Deferred tax asset vs deferred tax liability

·  1  Understand the difference between a deferred tax asset and a deferred tax liability. A deferred tax asset arises because taxes have been paid (or losses have been carried forward). Deferred tax liabilities are tax payments that have made it to the income statement, but have not flowed through to the cash flow statement.That is, no cash has changed accounts.

·  2  Review the causes of deferred taxes. Deferred taxes usually originate on the income statement. Accelerated depreciation (which speeds up expenses, and lowers tax payments) is one common cause. In general, any asset with a higher book value (as carried in the books) than tax basis will have a deferred tax liability. If the carrying value is less than the tax basis, it will result in a deferred asset.

·  3   Work through an example. The accounting income for Company XYZ is $110 and the tax expense is 20% of the accounting income. The tax expense is $22 ($110*.20). Income tax payable is the amount the IRS demands a corporation pay (the company has not been paid yet).

·  4   Calculate the deferred tax. The difference between the $110 gross income and the $88 in taxable income is $22. This amount is a deferred tax liability.

 

·  5  Change to a deferred tax asset. Had the amount been paid (carry forward) prior to taxes being due to the IRS, the amount would be considered a tax asset.

Accounting Treatment

• The accounting treatment of deferred taxes is regulated under U.S. Generally Accepted Accounting Principles, and the Financial Accounting Standards Board (FASB) has released SFAS No. 109 to cover the accounting issues related to deferred taxes.

Deferred Tax Asset

• A deferred tax asset is created when a company has paid taxes to the government, but not yet recorded the expense on its income statement for financial purposes. A deferred tax asset can also be composed of tax losses from previous years that are carried forward to offset future gains. This deferred tax asset is reduced if the tax benefits of the assets are not expected to be realized.

Deferred Tax Liability

• A deferred tax liability is created when a company has expensed a tax payment for financial accounting purposes, but not paid the taxes due on its tax return. This can be caused by adopting different accounting methods for financial versus tax purposes.