Deferred tax liability definition
/What is a Deferred Tax Liability?
A deferred tax liability is income taxes payable in a future period. The liability arises from differences in the methods used to account for certain transactions under tax rules and the applicable accounting framework. A considerable number of reporting periods may pass before a deferred tax liability is paid.
Example of a Deferred Tax Liability
A company uses straight-line depreciation for accounting purposes but accelerated depreciation for tax purposes. In the early years, its tax depreciation will be higher than the book (accounting) depreciation, resulting in lower taxable income initially but higher taxable income in later years as the depreciation evens out. The company defers part of its tax expense to a future period, creating a deferred tax liability.
Accounting for a Deferred Tax Liability
The initial entry for a deferred tax liability is a credit entry, which is eventually reversed with a debit when the liability is finally settled.
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FAQs
Are Deferred Tax Liabilities Permanent?
Deferred tax liabilities are not permanent; they arise from temporary differences between the tax base and accounting base of assets or liabilities. These differences reverse over time, leading to the eventual payment of taxes. Once the temporary difference resolves, the deferred tax liability is eliminated.