Tax Deferred Meaning: Deferred Tax Asset vs Liability

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.

Tax deferred can also be a tax term that applies to certain tax filing situations. If you need to do small business taxes, this article might apply to you.

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

What is Tax Deferred?

Tax deferred is any tax made payable in the future rather than the present.

We pay taxes as we purchase taxed goods and services and allow employers to take out payroll tax from paychecks. These tax obligations can also come with due dates. 

Every tax season we file tax returns for the previous tax year to make sure we didn’t miss any of our tax obligations. Then we make up any difference in the taxes we paid vs the taxes we owe through getting tax refunds or making tax payments to the IRS.

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

Tax deferrals are related to a few other terms that we’ll also go over so that you know what it means to defer assets, liabilities, income tax, and more. 

What is a Deferred Tax Asset?

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A deferred tax asset (DTA) is a company asset that can represent a future tax deduction, tax credit, or tax rate reduction.

This includes things in a company’s accounts that could reduce its tax obligation in the future.

It's a tax deferred asset because the asset can't be used to reduce taxes now, but could be used to reduce taxes at a later date. 

What is a Deferred Tax Liability?

‍A deferred tax liability (DTL) is the amount of taxes a company will owe in the future due to a temporary difference in calculation methods, tax carryforwards, or uncertain tax positions.

Companies calculate revenue and expenses on their financial statements differently from how they calculate them for tax purposes. This makes a temporary difference between the way certain transactions are treated for accounting vs taxes. 

This is a tax liability for a company and is deferred until a later date when the temporary difference is reversed.

Deferred Tax Asset vs Liability

There are both similarities and differences between a deferred tax asset vs liability.

They are similar because they are both accounting terms and they both refer to differences in timing between taxes and a company’s accounting. 

They are different because they both refer to different amounts. A tax deferred asset refers to an amount a company can use to reduce future taxes, while a deferred tax liability refers to an amount a company owes in future taxes.

What is Deferred Income Tax?

‍Deferred income tax is the amount of income tax that a company expects to pay or recover in the future. 

This can happen when calculations to find net income and owed taxes on that net income are different. This could happen because of differing depreciation methods.

Depreciation methods are 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.

These different calculation methods could create either a tax deferred asset or a tax deferred liability for the company. A DTA would mean a tax credit in the future and money the company gets back. And a DTL would mean a tax payment in the future that the company will owe.

What is Payroll Tax Deferment?

‍Payroll tax deferment is when a company temporarily delays paying certain payroll taxes to the government. 

Normally, employers withhold payroll taxes from employee wages and pay those payroll taxes to the government. Individual employees can help decide tax withholdings for their wages using a W4 form.

The ability for companies to defer paying payroll taxes until a later date came about in the year 2020 as a way to provide some financial relief to businesses during the COVID-19 pandemic. This payroll tax deferment program was a part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and comes with its own requirements and qualifications to use. 

What is a Tax Deferred Exchange?

‍Tax deferred exchange is a method that defers sales tax on real estate property and reinvests the sale proceeds into a similar property. 

This can also be referred to as a 1031 exchange after Section 1031 of the Internal Revenue Code (IRC). The deferred sales tax can also potentially include capital gains taxes, depreciation recapture taxes, and other taxes that would normally be due upon the sale of a property.

This type of deferment is unique though, because the taxes aren't just being delayed to a later date, the thing that caused the owed taxes (the property sale) is being reinvested instead of taxes being paid.

How to Qualify for a Tax Deferred Exchange

There are requirements and procedures involved in being able to use a tax deferred exchange.

For example, the reinvestment needs to be into a similar kind of property to the sold property, the property must be used for business or investment purposes, and the investment exchange must be done in a certain timeframe. 

• The sold property sold must be reinvested into a similar property.
• The replacement property must be used for business or investment purposes.
• The property exchange must be completed within a specific timeframe.

There are also specific guidelines about things like vacation properties. 1031 exchanges require real estate investors to thoroughly research this section of the IRC and work with a financial professional so they don't run into problems.

How to Use a Tax Deferred Account

A tax deferred account is an investment account that allows investors to delay paying taxes on some investment gains. 

Some common examples of this type of account include tax deferred retirement accounts for types of retirement accounts like 401(k)s and IRAs, annuities, and certain types of insurance policies. The average person might use employer sponsored retirement plans to hold their retirement savings. 

When an investor places funds into this type of account, it keeps the investment tax free until after the money is withdrawn. Keeping investment money in this type of account can also lower your taxable income and potentially lower the tax bracket you fall under. 

These accounts come with great tax benefits, but it's also important to be mindful that they also come with certain restrictions and limitations.

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