What is 'Future Income Taxes'

Future Income taxes are income taxes deferred by discrepancies between, for example, net income reported on a tax return and net income reported on financial statements.  Computation of net income using different methods or in different time periods result in two figures. One is for tax purposes, and the other is for financial purposes and taxes will be different.  Accordingly, taxes reported on financial statements will be understated or overstated relative to taxes reported on a tax return. This difference creates a future income tax liability or benefits for financial reporting purposes.

BREAKING DOWN 'Future Income Taxes'

 

Future income taxes are accounting entries made by adjustment or reversal to a financial statement to account for differences between net income recognized and reported for tax and financial purposes. Taxing authorities consider net income, and ultimately taxes, in a different way than do companies on their financial statements. The main difference is when it comes to the amount or timing of income or expense recognition.  

Different Accounting Methods

The differences between the reporting of type, or timing of, income and expenses by accrual accounting and tax accounting methods cause future tax consequences. Accrual accounting is standard for financial reporting purposes. Tax accounting is usual for the Internal Revenue Code (IRC) tax reporting purposes. The nominal amount of the future income taxes is equal to the differences multiplied by the applicable tax rate. 

Using generally accepted accounting principals (GAAP) requires that, when reported to financial statements, income earned matches to expenses incurred during the same period. Income and expense are recognized when earned or incurred. Conversely, IRC’s tax accounting principles generally recognize income when it is received and expenses at payment. Differences can be permanent or temporary.

Permanent vs. Temporary Differences

In some cases, recognition of income or expenses by GAAP will never be recognized by IRC or vice versa, causing a permanent difference. For example, when GAAP recognizes income from a transaction (to assess and report performance data) that IRC doesn’t recognize (due to a non-recognition provision). In such cases, taxable and financial income and expenses will always be different. Hence, these differences are permanent. 

Temporary differences arise when GAAP recognizes income or expenses before or after the IRC does. Since the two use differing methods, avoiding temporary differences only happens when earned income is received, and incurred expenses are paid simultaneously. Any difference in the date of receipt or debit causes reporting in different time periods.

The use of an accounting reversal entry in the same period as the transaction allows for a matching entry and recognition by both GAAP and IRC methods. Matching of income and expense in the same period is bookend by completion causing taxable and financial income to be the same.

Future Tax Obligations and Benefits

There are two types of future income taxes, future income tax obligations or future income tax benefits. Future tax obligations are called deferred income tax liabilities. These future tax liabilities are taxes incurred but not yet owed on income earned but awaiting payment. Future tax benefits are called deferred income tax assets. These future income tax benefits are taxes owed on income received but not yet earned. To identify future tax as a liability or benefit, determine if taxable income and expense increases or decreases with the temporary difference.

Future income taxes are deferred income tax liabilities when taxable income decreases relative to financial income due to temporary differences and then increases when reversing temporary differences. A decrease followed by an increase means more taxes will be owed in the future. In short, relative decrease at the onset of temporary differences and relative increase in the reversal is a tax liability.

Future income taxes are deferred income tax assets when taxable income increases relative to financial income due to temporary differences and then decreases with reversal of the temporary difference. An increase followed by a decrease means fewer taxes will be owed in the future. In short, relative increase at the onset of temporary differences and a relative decrease in reversal is a tax benefit.

RELATED TERMS
  1. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
  2. Effective Tax Rate

    The effective tax rate is the average rate at which an individual ...
  3. Tax Break

    A tax break is a savings on a taxpayer's liability. It is also ...
  4. Income

    Income is money that an individual or business receives on a ...
  5. Tax Relief

    Tax relief is any program or incentive that reduces the amount ...
  6. Annualized Income

    Annualized income is an estimate of the amount of money that ...
Related Articles
  1. Taxes

    Deferred Tax Liability

    Deferred 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 ...
  2. Taxes

    Deferred Tax Asset

    A 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 ...
  3. Taxes

    Which Countries Have High Taxes on High Incomes?

    For high earners in these countries, the tax rate percentage on income exceeding a certain threshold can reach into the high 50s and low 60s.
  4. Financial Advisor

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  5. Taxes

    Taxes: Who Pays And How Much?

    When it comes to taxes, the debate is endless on who pays what, especially in Congress. With no new initiatives in sight, let's take a look at who is paying now.
  6. Taxes

    Comparing Long-Term vs. Short-Term Capital Gains Tax Rates

    A firm understanding of the difference between the taxation of long- and short-term capital gains is crucial to ensuring the benefits of your investment portfolio outweigh the costs.
  7. Taxes

    How to Reduce Risk With Tax Diversification

    Is your retirement income adequately diversified from a tax standpoint?
  8. Taxes

    Minimizing the Amount of Income Tax You Owe

    The amount of income you receive and tax deductions and credits you take impact how much you'll owe.
  9. Taxes

    How Tax Cuts Stimulate the Economy

    Learn the logic behind the belief that reducing government income benefits everyone.
RELATED FAQS
  1. What are some examples of a deferred tax liability?

    Learn why deferred tax liability exists, with specific examples that illustrate how it arises as a result of temporary differences. Read Answer >>
  2. What is the difference between a state income tax and a federal income tax?

    Learn the difference between state income tax and federal income tax based on tax rates, deductions, tax credits and taxable ... Read Answer >>
Trading Center