How to Calculate the Effective Tax Rate of a Corporation
Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance Updated November 21, 2018Written by: Cynthia Gaffney
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. With the right financial information and a calculator, you can easily calculate the effective tax rate paid by a given corporation.
Tips
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.
Statutory vs. Effective Tax Rate
The U.S. statutory tax rate for corporations is mandated by federal tax law. This rate has been 35 percent since 1992 and still applies for the 2017 tax year. Certain tax brackets have included a surcharge, adding up to a maximum of 39 percent statutory tax rate for corporations. On December 20, 2017 the Tax Cut and Jobs Act was passed by the U.S. Senate and House of Representatives, bringing corporations a new, flat statutory tax rate of 21 percent starting with tax year 2018.
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. Historically, the average corporate effective tax rate has been closer to 29 percent 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. With the newly-enacted statutory rate of 21 percent as the starting point, the average effective tax rate for corporations is likely to be significantly lower than this rate.
Effective Tax Rate Formula
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.
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.
Additional Factors To Consider
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. 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. Federal tax breaks for research and development costs and accelerated depreciation can also affect not only net income but applicable income tax rates. 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.