Deferred Tax Asset: What It Is and How to Calculate and Use It, With Examples

Deferred Tax Asset

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What Is a Deferred Tax Asset?

A deferred tax asset is an item on a company's balance sheet that reduces its taxable income in the future.

Such a line item asset can be found when a business overpays its taxes. This money will eventually be returned to the business in the form of tax relief. Therefore, the overpayment becomes an asset to the company.

A deferred tax asset is the opposite of a deferred tax liability, which indicates an expected increase in the amount of income tax owed by a company. 

Key Takeaways

  • A deferred tax asset is an item on the balance sheet that results from the overpayment or the advance payment of taxes.
  • It is the opposite of a deferred tax liability, which represents income taxes owed.
  • A deferred tax asset can arise when there are differences between tax rules and accounting rules.
  • They also occur with a carryover of tax losses.
  • Beginning in 2018, most companies could carry over a deferred tax asset indefinitely.

Understanding Deferred Tax Assets

A deferred tax asset is often created when taxes are paid or carried forward but cannot yet be recognized on the company's income statement.

For example, deferred tax assets can be created when the tax authorities recognize revenue or expenses at different times than those periods that the company follows, per an accounting standard.

These assets help reduce the company’s future tax liability.

It is important to note that a deferred tax asset is recognized only when the difference between the loss-value or depreciation of the asset is expected to offset its future profit.

A deferred tax asset might be compared to rent paid in advance or a refundable insurance premium. While the business no longer has the cash on hand, it does have its comparable value, and this must be reflected in its financial statements.

Examples of Deferred Tax Assets

One straightforward example of a deferred tax asset is the carryover of losses. If a business incurs a loss in a financial year, it usually is entitled to use that loss in order to lower its taxable income in the following years. In that sense, the loss is an asset.

Another scenario arises when there is a difference between accounting rules and tax rules. For example, deferred taxes exist when expenses are recognized in a company's income statement before they are required to be recognized by the tax authorities or when revenue is subject to taxes before it is taxable in the income statement.

Essentially, whenever the tax base or tax rules for assets and/or liabilities are different, there is an opportunity for the creation of a deferred tax asset.

There is no time limit on deferred tax assets. They can be used when it makes the most financial sense for a company. However, deferred tax assets can't be used with tax returns that have already been filed.

How to Calculate a Deferred Tax Asset

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Say a computer manufacturing company estimates, based on past experience, that the percentage of computers that will be sent back for warranty repairs in the next year is 2% of the total production. If the company's total revenue in year one is $3,000 and the warranty expense in its books is $60 (2% x $3,000), then the company's taxable income is $2,940.

However, most tax authorities do not allow companies to deduct expenses based on expected warranties. Thus, the company is required to pay taxes on the full $3,000.

If the tax rate for the company is 30%, the difference of $18 ($60 x 30%) between the taxes payable in the income statement and the actual taxes paid to the tax authorities is a deferred tax asset.

Special Considerations

There are some key characteristics of deferred tax assets to consider. First, starting in the 2018 tax year, they could be carried forward indefinitely for most companies, but are no longer able to be carried back.

The second thing to consider is how tax rates affect the value of deferred tax assets. If the tax rate goes up, it works in the company’s favor because the assets’ values also go up. This provides a bigger cushion for a larger income. But if the tax rate drops, the tax asset value also declines. This means that the company may not be able to use the whole benefit before the tax day deadline. 

Why Do Deferred Tax Assets Occur?

A balance sheet may reflect a deferred tax asset if a company has prepaid its taxes. It also may occur simply because of a difference in the time that a company pays its taxes and the time that the tax authority credits it. Or, it may indicate that the company overpaid its taxes. In such cases, the company's books need to reflect taxes paid by the company or money due to it.

Do Deferred Tax Assets Carry Forward?

Yes. Beginning in 2018, taxpayers could carry deferred tax assets forward indefinitely. They never expire and companies use them when it's most beneficial to do so.

What Is a Deferred Tax Asset vs. a Deferred Tax Liability?

A deferred tax asset represents a financial benefit, while a deferred tax liability indicates a future tax obligation or payment due. For instance, retirement savers with traditional 401(k) plans make contributions to their accounts using pre-tax income. When that money is eventually withdrawn, income tax is due on those contributions. That is a deferred tax liability.

The Bottom Line

A deferred tax asset relates to an overpayment or advance payment of taxes. For example, deferred tax assets can occur when there is a difference between when a tax authority recognizes revenue and when a company does, based on the accounting standards that the latter follows.

A deferred tax asset can reduce a company's taxable income in the future. Deferred tax assets are financial assets (as opposed to tangible assets) that appear on a company's balance sheet as non-current assets.

Article Sources
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  1. Internal Revenue Service. "Treasury Department and IRS Issue Guidance for Consolidated Groups Regarding Net Operating Losses."

  2. PWC. "Demystifying deferred tax accounting."

  3. Internal Revenue Service. "Publication 542: Corporations," Pages 14-15.

  4. Internal Revenue Service. "Instructions For Form 1139," Pages 1-2.

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