Pretax Financial Income

Income Tax Expense = Pretax Financial Income * Tax Rate

Pretax financial income is a financial reporting term determined according to GAAP, full accrual method is used.

Taxable Income

Tax Payable = Taxable Income * Tax Rate

Income taxes are paid on taxable income, which is the amount reported to the government. Taxable income is not the same as pretax financial income, which is the amount reported on financial statements. In the financial statements, pretax financial income minus related income taxes equals net (financial) income.

Financial income is calculated using current GAAP. In contrast, taxable income is calculated using the Internal Revenue Service (IRS) tax code. The two amounts are usually not the same because the objectives of financial reporting differ from those of the tax code. For example, the tax code has provisions to encourage certain types of economic activity, such as investment in new equipment. In contrast, the objective of financial reporting is to present information that will be useful to external users in making decisions about companies.

Temporary Differences

The two types of temporary differences are taxable differences and deductible differences.

Some of the differences between taxable income and financial income are temporary and are referred to as temporary differences. For example, some item that is included as revenue for tax purposes in the current year is included in financial income in the next year. Thus, the difference is temporary because it reverses in the future. Other types of differences that are not temporary are referred to as permanent differences. For example, certain types of income might never be taxable. The two types of temporary differences are taxable differences and deductible differences.