Deferred Income Tax
What it is:
Deferred income tax refers to a portion of income earned by a company during a given year for which the associated income tax has not yet been paid.
How it works (Example):
Certain accounting practices and tax laws often result in a portion of a company's income being realized and accounted for in one accounting period, but not taxable until another. For this reason, the income tax burden associated with this not-yet-taxed sum is reported as a liability until paid in the following accounting period.
To illustrate, suppose company XYZ earns $1m in a given quarter, $850k of which is taxable in the current quarter. Due to the manner by which XYZ accounts for income against tax codes, it is not required to pay tax on the remaining $150k until the following quarter. As a result, the $150k is still reflected on the income statement as part of the $1m in realized income for the current quarter, and the tax amount on the $150k is reflected as a liability on the balance sheet.
Why it Matters:
The possibility of deferred income tax is a reason why investors and prospective investors should examine a company's balance sheet in conjunction with its income statement to determine if there is a remaining taxable portion of income for a given period.