A deferred tax asset is a type of asset on a company’s balance sheet that is based on temporary differences between the company’s book and tax accounting. It can arise when a company pays taxes at a rate that is different than the rate used for financial reporting purposes. A deferred tax asset reflects the fact that a company will be able to use the tax deduction in the future, when the rate used for financial reporting is the same as the rate used for tax purposes.
The primary benefit of having a deferred tax asset is that it can help a company reduce its taxes in the future. When a company has a deferred tax asset, it can use it to reduce the taxes it pays in the future. This can help a company reduce its overall tax liability, as well as its effective tax rate.
How Does a Deferred Tax Asset Work?
A deferred tax asset is created when a company pays taxes at a rate that is different than the rate used for financial reporting purposes. For example, a company may pay taxes at a rate of 30%, but report its income for financial reporting purposes at a rate of 25%. The difference between the two rates creates a deferred tax asset.
The deferred tax asset is recognized on the company’s balance sheet as an asset. It reflects the fact that the company will be able to use the tax deduction in the future, when the rate used for financial reporting is the same as the rate used for tax purposes.
The deferred tax asset is not a liquid asset, meaning that it cannot be converted into cash. The deferred tax asset can only be used to offset future tax liabilities.
What Are the Benefits of a Deferred Tax Asset?
The primary benefit of having a deferred tax asset is that it can help a company reduce its taxes in the future. When a company has a deferred tax asset, it can use it to offset future tax liabilities. This means that the company will not have to pay taxes on income that it has already paid taxes on in the past.
A deferred tax asset can also help a company reduce its effective tax rate. By using the deferred tax asset to offset future tax liabilities, a company can reduce its overall tax liability. This can help the company save money on taxes and can result in a lower effective tax rate.
How Can I Calculate a Deferred Tax Asset?
The amount of a deferred tax asset is calculated by subtracting the tax rate used for financial reporting purposes from the tax rate used for tax purposes. The difference between the two rates is multiplied by the company’s taxable income to calculate the deferred tax asset.
For example, if a company pays taxes at a rate of 30%, but reports its income for financial reporting purposes at a rate of 25%, the deferred tax asset would be calculated as follows:
Deferred Tax Asset = (30% – 25%) x Taxable Income
The deferred tax asset would be calculated as 5% of the company’s taxable income.
What Are the Risks of a Deferred Tax Asset?
The primary risk of having a deferred tax asset is that the company may not be able to use the asset in the future. This can occur if the company’s financial or tax circumstances change. For example, if the company’s taxable income decreases, the deferred tax asset may no longer be able to be used to offset future tax liabilities.
In addition, a deferred tax asset can be subject to a valuation allowance. A valuation allowance is an amount set aside to cover any potential losses that may arise from the deferred tax asset. This means that the company may not be able to use the full amount of the deferred tax asset.
Conclusion
A deferred tax asset is a type of asset on a company’s balance sheet that is based on temporary differences between the company’s book and tax accounting. It can help a company reduce its taxes in the future and can result in a lower effective tax rate. The amount of a deferred tax asset is calculated by subtracting the tax rate used for financial reporting purposes from the tax rate used for tax purposes. The primary risk of having a deferred tax asset is that the company may not be able to use the asset in the future.
