The nominal U.S. corporate tax rate is 35%, but relatively few companies pay the full amount. The portion of profits a company actually owes is known as its effective tax rate.
There are a number of reasons an effective tax rate might differ from the statutory rate:
Foreign sales are usually taxed at a lower rate than U.S. sales. So a company that generates a big portion of its profits overseas is going to pay a lower average tax rate on its overall profits.
Many companies benefit from federal tax breaks including those meant to encourage investment in research and development, oil and gas exploration and production, accelerated depreciation on machinery and equipment, domestic manufacturing, and interest on state and local bonds.
Companies that have lost money in the past can use those losses to offset a portion of their current and future profits.
Tax loopholes. A popular one with technology, pharmaceutical, medical device, and financial companies involves transferring profits to shell subsidiaries in low-tax countries such as Ireland, the Netherlands, Luxembourg, Belgium, Bermuda, and the Cayman Islands.
As of late 2015, the median effective tax rate for S&P 500 companies was 29%, according to data from S&P Capital IQ.
Effective tax rate might not get as much attention as other financial metrics, but it can make a big difference to a company's bottom-line profitability.
How to calculate an effective tax rate
You can calculate a company's effective tax rate using just a couple of lines on its income statement.
Simply divide the income tax expense (sometimes called "provision for income taxes") by earnings before taxes (also known as "income before provision for income taxes").
Here's the formula:
Effective Tax Rate = Income Tax Expense / Earnings Before Taxes (EBT)
For instance, in fiscal 2014 Google reported an income tax expense of $3,331 million on $17,259 million in pre-tax earnings. So its effective tax rate was 19% ($3,331 / $17,259).
Had Google owed 35% on its pre-tax profits, net income would have been $11.7 billion, instead of the $14.4 billion it reported.
Based on the company's valuation at the time, the difference was worth an extra $76 billion in Google's market value. ($427 vs. $526 per share.)
Smart investing requires having a good handle on lots of numbers like these. If you think you're ready, or if you need more information, come on over to our Broker Center, and we'll help you take the next step.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in the Foolsaurus. Pop on over there to learn more about our Wiki and how you can be involved in helping the world invest, better! If you see any issues with this page, please email us at firstname.lastname@example.org. Thanks -- and Fool on!
the_motley_fool has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.