How to Calculate the Effective Tax Rate of a Corporation

How do you work out the corporation tax? If you own such a business entity, you need to figure the effective tax rate for your business. After all, corporations pay federal income taxes just like everyone else.

Federal tax laws dictate corporation tax rates, but this isn't what actually gets paid to the government. Corporations take advantage of many legal tax strategies to save some money by cutting their tax bill and lowering their tax rate.

So, in order to calculate the effective tax rate paid by a corporation, you must divide their income tax expenses by the company's earnings before taxes, or EBT.

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The U.S. statutory tax rate for corporations is mandated by federal tax law. Currently, corporations are subject to a ​21 percent​ tax rate in addition to state corporate taxes which range from ​zero to 11.5 percent​. The existing rates are based on a tax reform legislation, which was enacted on December 22, 2017.

However, there are suggestions to raise the rates up to ​28 percent​. Others propose a raise to ​25 percent​. But for the 2021 tax year, the ​21 percent​ corporation plus state tax rates apply.

On the other hand, the effective tax rate, or the percentage tax rate actually paid by corporations, differs quite a bit from the statutory rate. This effective tax rate represents the percentage taxes paid after accounting for all tax breaks.

In addition, the average corporate effective tax rate is much lower due to various tax credits, deductions, exemptions, preferential rates and loopholes that reduced the actual, applicable tax rate and the amount of profit available for taxation. Further, the 21 percent corporation tax starting point, has contributed towards the significant reduction of the average effective tax rate for corporations.

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To calculate the effective tax rate of any corporation, you'll need to have a copy of the company's profit and loss statement. Down towards the bottom of the statement; locate the income tax expense, usually called "provision for income taxes." Divide this number by the company's earnings before taxes, or EBT.

And then, use the effective tax rate formula:

​Effective Tax Rate = Income Tax Expense / EBT​

EBT represents the company's remaining profit after deducting the following costs from gross sales: cost of goods sold, selling, general & administrative expenses (SG&A), interest, depreciation, amortization and any other operating expenses. You can also use a helpful effective tax rate calculator to help you crunch these numbers.

Each corporation has its own unique business structure, circumstances and tax advantages. This affects the actual, or effective, tax rate a given company will ultimately pay.

For example, troubled companies experiencing financial losses in previous years can use their old losses to offset profits in the current tax year to lower taxable income. And federal tax breaks for research and development costs and accelerated depreciation can also affect not only net income but applicable income tax rates.

In addition, multinational corporations may have varied tax structures for non-U.S. entities, with sales made in foreign lands subject to lower tax rates. When companies choose where to locate a new business unit, they may strategically consider various countries based on the lowest, most favorable corporate tax rates.

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