Taxes not accounted for under ASC 740 are the ones whose base is something other than net income: sales and use taxes, property taxes, payroll taxes, excise taxes, value-added and goods and services taxes, gross receipts taxes, and the non-income portions of hybrid franchise or minimum taxes. ASC 740 governs current and deferred accounting only for taxes measured on income or profit. Everything else is recorded as an operating expense or capitalized into inventory, with any unpaid amount sitting in accrued liabilities.
The Base Test
ASC 740 has two jobs: recognize taxes payable or refundable for the current period, and recognize deferred tax assets and liabilities for the future tax consequences of events already in the financial statements or tax returns.1FASB. Income Taxes (Topic 740) Both jobs depend on the tax being sensitive to income. A property tax bill next year does not change because a company accelerates depreciation this year. A payroll tax next quarter does not shift because warranty accruals are timed differently on the books. That disconnect is why non-income taxes stay out.
So the classification question comes down to one thing. Trace the calculation back to its base. If the number starts from net income, taxable earnings, or net profit in any form, ASC 740 applies. If it starts from transaction value, asset value, wages, product quantity, or gross revenue, it does not. The name printed on the tax bill is not the deciding factor. A “franchise tax” can sit fully inside ASC 740, fully outside, or split between the two depending on how the state calculates it.
Sales and Use Taxes
Sales taxes are assessed on the transaction value of goods and services sold to consumers. Use taxes serve a parallel purpose when a buyer acquires something without paying sales tax, typically in cross-border purchases. In both cases the base is the price of the transaction, not the seller’s profit.
From the seller’s perspective, sales tax is money collected on behalf of the government. It moves through the balance sheet as a liability, often labeled Sales Tax Payable, and never touches the income statement as revenue or expense. The seller is an intermediary, not the taxpayer.
Property Taxes
Property taxes are assessed against the value of real or personal property. Profitability is irrelevant to the calculation. A factory generating millions in profit and an idle factory owe the same tax if the assessed values are identical.
Property taxes are expensed over the period they cover. A bill received in December for the following calendar year is accrued and recognized monthly through that year, matching the expense to the period government services are provided. The liability appears as a current obligation, typically inside accrued expenses. Property taxes allocable to a production facility are an exception on placement, not on classification: they get capitalized into inventory cost along with other production costs, and reach the income statement through cost of goods sold when the inventory is sold.
Payroll Taxes
Payroll taxes are based on wages paid, not company earnings. The employer’s share of Social Security tax is 6.2% of each employee’s wages up to the 2026 wage base of $184,500, and Medicare tax adds another 1.45% with no cap.2Office of the Law Revision Counsel. 26 USC 3111 – Tax on Employers3Social Security Administration. Contribution and Benefit Base Federal unemployment tax (FUTA) is 6.0% on the first $7,000 of each employee’s wages, though most employers receive a 5.4% credit that brings the effective rate to 0.6%.4Internal Revenue Service. FUTA Credit Reduction
Some of these taxes are split between employer and employee, and others fall entirely on the employer. FUTA is paid solely by the employer and never withheld from employee pay.5Internal Revenue Service. Understanding Employment Taxes For financial reporting, only the employer’s portion is an expense; the employee’s withheld portion is a pass-through liability.
The employer’s payroll tax expense is recorded as a component of labor cost. For production workers it lands in cost of goods sold, and for office and sales staff it lands in selling, general, and administrative expenses. None of it enters the income tax provision.
Excise Taxes
Excise taxes are levied on specific goods, services, and activities. Federal excise applies to fuel, airline tickets, tobacco, heavy trucks, and indoor tanning services, among other categories.6Internal Revenue Service. Basic Things All Businesses Should Know About Excise Tax The base is tied to quantity, weight, or the value of a specific product. A gasoline excise is charged per gallon, not as a percentage of the refiner’s profits.
Treatment depends on how the tax relates to the product. Excise paid on raw materials or goods held for resale is capitalized into inventory as a cost necessary to bring the inventory to its present condition, and reaches the income statement through cost of goods sold when the inventory is sold. Excise taxes not tied to inventory, such as tax on company vehicle fuel, are expensed as incurred.
Value-Added Tax and Goods and Services Tax
VAT and GST are consumption taxes common outside the United States, used in more than 160 countries in some form. They are assessed on the value added at each stage of production and distribution, with the final burden falling on the end consumer.
