Income tax payable is a liability that an entity incurs that is based on its reported level of profitability. The tax can be payable to a variety of governments, such as the federal and state governments within which the entity resides. Once the organization pays the income tax, the liability is eliminated. As an alternative to payment, the income tax liability can be reduced through the application of offsetting tax credits granted by the applicable government entity. Since tax credits typically expire after a period of time, one must pay close attention to which ones are available and can be applied to an income tax payable.
The amount of income tax payable is not necessarily based solely on the accounting profit reported by a business. There may be a number of adjustments allowed by the government that alters the accounting profit to result in a taxable profit, against which the income tax rate is then applied. These adjustments can result in timing differences between the recognition of profits for accounting and tax reporting that can, in turn, create differences in the amount of income tax payable (as calculated on a tax return) and the income tax expense reported in a company's income statement.
For example, governments typically allow the use of accelerated depreciation for the purposes of calculating income taxes, which tends to delay the payment of taxes to a later period. This varies from the more common straight-line depreciation used by businesses for all other reporting purposes. The result is a timing difference between the recognition of income for financial and tax reporting purposes.
The income tax payable is usually classified as a current liability in the balance sheet, since it is normally payable to the applicable government(s) within one year.
For example, if ABC International has $100,000 of before-tax profits, and the federal government imposes a 35% income tax, then ABC should record a debit to the income tax expense account of $35,000 and a credit to the income tax payable account of $35,000. When ABC later pays the tax, it debits the income tax payable account for $35,000, and credits the cash account for $35,000.