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)
Benefit from tax rate in year 1 = [$42,500 x (40%-20%)] - [$30,000 x (40%-20%)]
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
InvestingDeferred 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 ...
Personal FinanceA Deferred Tax Asset is an asset on a company’s balance sheet that may be used to reduce taxable income. It is the opposite of a deferred tax liability, which describes something that will increase ...
InvestingNet of tax is a figure that has been adjusted for taxes.
Personal FinanceThe effective tax rate is the average rate at which an individual or corporation is taxed per year.
InvestingDeferred income tax is a liability on a balance sheet that reflects income tax that is allocable to the current period, but has not yet been paid.
Personal FinanceLearn the logic behind the belief that reducing government income benefits everyone.
Personal FinanceLearn 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.
Personal FinanceThe number of taxes that we now consider a given did not always exist. Find out how they arose.
Personal FinanceWe look at how U.S. taxes have changed since their inception.
Personal FinanceTaxes are mandatory fees that individuals and corporations must pay to their governments.