Deferred Income Tax Explained 2025: Costs, Purpose & Real-World Examples

Julia Kagan is a respected financial and consumer journalist, formerly a senior editor specializing in personal finance at Investopedia.

What Is Deferred Income Tax?

Deferred income tax refers to a liability recorded on a company's balance sheet due to timing differences between when income is recognized under tax laws versus accounting principles. This means the tax expense reported in financial statements may not match the actual tax payable to tax authorities.

For example, a company might report a certain tax expense for the fiscal year but postpone some tax payments due to differences in accounting and tax regulations.

Key Insights

• Deferred income tax arises from discrepancies between tax code (such as IRS rules) and accounting standards (like GAAP).
• It appears as a liability on the balance sheet, representing taxes owed in the future.
• Common causes include variations in depreciation methods allowed by GAAP and the IRS.
• Deferred tax liabilities can be classified as either current or long-term depending on when payment is due.

Understanding Deferred Income Tax

In the United States, Generally Accepted Accounting Principles (GAAP) dictate how companies recognize and disclose economic events, including income tax expense, which is based on GAAP income.

Conversely, the IRS follows its own tax code, which can require different treatments for income and expenses. These regulatory differences cause variations in net income and taxable income, leading to deferred income tax.

Important Note

A deferred income tax liability emerges when the income tax expense shown on financial statements differs from the tax amount payable to the IRS.

Sometimes, the tax payable on a return may exceed the financial statement expense, but over time, these differences usually balance out, reducing the deferred tax account to zero.

If the situation reverses, resulting in overpaid taxes compared to accounting income, a deferred tax asset is recorded, representing an expected future economic benefit.

Deferred Income Tax Example

A typical example involves depreciation. GAAP permits multiple depreciation methods, while the IRS mandates a specific approach. Due to this, depreciation expense recorded on financial statements often differs from that on tax returns.

Over an asset’s lifespan, these discrepancies balance out — by the end, total depreciation equals across both methods, and no deferred tax liability remains.

Is Deferred Income Tax an Asset or Liability?

Deferred income tax is usually a liability because it represents taxes owed in the future. However, if a company has paid more taxes than required based on accounting income, it records a deferred tax asset, shown as a non-current asset on the balance sheet.

Deferred Income Tax in Simple Terms

It’s tax that a company will pay in the future due to timing differences in recognizing income for accounting versus tax purposes.

Difference Between Current Tax and Deferred Tax

Current tax is the amount payable immediately, while deferred tax represents tax obligations postponed to future periods.

Final Thoughts

Deferred income tax highlights the gap between tax liabilities reported in financial statements and actual taxes paid to authorities, caused by differing income recognition rules. This results in deferred tax liabilities or assets, reflecting taxes to be settled in future periods and ensuring transparent and accurate financial reporting.

Explore useful articles in Corporate Finance as of 06-12-2023. The article titled " Deferred Income Tax Explained 2025: Costs, Purpose & Real-World Examples " offers in-depth analysis and practical advice in the Corporate Finance field. Each article is carefully crafted by experts to provide maximum value to readers.

The " Deferred Income Tax Explained 2025: Costs, Purpose & Real-World Examples " article expands your knowledge in Corporate Finance, keeps you informed about the latest developments, and helps you make well-informed decisions. Each article is based on unique content, ensuring originality and quality.