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Deferred Income Tax

See Also:
Marginal Tax Rate
Prepaid Income Tax
Flat Tax Rates
Tax Brackets
Deferred Revenue
Cash Flow After Tax

Deferred Income Tax¶

In accounting, deferred income tax is a liability listed on the balance sheet that represents an obligation to pay taxes.

Deferred Tax Asset and Liability

Most large corporations prepare two sets of financial records – one set for investors and one set for tax authorities. The set of financial records intended for investors is prepared according to GAAP standards and is meant to accurately portray the company’s financial performance and condition. The set of financial records intended for tax authorities is prepared according to IRS tax laws and is meant to minimize the taxes the company has to pay.

Sometimes the two sets of financial records differ in terms of taxes. This can result in the company paying taxes that have not been incurred according to the GAAP records. This creates a deferred tax asset on the balance sheet in the GAAP records called prepaid income tax. Or it can result in the company incurring taxes according to the GAAP records that don’t yet have to be paid according to the IRS records. This creates a tax liability on the balance sheet in the GAAP records called deferred income tax. The discrepancies are typically caused by differences in the timing of the recognition of expenses and revenues or the usage of differing methods of depreciating assets in the two sets of financial records.

More simply, when the company pays income taxes before recognizing the need to pay those income taxes the amount paid is recorded as an asset on the balance sheet because it represents a future benefit to the company. The asset account is called prepaid taxes. When the company recognizes the need to pay income taxes before those income taxes are actually paid the amount is recorded as a liability on the balance sheet because it represents a future obligation of the company. The liability account is called deferred income tax.

Deferred Income Tax Example

For example, if a corporation prepares two sets of financial statements and uses different accounting techniques in each set of documents, the tax records may end up showing different amounts. Let’s say the ABC Company prepared one set of financial statements for the IRS that shows a tax expense of $150,000.

However, during that same fiscal period, the set of financial statements the company prepared for investors shows the company owes taxes of $200,000. The difference of $50,000, which represents taxes owed according to the GAAP financial statements, has not yet been paid because it is not owed according to the IRS financial statements. This amount is then recorded as a liability on the balance sheet in the GAAP records indicating an obligation to pay income taxes in the future.