Redpath Insights

Deferred Tax Liability and Your Company's Balance Sheet

by Sean Sullivan

November 20, 2014 — Defer. Defer. Defer.  That is usually the name of the game for income tax strategy.  What does that mean for how we look at company balance sheets?

The definition of “Deferred Tax Liability” is an account on a company's balance sheet that is a result of temporary differences between the company's accounting and tax carrying values, the anticipated and enacted income tax rate, and estimated taxes payable for the current year.  They occur when items of income or expense are treated differently in financial statements than in tax returns.  Assets are booked for expected future tax benefits while liabilities are recorded for expected future tax costs.  This keeps future tax obligations in front of company stakeholders and financial statement users such as bankers.

Different treatment causes timing difference that is temporary in nature.  Common timing differences include cash basis accounting, advance rent income, prepaid expenses, long-term contracts, depreciation methods, deferred compensation, installment sales, prepaid subscription income, bad debt reserves, warranty expense and loss contingencies.  Pass through entities present a unique issue.  S-Corp’s and LLC’s don’t pay taxes, so how can they have deferred taxes?  Everyone involved in the financial results of a pass-through entity understands the entity does pay taxes on income earned.  The entity pays in the form of equity distributions to its owners.  The unique issue for pass-throughs?  They don’t book deferred tax distributions.  There is no deferred tax on the company balance sheet to remind financial statement users of looming future tax obligations.

Common permanent treatment differences include life insurance premiums and proceeds, fines and penalties, and meals and entertainment.  Examples of exclusions or special deductions are municipal bond interest, dividend received deduction, or percentage depletion.

The current importance of deferred taxes is due to federal bonus tax depreciation deductions allowed from 2008-2013.  These accelerated deductions have potentially created large deferred tax obligations for many businesses.

Timing is everything to avoid the ambush.  Credit and cash flow presentations must include discussion or schedule of significant timing differences and expected impact on company cash flow.  Most information is provided in financial statement disclosures for tax paying entities.  Pass through entities require supplemental analysis, including a schedule of timing differences and tax component of distributions to get a practice of when deferred tax liabilities will be coming due.

Planning how to handle implications of reversing bonus depreciation deductions is probably the current greatest concern.  Getting your arms around the issue is the first step.  Proper tax planning is the next.  Remember: defer defer defer.

Sean Sullivan

Sean Sullivan

Sean Sullivan specializes in both creative and strategic marketing initiatives. Key areas of expertise include lead generation and new customer acquisition, content development, project management, art direction, and multi-channel campaign implementation. A process-oriented strategic thinker, Sean is adept at translating ideas and key messages into actionable insights and effective customer-focused marketing communications. Prior to joining Redpath and Company, Sean served as a Marketing Account Manager at C.H. Robinson where he balanced a number of responsibilities including driving revenue growth, building brand awareness, utilizing multi-channel marketing tactics, and leading high profile, cross-functional projects such as brand integrations and global tagline development.