Deferred Income Tax
A deferred income tax is a liability recorded on a balance sheet resulting from a difference in income recognition between tax laws and the company's accounting methods. A deferred income tax liability results from the difference between the income tax expense reported on the income statement and the income tax payable. A deferred income tax is a liability recorded on a balance sheet resulting from a difference in income recognition between tax laws and the company's accounting methods. Situations may arise where the income tax payable on a tax return is higher than the income tax expense on a financial statement. Deferred income tax is a result of the difference in income recognition between tax laws (i.e., the IRS) and accounting methods (i.e., GAAP).
What Is Deferred Income Tax?
A deferred income tax is a liability recorded on a balance sheet resulting from a difference in income recognition between tax laws and the company's accounting methods. For this reason, the company's payable income tax may not equate to the total tax expense reported.
The total tax expense for a specific fiscal year may be different than the tax liability owed to the Internal Revenue Service (IRS) as the company is postponing payment based on accounting rule differences.
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 record, is calculated using GAAP income.
A deferred income tax liability results from the difference between the income tax expense reported on the income statement and the income tax payable.
In contrast, the IRS tax code specifies special rules on the treatment of events. The differences between IRS rules and GAAP guidelines result in different computations of net income, and subsequently, income taxes due on that income.
Situations may arise where the income tax payable on a tax return is higher than the income tax expense on a financial statement. In time, if no other reconciling events happen, the deferred income tax account would net to $0.
However, without a deferred income tax liability account, a deferred income tax asset would be created. This account would represent the future economic benefit expected to be received because income taxes charged were in excess based on GAAP income.
Examples of Deferred Income
The most common situation that generates a deferred income tax liability is from differences in depreciation methods. GAAP guidelines allow businesses to choose between multiple depreciation practices. However, the IRS requires the use of a depreciation method that is different from all the available GAAP methods.
For this reason, the amount of depreciation recorded on a financial statement is usually different than the calculations found on a company’s tax return. Over the life of an asset, the value of the depreciation in both areas changes. At the end of the life of the asset, no deferred tax liability exists, as the total depreciation between the two methods is equal.
Related terms:
Balance Sheet : Formula & Examples
A balance sheet is a financial statement that reports a company's assets, liabilities and shareholder equity at a specific point in time. read more
Deferred Tax Asset
A deferred tax asset is a line item on a company's balance sheet that reduces its taxable income. read more
Deferred Tax Liability
A deferred tax liability is a line item on a balance sheet that indicates that taxes in a certain amount have not been paid but are due in the future. read more
Depreciation
Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account for declines in value over time. read more
Financial Accounting
Financial accounting is the process of recording, summarizing and reporting the myriad of a company's transactions to provide an accurate picture of its financial position. read more
Generally Accepted Accounting Principles (GAAP)
GAAP is a common set of generally accepted accounting principles, standards, and procedures that public companies in the U.S. must follow when they compile their financial statements. read more
Income Tax Payable
Income tax payable is an account in a balance sheet's current liability section that records income taxes owed. read more
What Is the Internal Revenue Service (IRS)?
The Internal Revenue Service (IRS) is the U.S. federal agency that oversees the collection of taxes—primarily income taxes—and the enforcement of tax laws. read more
Net Income (NI)
Net income, also called net earnings, is sales minus cost of goods sold, general expenses, taxes, and interest. read more