What is Deferred Income Tax?

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 Does Deferred Income Tax Work?

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 tax liability until paid in the following accounting period.

To illustrate, suppose company XYZ earns $1 million in a given quarter, $850,000 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 $150,000 until the following quarter. As a result, the $150,000 is still reflected on the income statement as part of the $1 million in realized income for the current quarter and the amount of tax on the $150,000 is reflected as a liability on the balance sheet.

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Why Does Deferred Income Tax Matter?

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.

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