What Is a Deferred Tax Asset?

What Is a Deferred Tax Asset?

Let me explain what a deferred tax asset is. It's a key part of a company's financial strategy, showing up on the balance sheet as a way to reduce future taxable income.

These assets come about when a company overpays its taxes, which leads to tax relief down the line that the business records as an asset. On the flip side, deferred tax liabilities mean you'll have higher tax obligations in the future. You need to understand this difference and how it affects tax management and overall financial health.

Key Takeaways

A deferred tax asset is a future financial benefit on your balance sheet when you've paid more taxes than owed right now, which can cut down on taxes later. These often stem from timing differences between when tax authorities see revenue or expenses and when they're in your financial statements.

Since 2018, you can use these assets indefinitely, applying them when it benefits you most. Their value changes with tax rates—going up when rates rise and down when they fall. Remember, they're not the same as deferred tax liabilities, which are future taxes you owe, like on withdrawals from pre-tax retirement accounts.

Breaking Down Deferred Tax Assets: What You Need to Know

A deferred tax asset forms when you've paid or carried forward taxes that aren't yet on the income statement. It happens because tax authorities recognize revenue or expenses at different times than your accounting period, helping to lower future tax liability.

You only recognize one when a loss or depreciation is set to offset future profits. Think of it like prepaid rent or a refundable insurance premium— you've spent the cash, but you still have that value, and it needs to show in your financial statements.

Examples of Deferred Tax Assets

Take the carryover of losses as a simple example. If your business loses money in a year, you can usually use that loss to reduce taxable income in coming years. That future tax saving turns the loss into an asset.

Another case is when accounting rules differ from tax rules, like recognizing expenses or revenues earlier in accounting than for taxes. Deferred tax assets also arise from differences in rules for assets or liabilities.

Keep in mind, there's no time limit on these assets—they can be used whenever it makes financial sense, but you can't apply them to past tax returns.

Calculating Deferred Tax Assets: A Step-by-Step Guide

First, identify differences between your accounting profits and taxable profits, spotting where taxes are paid but not yet in the financial statements. Then, calculate the adjustment for these differences—for instance, if warranty expenses aren't tax-deductible right away, figure out the future deduction amount.

Next, apply the current tax rate to that adjustment by multiplying the difference by the corporate tax rate to get the deferred tax asset value. Finally, record it on the balance sheet as a non-current asset in your financial statements. (Note: There's typically an image here illustrating this process, showing steps like identifying differences and applying tax rates.)

Key Considerations for Deferred Tax Assets

Starting in 2018, these assets can be carried forward indefinitely for most companies, but you can't carry them back anymore. Some farming losses might still go back up to two years, though.

Watch how tax rate changes affect them—if rates go up, the asset's value increases, giving more financial buffer. If rates drop, the value decreases, and you might not get the full benefit before any deadlines.

Why Do Deferred Tax Assets Occur?

They show up on the balance sheet when a company prepays or overpays taxes, or from timing differences in tax payments and credits. Your books have to reflect these paid or owed taxes accurately.

Do Deferred Tax Assets Carry Forward?

Yes, since 2018, you can carry them forward indefinitely. They don't expire, and you use them when it's most advantageous.

What Is a Deferred Tax Asset vs. a Deferred Tax Liability?

A deferred tax asset is a financial benefit, while a liability is a future tax payment you owe. For example, in a traditional 401(k), you contribute pre-tax, but taxes are due on withdrawal—that's a deferred tax liability.

The Bottom Line

A deferred tax asset comes from overpaying or advancing taxes, often due to differences in when revenue is recognized by tax authorities versus your accounting standards, or from carrying forward losses to cut future taxes. It reduces your company's taxable income later on and appears as a non-current financial asset on the balance sheet.