Pre-Tax Income
Pre-tax income, also called earnings before tax (EBT), is a company's total profit after all operating expenses and interest costs but before the income tax provision, and serves as the basis for calculating the effective tax rate and for comparing profitability across companies with different tax attributes or jurisdictions.
Pre-tax income is the penultimate line on the income statement before arriving at net income. The path from operating income to pre-tax income involves adding non-operating income items and subtracting non-operating expenses, primarily interest expense on debt, with net effect typically resulting in pre-tax income being lower than operating income for leveraged companies. Non-operating income may include interest earned on cash balances, gains on asset sales, equity income from investments in associates, and foreign exchange gains.
For highly leveraged companies — particularly those resulting from leveraged buyouts — pre-tax income can be dramatically lower than operating income because substantial interest expense consumes most of the operating profit. A company with $1 billion in operating income but $800 million in annual interest expense has pre-tax income of only $200 million, making its effective earnings base far smaller than EBIT-based comparisons would suggest.
The effective tax rate — income tax expense divided by pre-tax income — reveals how much of pre-tax profits the company retains after taxes. The U.S. federal statutory corporate tax rate has been 21 percent since the Tax Cuts and Jobs Act of 2017, but effective rates vary significantly due to: tax credits (research and development credits, investment tax credits), differences between book and tax depreciation creating deferred tax assets or liabilities, offshore profit allocation in lower-tax jurisdictions, stock option deductions, and state and local taxes that add to the federal rate.
Analysts focused on after-tax comparability sometimes use pre-tax income to perform a tax-normalized comparison across companies. If Company A has an effective tax rate of 15 percent (benefiting from substantial tax credits) and Company B has an effective rate of 25 percent, comparing their net incomes overstates Company A's operational outperformance relative to Company B. Applying a normalized tax rate to both companies' pre-tax incomes removes this distortion.
Pre-tax income is also the starting point for deferred tax analysis. Temporary differences between when income is recognized for financial reporting purposes versus tax purposes create deferred tax assets (taxes paid early, creating a future benefit) or deferred tax liabilities (taxes deferred to the future). Large and growing deferred tax liabilities, particularly in capital-intensive businesses with accelerated tax depreciation, represent cash tax obligations that will eventually come due.