Deferred Tax Liability

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What is a 'Deferred Tax Liability'

A deferred tax liability is an account on a company's balance sheet that is a result of temporary differences between the company's accounting and tax carrying values, the anticipated and enacted income tax rate, and estimated taxes payable for the current year. This liability may be realized during any given year, which makes the deferred status appropriate.

Because there are differences between what a company can deduct for tax and accounting purposes, there is a difference between a company's taxable income and income before tax. A deferred tax liability records the fact the company will, in the future, pay more income tax because of a transaction that took place during the current period, such as an installment sale receivable.

BREAKING DOWN 'Deferred Tax Liability'

Because U.S. tax laws and accounting rules differ, a company's earnings before taxes on the income statement can be greater than its taxable income on a tax return, giving rise to a deferred tax liability on the company's balance sheet. The deferred tax liability represents a future tax payment a company is expected to make to appropriate tax authorities in the future, and it is calculated as the company's anticipated tax rate times the difference between its taxable income and accounting earnings before taxes.

Examples of Deferred Tax Liability Sources

A common source of deferred tax liability is the difference in depreciation expense treatment by tax laws and accounting rules. The depreciation expense for long-lived assets for financial statements purposes is typically calculated using a straight-line method, while tax regulations allow companies to use an accelerated depreciation method. Since the straight-line method produces lower depreciation when compared to that of the underaccelerated method, a company's accounting income is temporarily higher than its taxable income. The company recognizes the deferred tax liability on the differential between its accounting earnings before taxes and taxable income. As the company continues depreciating its assets, the difference between straight-line depreciation and accelerated depreciation narrows, and the amount of deferred tax liability is gradually removed through a series of offsetting accounting entries.

Another common source of deferred tax liability is an installment sale, which is the revenue recognized when a company sells its products on credit to be paid off in equal amounts in the future. Under accounting rules, the company is allowed to recognize full income from the installment sale of general merchandise, while tax laws require companies to recognize the income when installment payments are made. This creates a temporary positive difference between the company's accounting earnings and taxable income, as well as a deferred tax liability.

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  3. What is a deferred tax liability?

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  5. How does a company derecognize a deferred tax liability?

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