How Do I The Deduction of Income Taxes in My Net Income On My Profit & Loss/ Balance Sheet?
BV00
Member Posts: 13
I have a question regarding reflecting the deduction of my income taxes set aside from each of my payments in my Wave account, thus more accurately representing my net income. For context, I have a separate bank account (in the real world) for the purpose of setting aside portions of my payments to ultimately pay my income tax. This account is in fact linked to my Wave account, however that sum of money contained in that tax account is not being deducted from my gross income in Wave. As a result, my net income is inaccurate in my profit & loss, balance sheet, etc... How can I rectify this? How can I show in Wave that the appropriate sum of money is being set aside for the purpose of paying my income tax when the time comes, thus correcting my net income figure? Thank you to anyone who can clarify.
Comments
Hey @BV00 !
Income tax payments are an expense, but not a deductible expense for the current year. The amount you're paying in income tax in any year is relative to the income you made last year, but you pay your income tax for last year this year. But if you remit that payment in the current year, and it's treated as an expense, it deducts from your income this year and artificially deflates the income you earned this year.
From what I understand, the proper way to account for this, is to record an accrued expense in the prior year equal to the amount that you owe for that year (credit: Income Tax payable, debit: income tax expense). This allows the expense to be recognized last year, after you've already calculated true profit. When the payment is remitted this year, you can categorize it to the Income Tax payable account to clear out the liability -- that way it won't hit your P&L for the current year, and interfere with the current year's earnings.
With that being said, I would highly recommend reaching out to a registered CPA to ensure that you don't get incorrect advice on how to do your accounting. I hope this helps!
Thanks @JulianP . I think I understand your response. Unless I missed something in your answer however, I believe my only question is at the end of each fiscal year (ending Dec 31), is it necessary for my P&L and Balance Sheet to reflect my net profit in the form of gross-income tax? In Wave, the only deductions made to the gross income are any expenses listed in Chart of Accounts that I may have. From what I understand in your answer, if I wanted to represent income tax as a deduction from my gross, it would be an accrued expense. Would this be a long term liability? And would it be necessary to reflect it in this manner? Or is "Net profit" sufficient? Thank you for your patience and I appreciate any clarification.
Hey again @BV00 !
Income tax paid is an expense, but an after tax expense. Once you've filed your tax return for any year, and determine what you owe, you can add an accrued expense to that year. For instance, once I've filed my 2019 return, and I know how much I owe for 2019, I can record a journal transaction at the end of 2019 where I debit "Income Tax Expense" expense category and credit "Income Tax Payable" short term liability (it is short-term because the expectation is that it would be paid within a year) for the amount that I owe for 2019. This allows the expense to be recognized in the year that it was accrued as well as the fact that the amount is owing as of the end of 2019. But again, this shouldn't be added in until after I've calculated my net profit for the year, and know how much I owe. Remember, the tax expense is an after tax expense; it should not deduct from the net profit in 2019, rather, it is the amount owed as a result of the net profit in 2019.
In 2020, when I actually remit my income tax payment, I can categorize that withdrawal to "Income Tax Payable". This does two important things: 1) it clears out the tax amount that I recorded as owing at the end of 2019 and 2) because I'm clearing out a liability, it won't impact my P&L for 2020 (which it should not: again, this is just an amount that I owe as a result of my net profit in 2019, it should not impact my net profit for 2020).
I hope that helps clear things up, BV00!
Thank you very much @JulianP. This does clear things up. I appreciate your patience and willingness to help.
@BV00 said they have a separate real-world bank account for the purposes of paying income tax. I don't have such a separate account - I simply have personal and business bank accounts. Which bank account should I be paying income tax from? Does @JulianP 's answers still apply without a separate bank account for paying income tax only?
Hey @ThomasDaly. I would assume @JulianP's answers still apply because my question was simply about how to reflect the income taxes in Wave specifically regardless of my bank accounts in real life. But I would still reach out to an accountant to be sure of anything else.