Deferred Income Tax: Definition, Purpose, and Examples

Deferred Income Tax

Zoe Hansen / Investopedia

What Is Deferred Income Tax?

A deferred income tax is a liability recorded on a balance sheet resulting from a difference in income recognition between tax laws and the company’s accounting methods. For this reason, the company’s payable income tax may not equate to the total tax expense reported. 

The total tax expense for a specific fiscal year may be different from the tax liability owed to the Internal Revenue Service (IRS), as the company is postponing payment based on accounting rule differences.

Key Takeaways

  • Deferred income tax is a result of the difference in income recognition between tax laws (i.e., the Internal Revenue Service [IRS]) and accounting methods (i.e., generally accepted accounting principles [GAAP]).
  • Deferred income tax shows up as a liability on the balance sheet.  
  • The difference in depreciation methods used by the IRS and GAAP is the most common cause of deferred income tax. 
  • Deferred income tax can be classified as either a current or long-term liability.

Deferred Income Tax

What Is the Purpose of Deferred Income Tax?

Generally accepted accounting principles (GAAP) guide financial accounting practices. GAAP accounting requires the calculation and disclosure of economic events in a specific manner. Income tax expense, which is a financial accounting record, is calculated using GAAP income. 

A deferred income tax liability results from the difference between the income tax expense reported on the income statement and the income tax payable.

In contrast, the IRS tax code specifies special rules on the treatment of events. The differences between IRS rules and GAAP guidelines result in different computations of net income, and subsequently, income taxes due on that income.

Situations may arise where the income tax payable on a tax return is higher than the income tax expense on a financial statement. In time, if no other reconciling events happen, the deferred income tax account would net to $0. 

However, without a deferred income tax liability account, a deferred income tax asset would be created. This account would represent the future economic benefit expected to be received because income taxes charged were in excess based on GAAP income.

Examples of Deferred Income

The most common situation that generates a deferred income tax liability is from differences in depreciation methods. GAAP guidelines allow businesses to choose between multiple depreciation practices. However, the IRS requires the use of a depreciation method that is different from all available GAAP methods. 

For this reason, the amount of depreciation recorded on a financial statement is usually different from the calculations found on a company’s tax return. Over the life of an asset, the value of the depreciation in both areas changes. At the end of the life of the asset, no deferred tax liability exists, as the total depreciation between the two methods is equal.

Why is deferred income tax an asset?

Deferred income tax can be considered either an asset or a liability depending on whether a company has overpaid or owes the taxes it has paid to tax authorities. However, it appears as a liability on the balance sheet.

What is deferred income tax in simple terms?

Deferred income tax is tax that must be paid in the future to account for differences in how companies recognize income and how tax authorities recognize income.

What is the difference between current tax and deferred tax?

Current tax is paid for a specific period, while deferred tax is intended to be paid in the future.

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