Businesses act as collection agents. They charge VAT on their sales (output tax) and pay VAT on their purchases (input tax), then remit the difference to the government. The net position appears on the balance sheet as a liability or a receivable. Because the tax base is transaction value rather than profit, VAT and GST never appear in the income tax provision.
Gross Receipts Taxes
Gross receipts taxes are calculated on a company’s total revenue with few or no deductions for business expenses. Several states impose taxes of this kind, sometimes labeled margin taxes. Because the base is gross sales rather than net income, they are generally excluded from ASC 740.
These taxes are recorded as operating costs, usually inside selling, general, and administrative expenses. If they are directly tied to production revenue, they can be classified within cost of goods sold. The defining feature that keeps them outside ASC 740 is that the company owes the tax regardless of whether it earns a profit. A loss-making company still owes a gross receipts tax on its revenue.
Hybrid Taxes: Franchise and Minimum Taxes
Some taxes do not sit cleanly on one side of the line. Treatment turns on how the specific jurisdiction structures the calculation, and this is where classification errors are most common.
Franchise Taxes
Franchise taxes are charged by states for the privilege of doing business there. Some states base the tax on net worth, capital stock, or total assets, which makes it a non-income tax expensed as an operating cost. Other states base it on net income, which puts it inside ASC 740.
The complicated version is the hybrid franchise tax, where a company pays the greater of an income-based amount and a non-income-based amount. ASC 740-10-15-4 addresses this directly. When a franchise tax is partially based on income, the company recognizes deferred tax assets and liabilities for temporary differences using the applicable income tax rate. Current tax expense equal to the income-based calculation falls under ASC 740, and any additional amount above that — the excess attributable to the capital or net-worth base — is expensed as a non-income tax.1FASB. Income Taxes (Topic 740)
One important nuance. When evaluating whether deferred tax assets are realizable, the company cannot consider the possibility of paying the non-income-based tax in future years. The realizability analysis looks only at the income-based tax system.1FASB. Income Taxes (Topic 740)
State Minimum Taxes
Many states impose a minimum tax, a fixed dollar amount corporations must pay even when their income-based tax would be lower. If a company’s calculated income tax exceeds the minimum, it pays the income tax and ASC 740 applies to the full amount. Complexity arises when the income-based calculation falls short.
In that case the payment is split. The portion equal to the calculated income tax is accounted for under ASC 740. The remainder, the excess of the minimum over the income-based amount, is treated as a non-income tax and expensed as an operating cost. Only the income-driven portion enters the deferred tax framework.
Where Excluded Taxes Land in the Financials
Non-income taxes bypass the entire deferred tax framework. There are no temporary differences to track, no deferred tax assets or liabilities to record, and no rate reconciliation to prepare. The accounting is direct: recognize the expense, record the liability.
Most excluded taxes are period expenses. The employer’s share of payroll taxes, property taxes on the corporate headquarters, and excise taxes on non-inventory items all flow to the income statement, usually within selling, general, and administrative expenses. The classification depends on what the tax relates to; payroll taxes on production workers, for example, sit in cost of goods sold.
Taxes that attach to inventory are the exception. Excise taxes on raw materials, import duties, and property taxes allocable to a production facility are capitalized into inventory cost under the principle that inventory should reflect all costs necessary to bring it to its present location and condition. Those costs reach the income statement through cost of goods sold when the related inventory is sold, which avoids a timing mismatch between paying the tax and recognizing the revenue.
On the balance sheet, unpaid non-income taxes appear as current liabilities. They are grouped within accrued expenses or labeled separately as Other Taxes Payable to distinguish them from income tax payable.
Why the In-or-Out Call Matters for Disclosure
Classification affects more than the income statement. For fiscal years beginning after December 15, 2024, public companies must comply with expanded income tax disclosure rules under ASU 2023-09, including a disaggregated rate reconciliation and separate disclosure of any reconciling item whose tax effect equals or exceeds 5% of the amount computed by multiplying pretax income by the statutory rate.7FASB. ASU 2023-09 Income Taxes (Topic 740) Those rules apply only to taxes within ASC 740.
Putting a tax in the wrong bucket therefore has two effects. A tax wrongly pulled into ASC 740 shows up in the provision and the rate reconciliation, distorting effective tax rate analysis. A tax wrongly excluded misses the deferred tax accounting and disclosures it should receive. The base test is the safeguard: identify the base, and the accounting and disclosure treatment follow.