Deferred Income Tax

Ability-To-Pay Taxation

What is deferred income tax?

A deferred tax is a liability recorded on the balance sheet resulting from a difference in the recognition of the result between tax laws and the accounting methods of the company. For this reason, the income tax payable by the company may not correspond to the total tax charge declared.

The total tax burden for a specific year may be different from the tax debt due to the IRS because the company defers the payment due to differences in accounting rules.

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Deferred income tax

Understanding deferred income tax

Generally accepted accounting principles (GAAP) guide financial accounting practices. GAAP accounting requires the calculation and disclosure of economic events in a specific manner. Income tax expense, which is a financial accounting document, is calculated using GAAP income.

A deferred tax liability results from the difference between the income tax expense presented in the income statement and the income tax payable.

In contrast, the Internal Revenue Service (IRS) tax code specifies special rules for handling events. The differences between the IRS rules and GAAP guidelines result in different calculations of net income and, therefore, of income taxes due on that income.

Situations can arise when the income tax payable in a tax return is greater than the income tax expense in a financial statement. Ultimately, if no other reconciliation event occurs, the deferred tax account would be net at $ 0.

However, without a deferred tax liability account, a deferred tax asset would be created. This account would represent the future economic benefit that should be received because the taxes on imputed profits were greater than GAAP income.

Key points to remember

  • Deferred income tax results from the difference in the recognition of income between tax laws (i.e., the IRS) and accounting methods (i.e., GAAP).
  • Deferred tax appears as a liability on the balance sheet.
  • The difference in the depreciation methods used by the IRS and GAAP is the most common cause of deferred tax.
  • Deferred income tax can be classified as a short-term or long-term liability.

Examples of deferred revenue

The most common situation that generates deferred tax liabilities arises from differences in depreciation methods. GAAP guidelines allow companies to choose between several depreciation practices. However, the IRS requires the use of a depreciation method different from all available GAAP methods.

For this reason, the amount of depreciation recorded in a financial statement is generally different from the calculations in a business income tax return. Over the life of the asset, the value of depreciation in both areas changes. At the end of the asset’s useful life, no deferred tax liability exists, since the total amortization between the two methods is equal.

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