Deferred Tax Liability
Deferred tax liability is a tax liability that is not paid when the income is earned but is paid in the future when the income is realized. It is typically incurred on assets that are not yet taxable, such as depreciation of equipment.
Causes of Deferred Tax Liability:
- Depreciation of assets: When assets are depreciated, the depreciation expense reduces taxable income, resulting in a deferred tax liability for the future years.
- Deferred revenue: Income that is earned but not collected until the following year is treated as deferred tax liability.
- Carryback provisions: Certain tax deductions or credits can be carried back to previous years, creating a deferred tax liability for those years.
Examples of Deferred Tax Liability:
- A company purchases equipment for $100,000. The equipment is depreciated over five years, reducing taxable income by $20,000 each year. This results in a deferred tax liability of $20,000 for each of the next five years.
- A company receives payment for services that will be performed in the next year. The revenue is recorded as deferred tax liability until the services are performed.
Accounting Treatment:
Deferred tax liability is accounted for using a deferred tax liability account. The liability is increased when taxable income increases and decreased when taxable income decreases. The changes in the liability are recorded in the period they occur.
Financial Statement Disclosures:
Companies are required to disclose their deferred tax liability on their financial statements. This disclosure typically includes the amount of the liability, the related tax rate, and the expected timing of payment.
Tax Implications:
Deferred tax liability has a significant tax implication as it can affect the company’s taxable income and taxable liability in different periods. It is important for companies to manage their deferred tax liability effectively to ensure they are paying the correct taxes at the appropriate time.
FAQs
What is the difference between DTA and DTL?
Deferred Tax Asset (DTA) represents future tax savings, occurring when a company has paid more taxes upfront than it owes. Deferred Tax Liability (DTL), on the other hand, represents future tax obligations when a company has postponed some tax payments. DTA is beneficial for the company, while DTL indicates future tax payments.
What is a deferred tax asset with an example?
A deferred tax asset arises when a company pays taxes in advance or has tax-deductible losses. For example, if a company overpays taxes due to temporary differences like depreciation, it can record a deferred tax asset, which will reduce future taxable income.
What is the difference between deferred tax expense and deferred tax liability?
Deferred tax expense refers to the adjustment made to account for future tax liabilities or assets. A deferred tax liability, however, specifically represents taxes that will be owed in the future due to temporary differences in recognizing income or expenses for tax purposes versus accounting standards.
When do you recognize a deferred tax asset?
A deferred tax asset is recognized when there is a reasonable expectation that the company will have future taxable income to offset the asset. This typically occurs due to deductible temporary differences, tax credits, or losses carried forward.
Is deferred tax asset a cash-like item?
No, deferred tax assets are not cash-like items. They represent potential future tax benefits but do not directly provide cash. Instead, they reduce future tax liabilities when realized.
