What is Deferred Tax Liability and How it is Calculated

What is Deferred Tax Liability and How is Calculated

The concept of deferred tax liability is an idea which a student of commerce should know about. There are many accounting fundamentals that you need to grasp when learning the subtle art of bookkeeping that is devoted to keeping a tab on every penny that is earned or spent. These basics are quite easy to understand, but what makes them cumbersome to grasp is the stiff accounting terminology. You will take time to get used to the accounting lingo, but focusing on understanding the fundamental concepts will certainly help you out.

Taxes are an inevitable liability that every business running in any country must bear. Businesses are the major revenue generators of any country. Accounting for taxes is one of the prime responsibilities of any company accountant. Besides loans and other debt payments, paying taxes is one of the major obligations for any business.

What is Deferred Tax Liability?

The epithet – ‘Deferred’ points describes something that is ‘delayed’. I am sure you already know what’s tax liability. As you know, liability in accounting terms is any form of unpaid financial debt. To sum up, it is unpaid tax debt of a company that needs to be paid off in the future. Any financial transaction made by the company, that brings in tax liabilities, which are not immediately paid for, is noted down under the ‘Deferred Tax’ category.

It is a liability which must be eventually paid for, by the company in the future. If payment of taxes is delayed year after year, the tax liability is naturally going to pile up and become a financial burden. The best strategy for any business is to clear its tax debt in the same financial year, and unburden the future financial year, from the deferred tax liability generated in previous years. Fund allocation for each year needs to be planned in such a way, that tax liability is accounted for.

How is it Calculated?

The calculation of deferred income tax liability for any company can be complicated when there are several income sources to take into consideration and depreciation of asset value needs to be taken into consideration. Tax deductions need to be accounted for, after which you can calculate the actual taxable income. Once you have the value of the total taxable income, calculating the total tax liability is quite straightforward. From the knowledge of the federal tax rate and taxable income, computation of the tax liability can be done, using the following formula:

Taxable Income x Tax Rate =Total Tax Liability

Until the tax amount is paid by the business, it will be accounted for, as deferred tax liability. Thus it is simply unpaid tax debt of a company that needs to be accounted for. Sufficient funds need to be provided for to pay off tax debts in the future and it’s the responsibility of the accounting department to oversee this fund allocation.

If a company has to function smoothly and attain its long term objectives, the build up of a strong accounting department, which works silently in the background is essential. Deferred tax liabilities whose payment has been delayed for long, can come back and haunt a company, burning a big hole in the finances and inviting litigation. Therefore it’s best to pay up deferred tax liabilities on time and prevent further financial problems.