During income tax preparation, there may be payable taxes, which are not shown on the income tax. Normally, these back taxes are already paid by the company you made transactions with. This happens when the company failed to pay the cash tax. Thus, the resulting cash flow is still not reflected in their latest balance sheet. The taxes involved might be death taxes or taxes acquired through property exchange. This usually happens when there are discrepancies about the due date or time between accounting rules and the tax department. Thus, it will be for the taxpayer’s safekeeping until he decides to pay for it.
You can surely save a lot because of these deferred taxes. No matter how accurate your bookkeeping services are, it’s already beyond you. The definition of deferred taxes states it as interest, capital gains and other investment earnings, which can be accumulated without any additional fee from taxation. The individual retirement accounts (IRAs) and deferred annuities are common examples.
Because of this, US laws under IAS 12 and US GAAP (SFAS 109) have placed deferred taxes under the liability method so that it can be accounted for.
Through this method, deferred tax assets and liabilities can now be determined especially if there’s a gap between what you know and what is reflected in the income tax statements. The law has also protected deferred tax payable through the future earnings of the taxpayer. This is to have the fee offset. There are many instances where the deferred tax falls under liability.
You should always remember that an asset, which has a carrying value that is greater than its tax basis, would become a deferred tax asset. Another example of deferred tax asset is when a liability has a carrying value larger than its tax basis. The last example is when the liability has lesser value than its tax basis.
Most people see it as a huge advantage. You can use it as an additional source of investment. But it also has a downside because you have to pay for it in the future. Variable annuities as stated above are a common source of deferred tax.
You can grow your tax-deferred earnings depending on your investment premium. This doesn’t come quickly though. It takes a decade or two for the interest to roll in to your account. Another downside is the resulting capital gains tax. If you decide to sell a tax-deferred investment, which is over a year old, it would result in 5-15% capital gains tax rate, which is really low.
Stock dividends also go through the same issue. But this can be resolved by having the annuity turned into a steady stream of income. After that, the money can start pouring in. The tax-deferred earnings also have its benefits. This is because long-term deferred taxes will not be payable until the next year. This will give you enough time to turn into investments. If you invested in a booming company, it might take time before they can pay the cash tax, which will give more chances to make it grow.