# How to Calculate Before Tax Cost of Debt

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Most businesses deduct their paid interest expenses from their taxable income on their income tax returns, allowing them to reduce the actual cost of their company’s debt. But companies sometimes present the after-tax cost of debt without acknowledging the before-tax cost. That may be effective for the current year, but the company could lose the tax benefits and have to pay full cost without receiving those tax benefits if the tax code changes going forward.

You’ll, therefore, need the before-tax cost of debt as well. You must identify the after-tax cost of debt and the income tax rate for the company in question to accurately calculate the before-tax cost.

## Before-Tax Debt vs. After-Tax Debt

Taxes have a significant impact on the financial health of a company, so debts are typically divided into two categories: before-tax and after-tax. Before-tax debt doesn't take taxes into consideration. The after-tax cost of debt does. The after-tax cost of debt formula is effectively the amount of interest paid minus tax-deductible annual interest.

The after-tax cost is more representative of the company’s cost of debt because interest payments and a company’s total interest expense are usually tax deductible, according to the CFA Institute. After-tax cost of debt accounts for tax savings.

## You'll Need Debt Data

You'll need information on the specific debt and the company’s current tax rate to get started with your cost of debt formula. Often this information is well documented in a company's financial statements. You can sometimes pull the information you’ll need directly from these statements because they'll reflect the exact interest the company paid on their debts in a given timeframe rather than an average interest rate.

You may also be able to pull the information from a business's cash flow statements because they'll often detail pretax money movements there. The after-tax metrics can be saved for their income statements.

## Calculating Before-Tax Debt

Divide the company's effective tax rate by 100 to convert to a decimal. Its marginal tax rate isn't used in the calculation.

The actual federal and state tax rates are used together to pin down its effective tax rate: what it actually pays. The federal corporate tax rate was ‌21 percent‌ in the final quarter of 2022, according to the Tax Foundation, an independent tax policy nonprofit. Forty-four states and Washington, D.C., also tax corporate income at rates ranging from ‌2.5 to 11.5 percent‌.

Let's assume that a company's total effective tax rate is ‌29 percent.‌ Divide 29 by 100 to get 0.29. Subtract the company's tax rate expressed as a decimal from 1. In this example, subtract 0.29 from 1 to get 0.71.

Divide the company's after-tax cost of debt by the result to calculate the company's before-tax cost of debt. In this example, if the company's after-tax cost of debt equals \$830,000, you'll then divide \$830,000 by 0.71 to find a before-tax cost of debt of \$1,169,014.08.

You can then backtrack to show the difference side by side if you need the after-tax cost as well. You can also express this number as a percentage by dividing the pretax cost of debt by total debt outstanding.