Here’s what you need to know about deferred tax liabilities and the common reasons behind them.
In this article:
- Using Different Asset Depreciation Schedules
- Using Different Revenue Recognition Schedules
- Using Different Inventory Schedules
Deferred Tax Liabilities: 3 Common Causes
Deferred Tax Liabilities (DTL) result from certain differences between GAAP and IFRS accounting standards and the country’s tax laws. When these procedural conflicts trigger a discrepancy between taxable income as reflected in a taxpayer’s financial statement and their tax returns, deferred tax liabilities occur.
Basically, the concept of DTL owes to financial statements preempting payable taxes not yet included or recognized in current/scheduled tax returns. It is the direct opposite of a Deferred Tax Asset (DTA) whereby a company pays taxes in advance which have yet to be recognized by internal books, hence anticipating an increase in assets for the next fiscal year.
1. Using Different Asset Depreciation Schedules
Tax codes allow companies to keep two sets of financial books. One set serves internal bookkeeping purposes as well as for presenting to shareholders, while the other caters to their income taxes.
Normally, accountants use separate asset depreciation schedules for these books. These methods include the accelerated depreciation and straight-line depreciation method.
The accelerated depreciation method results in increased asset reduction. Reduced assets translate to reduced income taxes.
Meanwhile, the straight-line depreciation method is a more consistently sustained way of depreciating assets and properties. This means that no abrupt asset reduction occurs, hence no abrupt discrepancies in tax rates, too.
Consider a business using the accelerated depreciation method for tax accounting and the straight-line method for internal books. These two books will inevitably show differing payable tax rates, which should be accounted for in the balance sheet as deferred tax liabilities.
2. Using Different Revenue Recognition Schedules
Revenue recognition schedules are other known triggers of deferred tax liabilities. Revenue recognition schedule refers to when business accounts for income in its financial statements.
This scenario does not apply to businesses that receive full payments from customers. It mainly covers businesses that allow installment payment.
Consider a business with yearly sales amounting to $50,000 with a tax rate of 30%. If this amount is payable under installment terms and covers more than a single tax year, financial statements for tax purposes can defer tax liabilities on this income.
This means businesses can pay taxes on a portion of the sales that have been collected already. For example, 30% of $10,000 ($3,000).
Financial statements then reflect the remaining sum ($12,000) as anticipated payable taxes on the balance sheet.
3. Using Different Inventory Schedules
The U.S. tax laws favor the last-in-first-out (LIFO) method when accounting for inventories. Meanwhile, most businesses choose the first-in-first-out (FIFO) method for their internal bookkeeping.
This scenario does not put a business in a legal conflict with the IRS. However, financial statements, both internal and for tax purposes, must be kept in order via the declaration of deferred tax liabilities.
Here, deferred tax liabilities must put into consideration certain financial fluctuations that happen within the lifespan of the inventories. These fluctuations include shifts in the production costs of the inventories as well as their actual selling price.
As for the latter, here’s an example: A business that makes 1,000 pair of shoes per annum, increasing its product’s selling price from one fiscal year ($5/pair) to the next ($10/pair). The LIFO method will yield a taxable asset of $10,000 whereas the FIFO method, $5,000.
This scenario results in a $5,000 difference, which, at 30% tax rate, translates to $1,500 of deferred tax liabilities.
Deferred tax liabilities might sound like a challenging financial concept to grasp. This is understandable given both tax laws and accounting rules are highly specific sets of expertise.
It goes without saying that it’s possible to simplify the subject, as attempted herein. Also, by all means, consider consulting with a tax professional should there be more pressing concerns about the subject that’s not been addressed in this article.
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If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.