What Is Book Income?
The term “book income” generally means a company’s financial income before its taxes are taken into account. Determined in accordance with generally accepted accounting principles (GAAP), it is the amount a corporation reports on its financial statements for its investors or shareholders, as well as for financial regulators.
Sometimes the term is used to refer to a company’s net income reduced by taxes; it may be described more specifically as pre-tax or after-tax book income.
- Book income refers to the pre-tax income of an organization determined in accordance with (GAAP).
- Book income reflects an organization’s financial performance over a specific period of time.
- The Securities and Exchange Commission (SEC) requires public companies to report book income in compliance with GAAP.
- The purpose, rules, and calculation of a company’s book income and taxable income differ, resulting in amounts that can vary significantly.
- Because of their different purposes, companies generally try to maximize book income and minimize taxable income.
- The Biden Administration has proposed imposing a minimum tax on based on the book income of large corporations to prevent tax avoidance.
Understanding Book Income
The calculation of book income is based on GAAP financial accounting and reporting standards set by the Financial Accounting Standards Board (FASB). The Securities and Exchange Commission (SEC) requires public companies to adhere to these standards. Financial statement book income indicates a company’s financial performance over a specific period of time. Financial executives seeking to portray a company favorably strive to maximize publicly reported book income.
Because book income is determined in accordance with widely-used, standard accounting rules that take into account all income and expenses, other than tax liabilities, it facilitates a comparison of the performance of similar companies over the same time period. The use of GAAP accounting by state and local governments, public companies, many private companies and nonprofits, provides citizens and officials, shareholders and lenders, donors and grant-makers, with a readily understandable presentation of book income as well as other financial accounting measures.
Book Income vs. Taxable Income
Questions often arise about how book income differs from taxable income. The two are established and interpreted by different authorities, serve different purposes, and differ in amount. Because of these differences, a company’s book and taxable income may vary significantly. Neither fully reveals a company’s underlying economic capacity and health. Both book income and taxable income provide a snapshot of a company’s performance for only a specified, limited period of time. As a result, book income can include the results of one-time, isolated events without distinguishing them from the revenue and expenses of regular business operations.
Taxable income reflects another variable: Even if a company performs consistently over time, its taxable income can vary greatly from year to year because of changes in the tax law. Taxable income is the amount reported on a company’s tax return. It is the basis for a company’s tax liability to the government and generally is determined for a 12-month period. The calculation of taxable income is determined by laws and regulations that reflect a mix of economic concepts, public policy goals, and political interests.
Companies seek to minimize taxable income in order to limit their tax liabilities. Tax rules are set, and taxpayer compliance with them is enforced, by governmental authorities. In the United States, federal taxable income is defined by the Internal Revenue Code and administered by the Internal Revenue Service (IRS). States that impose income taxes define taxable income under their own tax laws, which often incorporate federal tax concepts and standards, and enforce the state law through their own tax agencies and commissions.
Special Considerations: Biden's Proposed Minimum Corporate Tax on Book Income
The Biden Administration has proposed using book income as the basis for a corporate minimum tax. In response to concerns about a substantial number of highly profitable, large corporations paying little or no U.S. corporate tax, the Biden Administration supports the enactment of a 15% minimum tax that would be calculated on the basis of large corporations’ book income. Corporations with a significant disparity between their book and taxable income would be required to make an additional payment to the IRS for the excess of up to 15% of their book income over their regular tax liability.
In addition, on October 8, 2021, the Biden Administration joined 135 other countries in an agreement that includes a 15% global corporate minimum tax starting in 2023. Implementation of President Biden's domestic minimum tax based on book income and the OECD tax changes would require coordination of their technical rules and revision or repeal of some present provisions of U.S. law that tax foreign income of U.S. corporations. Because both the Biden and OECD proposals require Congressional action before they can become effective, their adoption is not certain.
Are All Companies Required to Determine Book Income in Accordance With GAAP?
The SEC requires public companies to prepare their financial statements—including their determination of book income—in accordance with GAAP. Although generally not legally obligated, many private companies follow GAAP rules to facilitate borrowing, to attract investors, and to prepare for going public. Governments and many nonprofits adopt GAAP to demonstrate transparency and to provide a readily understandable picture of their financial health to officials, constituents, and donors.
Which Types of Income and Expenses Are Treated Differently in Calculating Book Income and Taxable Income?
Book income is determined using accrual accounting. However, taxable income may be determined using accrual, cash-basis, or a hybrid method, provided the method is used consistently and accurately reflects income.
The book and tax treatment of specific items of income and expense also differ; some differences are permanent, while others relate to timing. For example, each system may depreciate assets over a different number of years. Some costs may be deductible in calculating book income while they may be allowed as credits or deductions for tax purposes. All meals and entertainment expenses are deductible in arriving at book income, but tax rules allow a deduction for only 50% of business meals and no deduction at all for business entertainment.
Tax-exempt interest is excluded from taxable income but is included in book income. Fines and penalties reduce book income but are not deductible under tax rules. Some tax treatments are elective, but financial accounting rules that determine book income are standard.
How Does the Minimum Tax Proposed by the Biden Administration Relate to the Regular Corporate Income Tax?
The Biden proposal applies only to very large corporations, but all corporations must comply with the corporate tax. The minimum tax rate of 15% would apply to book income, but the regular corporate income tax is based on taxable income.
Assume that a company that is subject to the minimum corporate tax has a regular corporate tax liability that is less than 15% of its book income. The company's tax liability will be increased by the difference between the lower corporate tax amount and the amount equal to 15% of book income, so that the tax owed is equal to 15% of its book income. If a company's regular corporate income tax liability exceeds 15% of its book income, the company will owe the regular corporate income tax amount.