The formula to determine income tax expense is: O income before income tax expense (from the income statement) multiplied by the income tax rate. O income before income tax expense (from the tax return) multiplied by the income tax rate. taxable income (from the income statement) multiplied by the income tax rate. O taxable income (from the income tax return) multiplied by the income tax rate.
The Correct Answer and Explanation is:
Correct Answer: ✅ Taxable income (from the income tax return) multiplied by the income tax rate.
Explanation
The correct formula to determine income tax expense is:
Income Tax Expense = Taxable Income (from the income tax return) × Applicable Tax Rate
This is because income tax expense is calculated based on taxable income, not accounting income.
Here’s why:
In financial accounting, the income statement reports accounting income (also known as income before income tax or book income), which is calculated according to Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). However, this figure is not directly used to compute taxes owed.
The tax return, on the other hand, is prepared according to tax laws, which often differ significantly from accounting rules. For example, tax authorities may require different methods of depreciation, disallow certain expenses, or include/exclude income items differently. These differences create temporary or permanent differences between book income and taxable income.
Because of this, the IRS (or relevant tax authority) uses taxable income (which comes from the tax return) to determine how much income tax a company actually owes. The income tax expense recognized on the financial statements reflects the total tax obligation for that period, which includes:
- Current Tax Expense – based on taxable income from the tax return.
- Deferred Tax Expense/Benefit – arising from temporary differences between accounting income and taxable income, recorded in accordance with accounting standards (e.g., ASC 740 in U.S. GAAP).
Therefore, the most accurate base for computing income tax expense is taxable income from the tax return, because this is what determines how much tax is legally owed.
In summary, using accounting income from the income statement would misrepresent the actual tax obligation due to differences in rules. The tax return provides the true basis for calculating current tax payable, making it the correct source for determining income tax expense.
