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What Does It Mean to Deferred Income Tax

Deferred tax is a liability that is on a balance sheet. It results from differences in income tax accounting between tax laws (IRS) and accounting policies (GAAP GAAP, Generally Accepted Accounting Principles, is a recognized set of rules and procedures that govern accounting and corporate finance). A deferred tax liability typically occurs when the company`s usual accounting standards differ from the accounting policies used by the government. Depreciation of fixed assets is a common example. This results in a temporary positive difference between the balance sheet result and the company`s taxable income as well as a deferred tax liability. Another common source of deferred tax liabilities is installment sales. This is the income that is captured when a company sells its products on credit to be reimbursed the same amount in the future. However, without an account for deferred tax liabilities, a deferred tax asset would be created. This account would represent the expected future economic benefits as income taxes levied on the basis of GAAP revenues have been exceeded. The amortization expense of durable assets for financial statement purposes is generally calculated on a straight-line basis, while tax rules allow companies to apply an accelerated depreciation method. Because the straight-line method results in lower depreciation than the accelerated method, a corporation`s accounting income is temporarily higher than its taxable income. Deferred tax assets occur when the company has already paid the tax.

The advantage of deferred tax assets is that the company will have fewer tax burdens in subsequent years. As a result, GAAP rules and principles may sometimes differ from IRS rules and principles. Such differences in rules can lead to differences in the calculation and deferral of income tax payments. A deferred tax liability results from the difference between the income tax expense reported in the income statement and the income tax payable. It is calculated when the corporation`s expected tax rate multiplies the difference between taxable income and retained earnings before tax. The most common situation leading to a deferred tax liability results from differences in depreciation methods. GAAP guidelines allow businesses to choose between several depreciation practices. However, the IRS requires the use of a different depreciation method than all available GAAP methods. Deferred income tax is mainly due to differences in earnings recognition between tax laws (IRS) and accounting policies (GAAP). Below are the key features of the IRS and GAAP to better understand how different they are. For example, some expenses are not deductible under the IRS, but GAAP allows them to be deducted from income.

This results in differences between accounting net income or GAAP and tax or IRS net income. This is most often called a book to tax the difference. Definition: A deferred tax liability is an income tax that a corporation owes but is moved to future years due to a difference between GAAP accounting and income tax accounting. This can be a difficult concept for beginners, but it`s actually quite simple. IRS tax rules and GAAP are not always the same. Deferred tax is a liability recognised in a balance sheet that results from a difference in the recognition of results between tax laws and the company`s accounting policies. For this reason, the corporate income tax payable may not be equal to the total tax charges reported. The deferred tax liability would be $500 x 20% = $100.

So we can see that in this case, DTL is created in year 1, since the company posted a profit higher than the taxable profit. In year 2, however, the tax declared corresponds to the tax payable and therefore no income tax effect. From year 3, the tax shown is less than the tax payable and, as a result, DTLs begin to run out in their balance. Sometimes the two sets of financial documents differ in terms of taxes. This may result in the payment by the Tax Company of tax companies that have not been committed in accordance with GAAP records. This creates a deferred tax asset on the balance sheet in GAAP records, called a prepaid income tax. Or it may result in taxes under GAAP records that do not yet have to be paid according to irs records. This creates a tax liability on the balance sheet in GAAP records, called deferred income tax. Differences in the timing of recognition of expenses and revenues generally result in these differences. Or the use of different methods of asset amortization in both groups of financial documents is at the root of these discrepancies.

The company recognises the deferred tax liability on the difference between the profit or loss on the balance sheet before tax and the taxable result. As the company continues to write down its assets, the difference between straight-line and accelerated depreciation narrows, and the amount of deferred tax liabilities is gradually eliminated through a series of offsetting entries. The main cause of deferred income taxes is differences between the calculation of depreciation under the IRS and GAAP. A deferred tax liability is an entry on a corporation`s balance sheet that recognizes taxes that are due but are not payable until a later date. Most large companies prepare two sets of financial cases – one for investors and one for tax authorities. .