What is Deferred Tax?

August 23, 2022

What is deferred tax and does it apply to you? Find out what deferred taxes mean for you and your tax year.

The word "deferred" means to put something off to a future date. If I'm a student, I might defer a semester by going to school next spring instead of this fall. Deferments can also sometimes apply to certain tax filing situations. If you need to do small business taxes, this article might apply to you.

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What Does Deferred Tax Mean? 

Deferred tax is any tax made payable in the future rather than the present. Usually, taxes all have the same due dates. We pay taxes as we purchase taxed goods and services and allow employers to take out payroll tax from paychecks. Then, once a year, tax season comes around where we all file tax returns to make sure we didn’t miss any of our tax obligations, and we make up any difference through getting tax refunds or making tax payments to the IRS. 

But when a tax becomes a deferred tax, the due date for those payments gets pushed to a later date. Notice that those tax obligations don't go away; the due dates for their payments just change. 

Deferred tax spelled out by wooden blocks

What is a Deferred Tax Liability?

Deferred taxes are often referred to as deferred tax liability. The word "liability" in this tax term involves a taxpayer's responsibility to pay taxes. A tax liability is a tax responsibility—the responsibility a person or a business has to pay certain taxes. When that responsibility is deferred to a later date, that's called a deferred tax liability.

What is Payroll Tax Deferment?

The payroll tax deferment allowed businesses, including the self-employed, to defer their tax obligations to payroll taxes. This deferment lets employers wait or hold off on paying their share of payroll taxes. Payroll taxes are the taxes taken from payroll by employers, and these taxes go toward Social Security and Medicare taxes. 

What is a Tax Deferred Exchange?

A tax deferred exchange has to do with real estate and the exchange of investment properties. Tax deferred exchanges deal with Section 1031 of the Internal Revenue Code (IRC). This type of investment property exchange allows the parties involved to postpone tax obligations on the properties until a later date. 

There are many requirements involved in a 1031 tax deferred exchange. For instance, the exchange can only be made with like-kind or similar types of property. So, you couldn’t exchange a mansion for an apartment property. There are also specific guidelines about things like vacation properties. 1031 exchanges require real estate investors who have thoroughly researched this section of the IRC, so they don't run into problems. 

What is a Deferred Tax Asset?

A deferred tax asset is the opposite of a deferred tax liability. A deferred tax asset is something in a company's accounts that could reduce its tax obligation in the future. It's a deferred asset because the asset can't be used to reduce taxes now, but could be used at a later date. 

A potential example of a deferred tax asset is when a company pays more taxes than it needed to. This entitles the company to a tax refund in the same way an individual could expect a tax refund.

What is Deferred Income Tax?

Deferred income tax can sometimes occur when the calculations to find net income and how much taxes are owed on that net income differ. This can sometimes happen due to a difference in depreciation methods.

Depreciation is how accountants for a company will calculate the value of business assets. There are different ways to calculate these values, which can cause variations in total net income and thus total taxes owed on that income. This is where deferred income tax comes in to help make up for these differences. 

coins racking up stack after stack

How Do Deferred Tax Liabilities Work?

A deferred tax liability often happens in the corporate world when there are temporary differences in the accounting books around a company's income and paid taxes. This can happen when the types of calculating methods used by a company's accountants are different than the calculations used by the IRS. 

For instance, if a company sells product A for $1,000, then they made a net income of $1,000. But if the customer buying product A uses an installment plan to pay $500 this year, and $500 next year, then that net income for the year might differ from the $1,000 sale the company made. 

In instances like this, company accounting records can be a little more complicated, calling for tax deferrals to help make up the differences in accounting books. 

In Conclusion,

You probably don't have to worry about deferred taxes as an individual taxpayer. But if you have a small business, then you might need to understand what deferred taxes are and how they apply to your work.