If the tax rate changes, then under the asset-liability (or balance sheet) method, all deferred tax assets and liabilities must be revaluated using the new tax rate that is expected to be in place at the time of the reversal.

An increase in the expected tax rate at time of reversal will create a larger tax burden than expected for the company once the transaction is reversed. That said, the current tax expense also increases. This will have a negative impact on current net income and decrease stockholders' equity. A decrease in the tax rate will have the opposite effect.

Example: Company ABC has an EBITDA of $50,000 in the first five years of operations. To generate this income it purchases a machine for $40,000, with no salvage value at the beginning of year 5. The equipment has a five-year life. For tax purposes the company uses the double-declining depreciation method and uses a straight-line depreciation for financial-reporting purposes. At the time of purchase, the estimated tax rate at time of reversal was 40%.

In year 2 the tax rate at time of reversal is estimated at 20%.

Taxes payable = new tax rate x taxable income
= 20% x $41,411= $8,222

Deferred taxes = new tax rate x (DDM-SL)
= 20% x ($8,889-$13,333)
= ($899)

Benefit from tax rate in year 1 = [$42,500 x (40%-20%)] - [$30,000 x (40%-20%)]
= $1,250

Tax expense = tax payable in year 2 - decrease in deferred taxes in year 2 - benefits from tax rate on year 1 taxes
= $8,889 + $899-$2,667= $4,667



Long-Term Liability Basics

Related Articles
  1. Taxes

    Deferred Tax Liability

    Deferred tax liability is a tax that has been assessed or is due for the current period, but has not yet been paid. The deferral arises because of timing differences between the accrual of the ...
  2. Managing Wealth

    What is the Effective Tax Rate?

    The effective tax rate is the average rate at which an individual or corporation is taxed per year.
  3. Taxes

    Why America's Taxes Are Too Low

    The solution to America's economic woes may not be in lowering taxes further, but may, in fact, lie in increasing them.
  4. Taxes

    Use Tax Vs. Internet Sales Tax: How Are They Different?

    Learn about the differences between a use tax and an Internet sales tax. Find out about transactions in which the taxes apply, and to whom they apply.
  5. Insights

    A Concise History Of Changes In U.S. Tax Law

    We look at how U.S. taxes have changed since their inception.
  6. Taxes

    5 State Tax Issues For When You Leave the Military

    When you're budgeting for post-military life, certain state tax issues need to be considered.
  7. Financial Advisor

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  8. Taxes

    Understanding Taxes

    Taxes are mandatory fees that individuals and corporations must pay to their governments.
  9. Taxes

    Federal Tax Brackets

    Why do we have income tax brackets? What do they do for us? Read this to understand the basics and where to find your own bracket.
  10. Taxes

    Which Countries Have the Highest Taxes on High Incomes?

    These countries charge the highest taxes on high incomes.
Frequently Asked Questions
  1. Where else can I save for retirement after I max out my Roth IRA?

    The first option to explore is to determine if you can contribute to a 401(k), 403(b), or 457 plan at work. If your employer ...
  2. How did George Soros "break the Bank of England"?

    In Britain, Black Wednesday (September 16, 1992) is known as the day that speculators broke the pound. They didn't actually ...
  3. What counts as "debts" and "income" when calculating my debt-to-income (DTI) ratio?

    It's important to know your debt-to-income ratio because it's the figure lenders use to measure your ability to repay the ...
  4. Who are Monsanto's main competitors?

    Learn about Monsanto Company's two main operating divisions and its main competitors within each sector, including The Mosaic ...
Trading Center