What Is a Deferred Tax Asset?

When it comes to a company’s taxes, there are two important categories to understand: assets and liabilities. Tax liability is anything that a person or company owes taxes on, such as income or revenue. Tax assets are anything that can be used to lower a person or company’s tax liability. Let’s take a look at what is a deferred tax asset, what causes them and how they work.

If you need help optimizing your tax strategy, consider working with a financial advisor.

Understanding Deferred Tax Assets

A deferred tax asset is an accounting item that represents taxes a company has already paid or overpaid and expects to recover in the future. It arises when taxable income is higher than accounting income in a given period, creating a future tax benefit. In simple terms, it reflects taxes that can be used to reduce future tax bills.

Deferred tax assets commonly result from timing differences between accounting rules and tax rules. Examples include net operating losses carried forward, certain tax credits or expenses that are recognized for accounting purposes before they are deductible for tax purposes. These differences allow a company to offset future taxable income.

Deferred tax assets can significantly affect a company’s financial statements and perceived profitability. They signal potential tax relief in future periods, which may improve cash flow when realized. However, their value depends on the company’s ability to generate sufficient taxable income going forward.

How Deferred Tax Assets Happen

Deferred tax assets arise primarily because accounting rules and tax laws don’t always recognize income and expenses at the same time. A company may record an expense on its financial statements before it’s allowed to deduct that expense for tax purposes. This mismatch creates a future tax benefit that shows up as a deferred tax asset. Here are some other of the major avenues that can lead to a deferred tax asset:

Losses: Businesses can record capital losses as tax write-offs and carry them forward from year to year.
Differences in depreciation accounting: How you account for the depreciation of assets like real estate (both in method and in rate) can result in the overpaying of taxes, creating a deferred tax asset on the balance sheet.
Business expenses: Expenses are common tax deductions, but sometimes they’re accounted for in the income statement before they’re accounted for on the tax statement.
Warranties: If a company expects a certain amount of warranties, it still pays taxes on the money that’s set aside to cover the cost. This can cause a discrepancy on the balance sheet, resulting in a deferred tax asset.

How Companies Can Use Deferred Tax Assets

Deferred tax assets sit on a company’s balance sheet as an intangible, financial asset. While they’re not as good as cash, they can function in a similar way when it comes to taxes. Essentially, it’s like overpaying on your credit card bill. While you used the money to pay off your card, there’s now a debit on the card that’s almost as good as cash.

A company can retain this deferred tax asset on its balance sheet indefinitely and use it to reduce future tax liability. Say it has $3,000 in deferred tax assets and a tax liability of $10,000. For the sake of example, imagine that the company is being taxed at a rate of 30%, meaning it owes $3,000 in taxes. The company can use its deferred tax asset to reduce the tax liability to $7,000, lowering its tax bill to $2,100 and saving $900.

Deferred Tax Assets vs. Deferred Tax Liabilities

Tax assets and tax liabilities are opposites. Your liabilities are what you owe taxes on, and your tax assets are what lower your liabilities. Where deferred tax assets are the result of overpayment or early payment, deferred tax liabilities are often from underpayment or delayed payment.

For example, if a company sells a product that’s paid for in installments, it may account for the taxes on the full-price sale of the product on its balance sheet. The company, however, may only pay taxes as the installments are paid. This is a deferred tax liability.

Here’s how the deferred tax liability is calculated: A company sells a product for $10,000 in five payments of $2,000. The company records the sale of $10,000 in its records. However, only the first payment has been made. So there’s $8,000 worth of future taxable income to account for. If this is taxed at 30%, that’s a tax-deferred liability of $2,400.

While these deferred tax liabilities restrict cash flow for companies, ultimately they’re just a part of doing business. The government levies taxes, and if businesses want to be in good standing, they’ll pay them.

Bottom Line

Deferred tax assets are the result of overpayment or early payment of taxes. They live on a company’s balance sheet and can be used to offset future taxes owed. They’re usually created by differences in business accounting and tax accounting. In many ways, they function like a debit that can be applied to taxes. They’re the opposite of deferred tax liabilities, which result from the underpayment or delayed payment of taxes. If you need help understanding how deferred tax assets could apply to you, talk to a qualified tax accountant or a financial advisor who specializes in businesses.

Tax Planning Tips

A financial advisor can help you optimize your financial plan to lower your tax liability. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goal, get started now.
You can use our federal income tax calculator to estimate future tax obligations. SmartAsset’s free online tool takes your income, location and filing status to project your marginal and effective taxes, total estimated taxes owed and more.
Are you a small business owner in need of some tax guidance? A good place to start is our Guide to Small Business Tax Deductions. Research what you need to know to make the right decisions come tax time.