Deferred tax liability is a tax obligation that has been deferred to a future period. This means that the tax liability has not yet been paid, but will be owed at some point in the future. Deferred tax liabilities can arise for a variety of reasons, including income earned in a previous year but not taxed until the current year (deferred income), or expenses incurred in the current year but not deducted until the following year (deferred expenses).
When there are time differences between the book tax and actual income tax, deferred tax liability or asset is generated. Temporary variances between pre-tax book income and taxable revenue can be caused by a variety of transactions, resulting in deferrals of taxes or liabilities. While the analysis of taxes in itself might be difficult, deferred tax assets and liabilities add another level of complexity to the process.
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What is Deferred Tax Liability?
Deferred tax liability is an income tax liability that has been deferred to a future period. The deferred tax liability arises when there is a difference between the carrying value of an asset or liability on the balance sheet and its tax value. It occurs when a tax is owed by a firm that has not yet been paid.
In a nutshell, deferred tax liabilities are incurred when income tax expense (income statement item) exceeds taxes payable (tax return), and the difference will reverse in the future. The amount of income taxes that will be paid in later years as a consequence of temporary taxable variances are known as DTL.
Understanding Deferred tax liabilities
Deferred tax liability means the amount of taxes a company owes for future tax payments. The company’s tax liability means that it will have to pay taxes in the future, but the amount is not yet known. The company’s deferred tax liability is recorded on its balance sheet as a liability.
Deferred tax liability arises when a company uses the accelerated depreciation method for financial reporting purposes, but the tax laws require the use of the straight-line method. This results in a higher reported income for financial reporting purposes, but a lower tax liability.
Deferred tax balances represent the amount of tax that a company owes in the future. This can be due to different tax laws or accounting methods used by the company. The company’s tax liability means the amount of future tax payments that the company will have to make. The net income of a company is used to calculate its deferred tax liability. The accelerated depreciation method is often used for financial reporting purposes. This results in a higher deferred tax liability.
Importance of Deferred Tax Liability
The deferred tax liability is an important part of a company’s financial statements. It represents the amount of taxes that a company will eventually have to pay but has deferred to a future period. This deferred amount can have a significant impact on a company’s cash flow and profitability.
Deferred tax liability is important because it represents a future obligation that a company will have to pay. This deferred amount can have a significant impact on a company’s cash flow and profitability. If a company does not have the cash to pay its deferred tax liability when it comes due, it may be forced to sell assets or take out loans to cover the amount.
A deferred tax liability can also impact a company’s stock price. If investors believe that a company will not be able to pay its deferred tax liability when it comes due, they may sell the stock, driving down the price.
Deferred Tax Liabilities Calculation
In general, country tax rules differ from accounting standards (GAAP and IFRS). This causes income tax expense to be recorded differently in the income statement than the actual amount of tax owed to the authorities.
The calculation of deferred tax liability revolves around finding the difference between a company’s taxable income and account earnings before taxes, multiplied by its expected tax rate.
An equation you can use to calculate your deferred tax liability is
DTL = Income Tax Expense – Taxes Payable + Deferred Tax Assets
How Deferred Tax Liability Works?
In order to deferred tax liability, there needs to be a difference between the carrying value of an asset or liability on the balance sheet and its tax value.
This usually occurs because of a temporary difference. A temporary difference is when an expense is deducted for accounting purposes but not yet deductible for tax purposes. The most common type of temporary difference is depreciation. When an asset is purchased, it is depreciated over time for accounting purposes but not yet depreciated for tax purposes. This creates a deferred tax liability because the taxes owed on the income generated by the asset are deferred to a later period.
Another example of a temporary difference is when interest expense is incurred but not yet deductible for tax purposes. This can happen when a company takes out a loan and immediately deducts the interest expense for accounting purposes, but the loan is not yet due and payable for tax purposes. This creates a deferred tax liability because the taxes owed on the income generated by the loan are deferred to a later period.
Permanent differences are those that will never result in deferred tax liability or assets. An example of a permanent difference is when gains or losses from the sale of assets are not taxed. These gains or losses are never included in taxable income so they can never create a deferred tax liability. Another example of a permanent difference is when income earned in foreign countries is not subject to U.S. taxes. This income is never included in taxable income so it can never create a deferred tax liability.
Deferred Tax Liability vs Deferred Tax Asset
A deferred tax asset is the opposite of deferred tax liability. A deferred tax asset is created when a company’s taxable income is less than its accounting income. This difference creates a temporary tax benefit that will reduce taxes owed in future periods.
An example of a deferred tax asset would be if a company has losses in one year but expects to be profitable in future years. The company can carry the losses forward to offset future taxable income and reduce its taxes owed. This deferred tax asset will reduce taxes owed in future periods and is therefore recorded on the balance sheet as an asset.
Some of the notable differences between these two are
- DTL is created when there is a difference between accounting income and taxable income while deferred tax asset is created when there is a difference between taxable income and accounting income.
- DTL increases the tax payable in the future while deferred tax asset decreases the tax payable in the future.
- The treatment of deferred tax liability and deferred tax assets are different. The deferred tax liability is treated as a current liability while the deferred tax asset is treated as a non-current asset.
- Income taxes payable for the current year include deferred tax liabilities while deferred tax assets are reported in the equity section of the balance sheet.
