There are many accounting items that make sense to accountants but are not as easy to interpret as they appear.

One of them is the expense shown on an Income statement for Income Tax. Everyone may have heard that the US Corporate tax rate is 35%, but the amount you will see shown is not usually 35% of a company's pre-tax profit.

In fact, it is often not even the total amount a company will actually pay in taxes for the time period shown.

The easy description of why this is the case is to understand that financial accounting which is used to report earnings is different from tax accounting which is used to determine actual taxes paid. There are differing rules for things like recognizing revenue and deducting expenses like depreciation. Like all of us, companies do everything they can to legally reduce and defer the taxes they actually pay. Most corporations actually pay less in taxes than is shown for each period on the financial statements.

The website nerdwallet.com, has just released an interesting study about how much US taxes corporations actually pay compared to what they show as income tax expense.

Corporate Tax Rates

They have also developed a tool which they've used to analyze the specifics for many US Corporations. It is pretty interesting to look through to see if you can find information for some of the companies your investment club owns.

Tax Payments

For example, a company such as Conoco shows an income tax provision of 46% of pre-tax earnings, but they actually paid 8% in US taxes. On average, the companies they analyzed reported tax rates of 27%, but only paid 13% in US taxes.

It's not a simple topic. It's easy to misinterpret and it's easy to spin the facts to support whatever point someone might be trying to make. Take what you read with a grain of salt. If you want to do something constructive, take a few minutes to try and understand what tax issues the companies you are investing in really are facing and how their quarterly earnings are being affected by accounting issues related to their tax reporting. These things are all described in their financial reports. Use the find feature in your browser to search through a 10-Q or 10-K for the phrase "Income Tax" and see what you find. You might not understand some of it, but you will find things that are easy to read and understand.

If you wonder why your stock prices are bouncing around, it may be because others are seeing or not seeing issues such as tax expense changes which are affecting earnings. They might be making things look temporarily better or worse than they might be for the long term. If you can learn to see them also, you'll be better positioned to make good investing decisions.

Laurie Frederiksen
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