When a company pays expenses or taxes upfront, it is called deferring tax assets and will benefit from lower taxes in the future. Deferred tax liabilities occur when income is recognized early for accounting purposes but the taxes on it are deferred to later periods. The company's financial position over time is accurately reflected due to timing mismatches between tax laws and accounting standards.
Deferred tax assets and liabilities are accounting items that pertain to timing differences in the recognition of income or expenses for financial reporting versus tax purposes. This is how it's broken down:
Tax asset that has been postponed
- When a company pays more taxes upfront or recognizes expenses for tax purposes earlier than for accounting purposes, it represents a benefit. This results in a decrease in taxes in the future.
- If a company incurs a loss and holds it over for future years, the resulting tax savings would be a deferred tax asset.
Tax liability that has been put off
- A company deferring taxes to the future is known as a future obligation, usually by recognizing income earlier for accounting purposes but delaying it for tax reporting.
- Accelerating depreciation for tax purposes may cause a lower taxable income in the beginning but a higher taxable income in later years, resulting in a deferred tax bill.
In a nutshell, deferred tax assets provide future tax savings and reduce future taxes. Whereas, the deferred tax liability is future tax payment and increases future taxes.