- DTL arises when an enterprise has book profit but not taxable profit or when an enterprise’s taxable profit is less than book profit while deferred tax asset occurs when an enterprise has taxable profit more than the book profit.
- DTL is created due to temporary differences while deferred tax asset is created due to permanent differences.
- The deferred tax liability will always be a debit balance while deferred tax asset can either be a debit or credit balance.
- The deferred tax liability is created when the tax rate is higher in the future as compared to the present while deferred tax asset is created when the tax rate is lower in the future as compared to the present.
- DTL indicates that an enterprise will have to pay more taxes in the future while deferred tax asset indicates that an enterprise will have to pay fewer taxes in the future.
Deferred tax liability examples
Some of the examples of DTL are
1. Tax Underpayment
It happens when the taxes due for a particular period are not paid on time. In that case, the deferred tax liability is created which is equal to the amount of tax due.
2. Losses Carried Forward
If a company has losses in a particular year, it can carry forward those losses to offset future taxable income. This deferred tax liability will reduce taxes owed in future periods.
3. Depreciation
When a company depreciation its assets for accounting purposes, it is allowed to take a tax deduction for that depreciation. This deferred tax liability will reduce taxes owed in future periods.
4. Accrued Expenses
If a company accrues expenses but does not pay them in the current period, those expenses can be deducted in future periods. This deferred tax liability will reduce taxes owed in future periods.
5. Deferred Revenue
If a company deferred revenue, it means that it has received payment for goods or services but has not yet delivered those goods or services. This deferred tax liability will reduce taxes owed in future periods.
6. Unused Tax Losses and Credits
If a company has losses or credits that it has not used in the current period, it can carry those forward to offset future taxable income. This deferred tax asset will reduce taxes owed in future periods.
How DTL impacts taxes
The majority of small businesses (as well as individuals) have a tax obligation from time to time, and it’s important for you to understand how DTL affects taxes. The fact is that if your company has an outstanding balance owing on its tax payments, it will have to make it up in the following year.
The only thing that would influence this is changes in the tax rates. Such changes will let your balance get fluctuated and hence, you might owe more money in taxes than you anticipated.
How DTL impacts the financial status of your business
From the point of view of business, the deferred tax liability is nothing but the deferred payment of taxes. This means that you have to pay more taxes in the future as compared to the present.
This deferred amount will impact your business in two ways-
1. First, this deferred amount will be treated as a current liability on your balance sheet. This will increase your liabilities and hence, reduce your equity.
2. Secondly, this deferred amount will reduce the cash available to you which can be used for other purposes like paying off debt or investing in new projects.
Thus, it is important for you to keep a track of DTL so that it does not have a negative impact on the financial status of your business.
How DTL impacts business growth
If deferred tax liability is not managed properly, it can have a negative impact on the growth of your business. This is because DTL will reduce the cash available to you which can be used for other purposes like investing in new projects or paying off debt.
This data is useful for investors who wish to evaluate whether or not they should put money into a company. If a firm appears to have an excessive amount of debt relative to its revenue, this may signal that the organization’s capacity to attract future capital will be jeopardized.
Deferred tax liabilities, on the other side, may be beneficial to some large businesses on the stock market since their net worth is represented as a lower number than what they have already accounted for. This might put them in a stronger financial position when it comes to paying dividends to shareholders and paying employees because the higher the company’s net worth they would find, the more money they will demand which might result in less discretionary income.
Therefore, you need to understand that DTL isn’t necessarily a negative thing, and it doesn’t imply you underpaid your taxes. You just need to think about it while managing your company’s finances. If you expect you’ll have to pay deferred taxes at some point, you need to focus on paying down other debts to keep the scales balanced.
Why would I have a deferred tax liability balance?
There are a variety of reasons you might have a deferred tax liability, but the most common one is because your company is making money. When you make money, you deferred taxes on that income until you actually receive it. This means that you have to pay taxes in the future, which creates a deferred tax liability.
Other reasons for deferred tax liabilities include carrying forward losses from previous years or claiming deductions in the current year that will be used in future years.
No matter what the reason is, if you have a deferred tax liability, it’s important to keep track of it and make sure it doesn’t get too high. Otherwise, you might find yourself in a difficult financial situation in the future.
How to reduce deferred tax liability
There are a few ways to reduce deferred tax liability, but the most common one is by using tax-advantaged investment accounts. These accounts allow you to defer taxes on the income you make in them until you withdraw the money.
Is there a benefit to deferred tax liabilities?
Some corporations have used deferred tax liabilities to help them actually save money on taxes. This is not to say your company should necessarily try this strategy, but it’s important to note how deferred tax liabilities are (sometimes) used in the corporate world.
Some businesses have used deferred tax liabilities to help them save money on taxes. It does not suggest that your firm should use this method, but it’s worth noting how DTL sometimes may function in your favor.
In 2018, when the corporate tax rate was cut from 35% to 21%, Forbes predicted that firms with large DTLs would benefit since they would be paying the lower rate for taxes owing rather than the maximum of 35%.
Conclusion!
On the concluding note, it is clear that deferred tax liability is a thing that needs to be managed with utmost care. DTL can have an impact on the growth of the business if not managed properly.
Also, deferred tax liabilities are created when a company is making money and recognizing the deferred taxes owed in future years. While deferred taxes can be a good thing for some companies, it’s crucial to keep on tracking them to make sure they don’t get too high. Otherwise, you might find yourself in a difficult financial situation in the future.
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