Deferred Tax Liability

What Is a Deferred Tax Liability?

A deferred tax liability is a listing on a company's balance sheet that records taxes that are owed yet are not due to be paid until a future date.

The liability is deferred due to a difference in timing between when the tax was accrued and when it is due to be paid. For instance, it could mirror a taxable transaction, for example, a installment sale that occurred one a certain date yet the taxes won't be due until a later date.

How Deferred Tax Liability Works

The deferred tax liability on a company balance sheet addresses a future tax payment that the company is committed to pay from here on out.

It is calculated as the company's anticipated tax rate times the difference between its taxable income and accounting earnings before taxes.

Deferred tax liability is the amount of taxes a company has "underpaid" which will be made up from now on. This doesn't mean that the company hasn't satisfied its tax obligations. Maybe it perceives a payment that isn't yet due.

For instance, a company that earned net income for the year realizes it should pay corporate income taxes. Since the tax liability applies to the current year, it must mirror an expense for a similar period. In any case, the tax won't really be paid until the next calendar year. To correct the gathering/cash timing difference, tax is recorded as a deferred tax liability.

Instances of Deferred Tax Liability

A common source of deferred tax liability is the difference in depreciation expense treatment by tax laws and accounting rules.

The depreciation expense for enduring assets for financial statement purposes is ordinarily calculated utilizing a straight-line method, while tax regulations permit companies to utilize an accelerated depreciation method. Since the straight-line method produces lower depreciation when compared to that of the under accelerated method, a company's accounting income is briefly higher than its taxable income.

The company perceives the deferred tax liability on the differential between its accounting earnings before taxes and taxable income. As the company keeps devaluing its assets, the difference between straight-line depreciation and accelerated depreciation limits, and the amount of deferred tax liability is progressively taken out through a series of offsetting accounting sections.

Installment Sales

One more common source of deferred tax liability is an installment sale. This is the revenue recognized when a company sells its products on credit to be paid off in equivalent amounts from here on out.

Under accounting rules, the company is permitted to perceive full income from the installment sale of general merchandise, while tax laws expect companies to perceive the income when installment payments are made.

This makes an impermanent positive difference between the company's accounting earnings and taxable income, as well as a deferred tax liability.

Features

• The obligation starts when a company or individual defers an event that would make it likewise perceive tax expenses in the current period.
• A deferred tax liability addresses an obligation to pay taxes from now on.
• For example, earning returns in a qualified retirement plan, similar to a 401(k), addresses a deferred tax liability since the retirement saver will eventually need to pay taxes on the saved income and gains upon withdrawal.

FAQ

How Is Deferred Tax Liability Calculated?

A company could sell a household item for $1,000 plus a 20% sales tax, payable in regularly scheduled payments by the customer. The customer will pay this more than two years ($500 + $500).In its financial records, the company will record a sale of $1,000.In its tax records, it will be recorded as $500 each year for two years.The deferred tax liability would be $500 x 20% = $100.

Is Deferred Tax Liability a Good or Bad Thing?

Deferred tax liability is a record of taxes that have been incurred yet have not yet been paid. This detail on a company's balance sheet reserves money for a known future expense.That decreases the cash flow that a company has accessible to spend, however that is not something terrible. The money has been reserved for a specific purpose, for example paying taxes the company owes. The company could be in a difficult situation assuming it spends that money on whatever else.

What Is an Example of Deferred Tax Liability?

A deferred tax liability normally happens when standard company accounting rules contrast from the accounting methods utilized by the government. The depreciation of fixed assets is a common example.Companies regularly report depreciation in their financial statements with a straight-line depreciation method. Basically, this equitably devalues the asset over time.But for tax purposes, the company will utilize an accelerated depreciation approach. Utilizing this method, the asset deteriorates at a greater rate in its initial years. A company might record a straight-line depreciation of $100 in its financial statements versus an accelerated depreciation of $200 in its tax books. Thusly, the deferred tax liability would rise to $100 duplicated by the tax rate of the company.