Deferred Tax Asset

Deferred Tax Asset

Sorting out your finances sometimes can seem like learning a new language. Everything accountants do have a valid, logical and legal reason — as well as a direct connection to real-world issues. A deferred tax asset is no different. A deferred tax asset is a line item on your balance sheet that you can use to reduce your taxable income for a given year. It’s the opposite of a deferred tax liability.

Deferred tax assets and deferred tax liabilities not only play a role in your taxes; they also impact your cash flow, now and in the future. Miller & Company LLP, NY Certified Public Accountants, a best rated CPA firm in NYC.

Although there are many reasons to have a deferred tax asset on your balance sheet (under Current Assets) and in your tax return, one of the more common is to cover future expenses on money you’ve earned in the current year. In this example, that future expense is a current asset since you have the money now to pay for the planned expense you haven’t yet paid.

What Exactly Is Deferred Tax?

The concept of deferred tax assets and liabilities came about because the way you calculate your taxes differs from the way you calculate your financial statements. The two equations use different instructions or guidelines. As a result, a line item that you see as an expense on a financial statement (such as your profit and loss statement) may actually end up an asset on your taxes.

The two accounting systems — finances and taxes — differ in some fundamental ways. Some differences don’t ever change. For example:

• A full 100 percent of your expenses are counted as liabilities on your balance sheet, but you can deduct only 50 percent of some expenses (client meeting expenses and gifts come to mind) from your taxes.
• If you earn any money from investing in municipal bonds, none of that income counts toward the taxes you owe.

Other types of assets vs liabilities are more fluid in nature, caused by the somewhat arbitrary period called a tax year. Given enough time, these assets and liabilities would cancel each other out, but year by year, you may experience them separately.

Examples of Deferred Tax Assets and Liabilities

Deferred tax assets refer to money you’ve paid in taxes toward a future tax deduction. It’s an asset because you can use it in the future as money, at least as far as your taxes are concerned. A few solid examples include:

• Future expenses. You were paid in full for an order you haven’t delivered yet, meaning all the expenses to come from that order haven’t been processed. So, while your company’s profit and loss statement reflects the expenses to come — because you know what they are — your tax form can only record the income, not the expenses that haven’t yet been paid. As a result, you now have a deferred tax asset which equals the difference in the taxes you paid and the taxes you’ll eventually owe. That deferred tax asset may mean lower taxes next year.
• Future returns. You sold $10 million worth of the widget your company produces. You expect a one percent return rate for defective units, costing you $100,000. You have to pay taxes on the $10 million dollars, even though you know you’ll have $100,000 in future expenses. So the tax you pay on that $100,000 becomes a deferred tax asset.
• Past overpayment. You paid too much in taxes the previous year, so this year, you want it back. This is non-taxable income since you’ve already paid taxes on the money when you earned it. The amount of taxes that you overpaid gets added to your deferred tax assets.

And now for several examples of deferred tax liabilities:

• You can depreciate the value of a purchase — such as a company car or computer equipment — in a year on your financial statement and on your taxes. But sometimes the tax code allows you to claim more depreciation or claim it faster than normal. The difference can be a deferred tax liability, because you’re paying less in taxes now, which means you’ll owe it in the future.
• Past underpayment. You paid less than you owed in taxes in the previous year. This year, you’ll have to pay the balance. Since it’s money you owe in the future, it’s considered a deferred tax liability.

Deferred Tax Assets vs Deferred Tax Liabilities

There’s an ebb and flow to business financials. It loosely corresponds to your cash flow. A deferred tax asset has a positive connotation because it’s money already spent that can benefit you in the future. At the same time, that deferred tax asset can affect your current cash on hand because you have to pay taxes on it since it’s money you have, but it’s also money you’re going to pay out to cover expenses.

A deferred tax liability, on the other hand, sounds like something to avoid. While it does refer to future money that you or your company will have to pay — therefore, it technically is a liability — a deferred tax liability actually increases your cash on hand. In other words, you’re using money now you’ll have to pay back in the future.

When you put the two together, you can recognize that some ebbs and some flows over time can be beneficial to your business. It all evens out in the end, but in the meantime, you either get the benefit of future deductions (from a deferred tax asset) or the benefit of more cash on hand (from a deferred tax liability). To find out how tax deferred assets and liabilities can help or hurt your business, talk to a best rated New York CPA at Miller & Company, one of the best accounting firms in Manhattan and the New York City metropolitan area.

Getting to Use Tax Deferred Assets

Just because your company has deferred tax assets on its books doesn’t mean you automatically get to use them in full. There are tax rules and conditions that govern their use. You or your company has to satisfy these conditions before you can benefit from them.

For example, some businesses and individuals, even successful ones, sometimes experience a loss. When this happens, you may not be able to deduct the entire loss amount. You may be able to carry the balance forward. In the language of taxes, you carry a net operating loss onto your subsequent tax forms until the balance runs out or expires (it doesn’t last forever). In this case, you have to earn enough — your net income has to be large enough — to cover the loss.

Since future income is unknown, at least to governing bodies, you can’t access your deferred tax assets unless and until you earn enough. It’s not guaranteed. The amount you can use in a given year is called your valuation allowance. To learn about the qualifications for using a deferred tax asset, talk to a Miller & Company CPA.

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