Let's say you sold an asset for a profit. Or you've earned revenue in exchange for goods or services. In both cases (and other similar cases in which you've earned money), you're supposed to pay taxes on those gains.
That's the case, at least in theory.
But theory and reality can differ in the real world of tax and financial accounting. This is definitely the case with deferred taxes. Deferred taxes represent the difference between a tax that is recorded "on the books," but might not be immediately taxable for various reasons.
There are two types of deferred tax: deferred tax assets and deferred tax liabilities.
A deferred tax asset, or DTA, is an item on a balance sheet that reduces taxable income at a future date. This indicates that a tax might have been paid but has yet to be recognized. They're listed as "non-current assets" on balance sheets.
Deferred tax assets include:
Net Operating Losses / Loss Carryover. Net operating loss occurs when a business incurs a financial loss for a specific period. It's possible to carry over that loss to future years to offset anticipated profit.
Tax Overpayments. Businesses often pay estimated taxes on a quarterly basis, in an attempt to lower the overall tax bill when income tax time rolls around. There are times, however, when overpayments can take place. These can also be used to offset owed taxes on future profits.
Bad Debt. Bad debt is a fancy term for a bill that a customer has no intention of paying. This can also occur when credit is extended and not paid off. Bad debt isn't considered "uncollectible" until it's officially written off. Once this happens, it is considered a direct loss, which can be used against future revenues.
Deferred tax assets never expire. They can be carried forward to future tax filings, ad infinitum. But they can't be applied to previous tax filings.
On the other hand, a deferred tax liability (DTL) is a listed tax payment on a balance sheet that doesn't have to be paid until a future tax filing. In other words, due to timing differences in accounting processes, tax payments might be able to be postponed for a later date. They're listed on balance sheets as "non-current liabilities," and might include the following:
Asset Depreciation. Depreciation allocates the cost of a physical or tangible asset over its useful lifetime. It can also represent an estimated reduction in a fixed asset's value, over time.
Tax Underpayment. Companies that don't pay enough of their estimated taxes on revenue end up underpaying. They still need to pay taxes and might need to do so in a following period or tax cycle.
Installment Sales. An installment sale occurs when the seller of an asset agrees to receive one or more payments in a tax year after the one in which a sale occurred. According to the IRS, the buyer can repay the seller in the form of a deed of trust, note, mortgage, or land contract.
Timing can be important when it comes to understanding deferred tax assets and deferred tax liabilities. It can be tricky to understand when and how to carryover or pay back what's owed. As such, working with a qualified tax professional can help set up payment schedules and tax strategies.