A deferred tax liability is the result of differences in the way a company does its financial accounting for reporting purposes according to generally accepted accounting principles (GAAP) versus tax accounting. The deferred tax liability represents an obligation to pay taxes in the future. The obligation originates when a company delays an event that would cause it to also recognize tax expenses in the current period.
Essentially, a deferred tax liability is a tax expense a company would otherwise have to recognize but has postponed to a later period due to accommodations in the tax code. It is important to note that the existence of a deferred tax liability does not indicate a company underpaid on its tax bill. It simply acknowledges the accounting differences in timing between when the tax was recognized in the company's financial statements relative to when the tax is effective via the tax code.
Why would a company account for taxable events, such as recognizing income, differently when reporting to shareholders versus taxing authorities? Varying motivations underlying the alternative presentations precipitates this behavior. A company wants to position itself in the best light to shareholders. At the same time, it is advantageous for a company to portray a muted position to taxing authorities because less income means less taxes. As such, it is in the company's best interest to take advantage of differences in the tax code relative to how it reports to shareholders.
One of the most common causes of deferred tax liabilities comes from varying asset depreciation schedules. For example, suppose a company uses an accelerated depreciation method to depreciate certain assets for tax reasons; more depreciation reduces income, which subsequently reduces taxes. Now, also suppose the company uses straight-line depreciation when reporting to shareholders. Because accelerated depreciation is front-loaded and straight-line is evenly distributed, straight-line depreciation results in greater income and greater taxes when reporting to shareholders. The company needs to account for the difference in tax expenses under the two reporting methods. It does so by creating a deferred tax liability on its balance sheet for the difference.