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Basics of Deferred Taxes
Earnings before taxes in your income statement is essentially the amount against which you should determine your payable tax expense. However, overlaps do occur between a period’s payable taxes and the filed tax return as a result of temporary differences -- that is, variances in your asset/liability valuation or revenue recognition. A deferred tax liability prevails when your payable tax, as reported in financial statements, exceeds your filed tax return. This means a portion of your payable tax is suspended to a future date. In contrast, a filed tax return that exceeds your due taxable income yields a deferred tax asset. It is as good as making an advance payment for taxes that are due in future.
Compute Taxable Income
Taxable income for a deferred tax liability is income before tax less temporary differences. For example, if your income statement has a pretax income of $10,450 and recognized earnings of $3,150 for a three-year installment sale, your taxable income will be $10,450 - ($3,150-$1,050) = $8,350. This shows that you recognized $3,150 for the installment sale but actually received $1,050 for the first installment. The $2,100 remains a temporary difference that will become due for taxation when you receive the pending installments. For a deferred tax asset, taxable income is the sum
of your pretax income and the temporary difference. For instance, if your $10,450 pretax income is not inclusive of a prepaid receipt of a $3,150 three-year installment sale filed in tax returns, your taxable income will be $10,450 + ($3,150-$1,050) = $12,550. Here, the temporary difference is $2,100, which represents unearned revenue you have received and filed in your income tax returns.
Determine Payable Income Tax
Apply the required tax rate on the taxable income to determine the payable income tax. For example, at an average tax rate of 30 percent, the income tax payable on the tax returns bearing a deferred tax liability would be 30/100 x $8,350 = $2,505, while the one for the returns bearing deferred tax asset would be 30/100 x $12,550 = $3,760.
Calculate Deferred Taxes
Multiply the average tax rate by the temporary difference to get the deferred tax liability or asset. For instance, at tax rate of 30 percent, a deferred tax liability or benefit for a $2,100 would generate a deferred tax of 30/100 x $2,100 = $630. The income tax expense for a $630 deferred tax liability on payable income tax of $2,505, would be $2,505 + $630 = $3,135. As for a $630 deferred tax asset on a taxable income of $3,760, it would be $3,760 - $630 = $3,130.