Deferred Tax - Asset, Calculation, Meaning, What It Is, Benefit, & How to Calculate
Being a business owner, knowing about deferred tax is a must. The deferred tax has several advantages that you must know of! But before that, if you don’t know what deferred tax is, then we have got you covered. In this article, we will talk about deferred tax in detail. First, we will cover the deferred tax meaning, types of deferred tax, deferred tax calculation, and benefits of deferred tax.
What Is Deferred Tax?
Investment earnings, such as interest, dividends, or capital gains that grow tax-free till the investor takes actual receipt of the profits, are referred to as having a tax-deferred status. Deferred tax is, therefore, the tax on items included in profit and loss accounts but not in taxable income but may be included in future taxable income, and vice versa.
An investor benefits from the tax-free growth of earnings with tax-deferred investments. Investments kept up until retirement may result in significant tax savings. The retiree will likely be in a lower tax bracket when they retire and won't be subject to early tax and product withdrawal penalties.
Participants may exclude all or a portion of their contributions from their taxable income if they invest in qualifying products, such as IRAs.
The benefit of taking deductions this year and paying less tax next year makes tax-deferred investments tempting.
Timing discrepancies or transient accounting variances may result in deferred tax. Timing discrepancies are those that develop over some time but can be undone in subsequent years. For instance, bonuses, depreciation on fixed assets, etc. Differences that create at one time and are not reversible in later years are referred to as permanent differences. For instance, any tax-exempt income, expenses that cannot be deducted for tax purposes, etc.
Types Of Deferred Tax
Deferred tax is divided into two categories: deferred tax assets and liabilities.
Deferred Tax Asset
When there is a difference between an organization's income statement and the related tax statement that enables the company to pay its tax liability for another period in advance or to reduce its tax liability for a subsequent period in a particular fiscal year, the difference is recorded as a deferred tax asset. In other words, if a firm reduces or eliminates its tax liability for a future year in advance, it will be considered a deferred tax asset.
Reasons For Deferred Tax Assets To Arise.
The causes that result in deferred tax assets are as follows.
- The taxing authorities consider expenses even before they need to be acknowledged.
- Earned income is taxed even before it is recognized.
- There are several tax laws or bases for assets and liabilities.
Deferred Tax Liability-
Suppose there is a mismatch between an organization's revenue statement and tax statement that suggests tax should accumulate in one year but that the corporation is obligated to pay it in a subsequent fiscal year. In that case, the difference will be treated as a deferred tax liability.
In other words, deferred tax liability is established when there is a gap in time between when a tax duty accrues and when a corporation is compelled to pay it. An organization must account for it using accounting standards in the year it originates since it reflects a future monetary commitment.
Reasons For Deferred Tax Liability To Arise
Several factors that cause a firm to incur a deferred tax liability are listed below.
- Double-counting of the numbers, for instance, most corporations maintain numerous versions of their financial statements for internal use and distribution to the public and tax authorities. This is especially true since important concepts like revenue, expense, and asset depreciation differ significantly between the tax code and accepted accounting principles.
- Businesses typically push their earnings and create deferred tax liability to show their shareholders the most profit.
- Businesses typically transfer present gains into the future to pay fewer taxes. This makes it possible to invest more money rather than paying taxes to the government.
Calculation Of Deferred Tax
Since deferred tax is simply the difference between gross earnings in a Profit & Loss Account and a tax statement, there are no strict guidelines for calculating it. The steps below can be used to manually calculate DTA:
- A list of all the assets and liabilities should be made.
- Figure out the tax bases.
- Determine the transient difference.
- Determine the tax obligation rate.
- Calculate the tax assets.
- Identify any items that are missing from the financial positions.
- After adding up all the variables, insert them into the accounts.
On the other hand, businesses can calculate their deferred tax assets using the calculator offered by the Income Tax department of India. The company's tax status, annual taxable revenue (pre-tax), assessment year, and expected yearly average tax rate are all necessary information to enter into this calculator.
Benefits Of Deferred Tax
Every corporation benefits from having deferred tax assets. It is regarded as positive news on a company's financial sheet. It represents taxes that have previously been paid but are not shown in a company's financial records. Similar to a prepaid tax, it assists businesses in lowering their future responsibilities. Additionally, an organization might be financially ready for future expenses by recognizing the liabilities using tax-deferred calculations. On the other hand, the realization of deferred tax assets can substantially lower future tax liabilities.
Financial Statements include Deferred Tax Liability (DTL) and Deferred Tax Asset (DTA), which are significant components. The income-tax expense of the business for that year, along with the years that follow, is affected by the adjustment made at year-end when the books of accounts are closed.