What Is Deferred Tax Liability?

One of the most important aspects of investing or business ownership is found in understanding the Federal Tax Code. Failure to understand that federal law could put you in a position to face hefty fines and potentially serve federal prison time. While the federal government always expects you to pay your taxes, it’s also important that you understand the legal delays that are provided within the Federal Tax Code. One such example is found in deferred tax liabilities. These legal delays provide investors and business owners with a temporary reprieve on paying federal income taxes on certain earnings.

What Is Tax Liability?

Ultimately, the term “tax liability” refers to the taxes that you owe for the earnings generated within a given tax year. You’ve probably had a tax liability for as long as you have been a member of the workforce. The federal government expects you to pay taxes on your earnings, and in some states, you are required to file a state income tax return. Unless your earned income was below the predetermined amount on which taxes are owed, or you had enough legal tax write offs to offset your earnings, you have had a tax liability.

Even outside of the scope of traditional employment, tax liabilities are an obstacle that Americans must deal with. For instance, if your primary source of income is investments, you will accrue a tax liability based on the profitability of your investments within a given tax year. If you are a business owner, you’re not exempt. In addition to the taxes that you personally owe based on the money you earned from your business, your business may owe taxes based on the profits it generated within the tax year.

A tax liability is the term assigned to any amount that you owe in taxes for a given tax year. Regardless of how the income is generated, there’s a good possibility that you will end the tax year with a tax liability.

What Is Deferred Tax Liability?

While there are some cases where paying taxes is unavoidable, it’s important to note that there are also situations in which tax liability can be deferred. In a business sense, deferred tax liability may refer to an instance in which revenue is billed in one tax year but is not actually earned until the following tax year. The term can also be applied to businesses that have come into an installment plan with the government that allows them to pay off their tax liability over time.

Investors can also take advantage of deferred tax liability. For instance, real estate investors often rely on something called a 1031 exchange that allows them to defer tax payment. When a commercial investment property is sold, an investor can purchase another like-kind property and thus defer the tax owed on the capital gains earned by the sale of the first property.

Understanding how to legally defer taxes can be a part of an investment strategy as it can keep more money working for an investor. It’s also a tool to have at your disposal should you face some difficult financial times and not be in a position to fully pay all of the taxes that you owe. Whenever you’re considering taking advantage of deferred tax liability laws, make sure that you work with a financial professional to ensure that you’re operating within the framework of the law.