Deferred Taxes

Differences between accounting profit and taxable income result in deferred taxes. Deferred taxes affect the total tax expense paid by a company, adjusting taxable income for any deferred tax asset or deferred tax liability.

Deferred tax assets occur when more income taxes are paid than what is recorded on the financial statements, and there is the expectation that the asset will reverse. A valuation allowance account would be created based on the probability of reversal. A deferred tax asset would be applied if there is a strong probability of accounting income in the following period.

Deferred tax liabilities occur when a shortfall of income taxes are paid than what is recorded on the financial statements. In the case of a deferred liability, income tax payable is less than tax expense and the liability is expected to be eliminated when income tax payable is greater than the tax expense.

Deferred taxes can be the result of differences in reporting standards as well as variations in an asset's tax base and its carrying amount. A tax loss carry forward arises when a company expects to reduce future taxable income by recognizing a loss in the current period. Differences in taxable income can result from:

Time lapses between revenue and expense recognition.
Disparity in carrying amount and tax bases of assets or liabilities.
Deductibility discrepancies for assets or liabilities gains and losses.
Tax rules.
Treatment for financial reports and taxable income as it relates to prior year adjustments.

These deferred assets or liabilities are the result of temporary differences and as such are expected to reverse over time. Conversely, permanent differences are those that are not expected to reverse and do not create a deferred tax. Examples of permanent differences include:

Tax credits that reduce taxes.
Revenues or expenses that are not allowed by tax laws.

Financial Terms by BetterTrades