Deferred Tax Liability

Deferred tax liability means that the company postpones its tax liability from the present period to a future period. Taxable differences give rise to deferred tax liabilities.

Deferral means postponed. Thus, deferred tax liability means that the company postpones its tax liability from the present period to a future period. Taxable differences give rise to deferred tax liabilities. Deferred tax liabilities consist of the tax effect of only one item: Taxable temporary differences.

Deferred Tax Liability = Taxable Differences * Tax Rate

In the Company A example, assume that the tax rate is 30 percent. Recall that the financial statement income was $12,000 in the years 2004 and 2005, but the taxable income was $4,000 in 2004 and $20,000 in 2005. That is, the company postponed the taxation of $8,000 of income from 2004 to 2005. The expected tax on this $8,000 of income that has been postponed is $2,400 ($8,000 x 0.30). This $2,400, referred to as a deferred tax liability, will become payable in the future.

Company A: Income Statement
Item	2004	2005
Revenues	$50,000	$50,000
-Expenses other than depreciation	30,000	30,000
-Depreciation	8,000	8,000
=Income before taxes	12,000	12,000
Taxable differences	8,000
Deferred Tax  Liability	2,400

 

Company A: Tax Return.   Tax Rate =		30%
Item	2004	2005
Revenues	$50,000	$50,000
-Expenses other than depreciation	30,000	30,000
-Depreciation	16,000	0
=Taxable Income	4,000	20,000

 

Note that some problems give the Deferred Tax Liability as of the beginning of the period and the taxable difference as of the end of the period (or vice-versa). Remember that the two are apples and oranges; to arrive at the balance of Deferred Tax Liability account at any point in time, you need to multiply the taxable differences by the applicable tax rate.

Examples:

Company had a taxable difference of $30,000 as of January 1, 2005. At the end of the year, it had $13,000 balance in its Deferred Tax Liability account. If the tax rate is 30%, what is the change in the deferred tax liability?

The beginning balance of the Deferred Tax Liability account is $9,000 ($30,000 x 0.3). Thus, the deferred tax liability has increased by $4,000 ($13,000 - $9,000) during the period.