid by the pre-tax income, i.e. earnings before tax ( EBT ) .
effective Tax Rate Formula
- Effective Tax Rate = Taxes Paid ÷ Pre-Tax Income
Apple Effective Tax Rate Example Calculation
The channel items with the taxes paid and pre-tax income can be found on the income statement, as shown in the trope downstairs .
Apple Pre-Tax Income and Income Taxes ( Source : AAPL 10-K )
From fiscal year 2019 to 2021, Apple ’ s effective tax rate can be calculated using the following formula :
- 2019: $10,481 million ÷ $65,737 million = 15.9%
- 2020: $9,680 million ÷ $67,091 million = 14.4%
- 2021: $14,527 million ÷ $109,207 million = 13.3%
effective Tax Rate vs Marginal Tax rate
The taxes paid by a caller based on the accrual-based income argument rarely matches the actual cash taxes paid to the IRS .
The effective tax pace is the actual percentage of taxes paid by a ship’s company based on its pre-tax income, whereas the fringy tax rate is the rate charged on the last dollar of income .
The bare tax rate is the tax income percentage applied to the last dollar of a company ’ mho taxable income, with the pursuit factors considered :
- Jurisdiction-Specific Statutory Tax Rate
- Federal Income Tax Brackets
The borderline tax rate adjusts according to the tax bracket under which the company ’ s profits twilight, i.e. the tax pace changes as the company earns more ( and moves into higher tax brackets ) .
The incremental, “ marginal ” income is then taxed at the corresponding bracket, rather than each dollar of income being taxed at the same fixed rate .
Causes of Effective and Marginal Tax Rate Differences
In practically all cases, there is a remainder between the pre-tax income displayed on the income statement and the taxable income as shown on the tax filing .
consequently, the effective and bare tax rates are rarely equivalent, as the effective tax rate recipe uses pre-tax income from the income argument, a fiscal statement that abides by accumulation accountancy .
typically, the effective tax pace is lower than the fringy tax pace, as most companies are incentivized to defer paying the government.
Under US GAAP report, most companies follow different account standards and rules for fiscal report vs. filing tax reports, as the subsequent sections will explain in more contingent .
Depreciation GAAP vs Tax accounting
submit tax liabilities ( DTLs ) stem turn from temp time differences related to GAAP/IRS accounting .
One argue the borderline and effective tax rate often differs is related to the concept of depreciation, the allotment of capital outgo ( CapEx ) across the fixed asset ’ sulfur useful life .
- Financial Reporting: Most companies elect to use straight-line depreciation, in which the PP&E is reduced in value by equal amounts each year.
- Tax Filing: The Internal Revenue Service (IRS), on the other hand, requires accelerated depreciation for tax purposes, resulting in deferred tax liabilities (DTLs).
The disparagement expense recorded in earlier periods for tax purposes is greater than the amount recorded on GAAP filings. But these tax differences are impermanent time discrepancies and the accumulative depreciation is the lapp at the goal of the day .
finally, an inflection point is reached in the asset ’ south useful liveliness assumption where the depreciation recorded for tax purposes is lower than the sum stated on the books, i.e. the DTLs gradually reach zero .
net income operate Losses ( NOLs )
many companies incur significant losses in earlier years and receive tax credits that can be applied to later periods once profitable, called net operating passing ( NOL ) carry-forwards .
A profitable caller can apply the previously accumulated tax credits to reduce their amount of taxes in the current and future periods, creating a difference in taxes under ledger and tax account .
write-off Recognition ( Bad Debt / Bad A/R )
If a company ’ randomness debt or accounts receivable ( A/R ) is deemed bad – called “ Bad Debt ” and “ Bad AR, ” respectively – submit tax assets ( DTAs ) are created, which causes differences in taxes .
The write-off is recorded on the income statement as a write-off ; however, it is not deducted from the company ’ randomness tax returns .
Forecasting – Effective or Marginal Tax Rate ?
For a discount cash stream ( DCF ) model, the decision on whether the effective tax rate or borderline tax rate should be used comes down to the terminal value premise .
The company ’ s tax rate is assumed to remain constant into perpetuity beyond the explicit calculate period .
With that said, if a expulsion uses the effective tax rate, the implicit assumption is that the postponement of taxes – i.e. DTLs and DTAs – are expected to be a continuously recurring note detail, as opposed to reaching zero over time .
intelligibly, that would be inaccurate since DTAs and DTLs finally unwind ( and the balance declines to zero ) .
Our recommendation is to evaluate a company ’ s effective tax rate in the by three to five years and then base the near-term tax rate premise consequently.
The effective tax rate can either be averaged if the tax rates are broadly within the like rate or by following the directional drift .
once the constant-growth stage approaches – i.e. the company ’ south operations have normalized – the tax rate assumption should converge to the bare tax rate .