How to Account for Negative Income Tax on the Income Statement
Business accounting and taxes can be complicated, but thinking about how the two relate makes it simpler. While it is obvious that income tax liability that is paid must be accounted for as a business expense, it is not as obvious how to deal with a negative income tax liability in accounting, or when this negative liability may come into play.
A business may end up with a negative income tax liability for a given tax year due to its specific situation. The business may have had very little net income or experienced a loss for the tax year, meaning that it has no tax liability in that year. In addition, the business may have taken advantage of available refundable tax credits, resulting in a negative tax liability. An end-of-year negative liability can also result if the business overpaid estimated taxes throughout the year. Each situation is accounted for differently.
A business receives a tax refund when it overpays its estimated income taxes throughout the year. Tax forms give the option to take the money as a refund or apply it to the following year's taxes. If the business owner elects to take a refund, a debit entry is made to accounts receivable for the refund due, and a credit entry is made to the expenses account used for tax expenses. The credit entry decreases the value of the expense account. When the refund is received, a debit entry is made to the cash account, with a credit entered in accounts receivable, decreasing its value.
Accounting is similar if the overpayment of income taxes is applied to the next tax year. A debit entry is made to the income tax payable liability account, decreasing its value. A corresponding credit entry is then made to the income tax expense account, decreasing the amount of expenses for the current year.
If a business is fortunate enough to have a negative tax liability due to tax credits, the entries vary depending on how the owner wishes to report this. If he wishes to use the negative liability to offset potential tax liabilities in the next accounting period, he can make a debit entry to cash for the refund received and a credit entry to the income tax expense account, decreasing the expense account. To defer the amount over several accounting periods, a debit entry is made for the refund received to cash, and a credit entry is made to a payable account to reflect the amount of taxes being spread out. During each period, a debit is made to the payable account, and a credit entered to the income tax expense account.
If the owner wishes to report negative tax liability or tax credits as revenue, he should make the debit entry to cash or accounts receivable for the amount of the refund and credit an appropriate income account to increase the amount of revenue.