What is the Taxable Income Formula?

In simple terms, it refers to the amount of income earned by an individual or an organization that eventually creates a potential tax liability. The formula for taxable income for an individual is a very simple prima facie, and the calculation is done by subtracting all the expenses that are tax exempted and all the applicable deductions from the total gross income.

For an individual, it is represented as,

On the other hand, the calculation of a corporation’s taxable income is done by deducting the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more, operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more and interest paid on debts from the company’s gross sales. Additionally, adjustment for a tax deduction or credit is made to arrive at the final income.

For Corporate, it is represented as,

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Explanation

The taxable income formula for an organization can be derived by using the following five steps:

  • Firstly, determine the total gross income of the individual. Gross total income includes all sources of income like wage/ salary, rental income from property, capital gains from the asset sale, income from other business interests, etc. Next, determine the total exemptions availed by the individual. Different types of tax-exemption may include charities, humanitarian aids, educational materials, etc. The list may vary depending on the reporting country. Next, determine the total deductions applicable to the individual’s income. Different types of tax deductions may include interest on a student loan, interest on a home loan, medical expenses, etc. This list may also vary depending on the reporting country. Finally, the taxable income formula is calculated by total exemptions and deductions from the individual’s total gross income, as shown below.Taxable Earning = Gross total income – Total exemptions – Total deductions

Step 1: Firstly, gross sales have to be confirmed by the sales department.

Step 2: Next, the cost of goods sold is determined by the accounts department.

Step 3: Next, the operating expense is also calculated from the accounts department.

Step 4: Next, the interest paid is calculated based on the rate of interest charged and the company’s outstanding debt.

Interest expense = Rate of interest * Debt

Step 5: Next, figure out all the tax deductions and credits applicable to the company.

Step 6: Finally, the calculation of the taxable income equation is done by deducting the cost of goods sold, operating expenses, and interest paid on debts from the gross sales of the companyGross Sales Of The CompanyGross Sales, also called Top-Line Sales of a Company, refers to the total sales amount earned over a given period, excluding returns, allowances, rebates, & any other discount. read more, as shown below.

Taxable Earning = Gross sales – Cost of goods sold – Operating expense – Interest expense – Tax deduction/ credit

Examples of Taxable Income Formula (with Excel Template)

Let’s see some simple to advance examples of the Taxable Income Formula to understand it better.

Example #1

Let us take David’s example to understand the taxable income tax calculation. He is entitled to a gross salary of $50,000 annually and pays 6% interest on his son’s education loan of $25,000. He is also eligible for a tax exemption of $10,000.

Below is data for the calculation of David’s Taxable Earnings.

Therefore, David’s Taxable Income can be calculated as,

Taxable Earning = Gross salary – Interest on education loan – Tax exemptions

= $50,000 – 10% * $25,000 – $10,000

= $37,500

Therefore, David’s taxable Earning is $37,500.

Example #2

Let us take the real-life example of Apple Inc.’s annual report for 2016, 2017, and 2018. The table gives a snapshot of the detailed calculation of taxable income for the years 2016, 2017, and 2018. The following information is available:

The below table shows data for the calculation of taxable earnings of Apple Inc.’s annual report for the years 2016, 2017, and 2018.

The taxable Income of Apple Inc.’s annual report for the year 2016 can be calculated as,

Taxable Earning= Net sales – Research and development expense – Selling, general and administrative expense – Interest expense + Non-operating income

= $215,639 – $131,376 – $10,045 – $14,194 – $1,456 + $2,804

Taxable Earnings = $61,372

Therefore, the taxable earnings of Apple Inc. stood at $61,372 Mn for the year 2016.

The Taxable Earning of Apple Inc.’s annual report for the year 2017 can be calculated as,

Taxable Earning = Net salesNet SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company’s gross sales.read more – Research and development expense – Selling, general and administrative expense – Interest expense + Non-operating income

= $229,234 – $141,048 – $11,581 – $15,261 – $2,323 + $5,068

= $64,089

The Taxable Earning of Apple Inc.’s annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more for the year 2018 can be calculated as follows,

= $265,595 – $163,756 – $14,236 – $16,705 – $3,240 + $5,245

= $72,903

Taxable Income Formula Calculator

You can use this Calculator

Relevance and Uses

For an individual, it is important to understand taxable income because it is more than just the salary earned at the job. If one receives any compensation, it will likely be considered under taxable income. Some of the uncommon examples of income included under taxable earnings are debt liability forgiven by the lender or creditor, lottery winnings, payments made for jury duty, gifts, unemployment benefits offered by the government, strike benefits, and even embezzled money.

The amount of taxes to be paid by an individual is lowered by tax credits, while the tax deductions and exemptions lower the individual’s taxable earnings. In the US accounting terminology, the items that qualify as “taxable income” are defined in the Internal Revenue Code Section 63. In contrast, the sources identified as “gross income” are defined in Section 61 of the Internal Revenue Code.

For a company, taxable earning is the earning before taxation after all the business expensesBusiness ExpensesBusiness expenses are those incurred in order to successfully run, operate, and maintain a business. Travel & conveyance, salaries, rent, entertainment, telephone and internet expenses are all examples of business expenses.read more have been recognized and the adjustments have been made. The understanding aids the preparation and filing of the business’ tax return.

This has been a guide to the Taxable Income Formula. Here we discuss how to calculate Taxable Income along with practical examples and downloadable excel templates. You may learn more about Accounting from the following articles –

  • Examples of Non-Operating IncomeExamples Of Non-Operating IncomeNon-Operating Income, also called Peripheral Income, is the capital amount that a business earns from non-core revenue-generating activities. The examples include profits/losses from a capital asset sale or Foreign Exchange Transactions, Dividend Income, Lawsuits losses, & Asset Impairment losses, etc. read moreInterpret Operating IncomeInterpret Operating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business.read moreRegressive TaxRegressive TaxA regressive tax is the system of taxation where all citizens in the country are taxed at the same rate without considering their income levels. As a result, a more significant percentage of the income of the low-income group is charged as tax compared to the high-income group.read moreDouble Taxation MeaningDouble Taxation MeaningDouble Taxation is a situation wherein a tax is levied twice on the same source of income. It usually occurs when the same income is taxed both at corporate as well as at the individual level.read more