Deferred Tax LiabilityDefined with Examples & More

Written By:
Lisa Borga

What is a Deferred Tax Liability?

A deferred tax liability (DTL) is a tax that a company owes which has not yet been paid.

This primarily occurs due to a difference in when revenue is earned and when it is actually received.

For example, if a credit sale is made in the first year and payment will only occur in the second, the business can defer its tax liability until the second year.

DTL is recorded on a business’s balance sheet and reflects taxes that the company must pay on a future date.

Understanding Deferred Tax Liabilities

A deferred tax liability appears on the balance sheet of a business and shows a tax payment that will be due in the future.

These tax liabilities occur due to the accounting income being higher than the business’s taxable income.

However, the difference is temporary and will end when the taxes are paid in the following accounting period.

A deferred tax liability is not the result of a business not paying its taxes.

Instead, it is a tax payment that is not yet due.

As an example, suppose a business has net income during the year on which it realizes it will need to pay taxes.

This DTL pertains to the present year; therefore, it must match an expense in the same accounting period.

However, the tax won’t be paid by the business until the following year.

Because of this difference in timing, the business will record the difference as a DTL.

Deferred Tax Liabilities and Depreciation Expense

deferred tax liability

One of the more common reasons businesses have deferred tax liabilities is due to the way depreciation expense is handled in tax laws as compared to accounting rules.

When businesses calculate depreciation for their financial statements for assets with long useful lifespans, the depreciation method they typically use is straight-line depreciation.

However, tax laws permit businesses to use accelerated methods of depreciation.

But, since using the straight-line method of depreciation results in lower depreciation than using an accelerated method, businesses end up with an accounting income that is greater than their taxable income.

This difference between the business’s taxable income and its accounting income before taxes results in its deferred tax liability.

The difference between the two methods of depreciation will decrease over time as the business continues to depreciate its assets.

This will cause the DTL to disappear in time after the appropriate offsetting accounting entries are made.

Installment Sales

Businesses may also have a deferred tax liability if they have income from installment sales.

Revenue from installment sales occurs when businesses sell products to customers on credit, which then allows the customers to pay off the purchases over time.

Businesses are permitted to recognize the entire amount of income from their general merchandise installment sales when following accounting rules.

In contrast, when following tax laws, businesses must recognize the income from installment sales when the customers make the installment payments.

Following different rules causes a business’s accounting income to be different from its taxable income and creates a deferred tax liability.

Are Deferred Tax Liabilities Good?

deferred tax liability

If a company has a deferred tax liability, it means the company owes taxes that it has not yet paid.

This liability is shown on the company’s balance sheet, and the money is reserved for this expense.

This liability does decrease the company’s cash flow.

However, this does not mean the deferred tax liability is bad.

It means the money is set aside for the taxes, which is important as it would cause problems if the company spent the money on something else.

Advantages and Disadvantages of Deferred Tax Liabilities

Deferred tax liabilities represent a future cash outflow that will reduce the amount the company has available to spend on this future date.

Because of the time value of money, all cash that a company receives now or outflows that it can put off until a future date are advantageous.

This means that a deferred tax liability is advantageous when compared with a current tax liability.

Deferred Tax Liability Example

Deferred tax liabilities are typically the result of a business’s accounting policies being different from the government’s accounting methods.

A good example of this is accounting for the depreciation of a business’s fixed assets.

Most businesses use straight-line depreciation when calculating depreciation for their financial statements.

With this method, an asset is depreciated evenly throughout its useful life.

However, when calculating depreciation for tax purposes, businesses will use an accelerated depreciation method.

This method allows businesses to depreciate assets more quickly in the early part of their useful life.

Therefore, a business might record depreciation of $300 in its financial statements by using the straight-line depreciation method and $600 in its tax records by using an accelerated method of depreciation.

In this situation, the business would calculate its DTL by multiplying $300 by its tax rate.

Computing Deferred Tax Liabilities

A business sold a mattress for $1,200 with $120 in taxes due to 10% in sales taxes.

The business allows customers to pay for their mattresses in 36 monthly installments.

This means the mattress will be paid for over a three-year period.

The company will record the sale in its accounting records as $1,200.

Whereas, in its tax records, the business will record the sale as $400 a year for three years.

This would cause a deferred tax liability of $40 ($400 x 10% = $40).

Key Takeaways

  • A deferred tax liability reflects a tax that is owed and must be paid on a future date.
  • This tax obligation arises when an event occurs that would create a tax liability that is delayed until a future period.

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  1. Purdue University "Computation of Deferred Tax Liabilities" Page 1 . March 28, 2022

  2. Cornell Law School "47 CFR § 32.4341 - Net deferred tax liability adjustments." Page 1 . March 28, 2022

  3. Cornell Law School "deferred tax liability" Page 1 . March 28, 2022