What is deferred income tax?
Deferred income tax refers to the amount of taxes a business owes or will recover in the future due to temporary differences between the way income and expenses are reported on financial statements and how they're reported to tax authorities. These differences occur because accounting rules (like GAAP) and tax rules (like the IRS code) often treat timing of income and expenses differently.
For small business owners, understanding deferred income tax is important for long-term financial planning, especially if your business uses accrual accounting or has timing differences in asset depreciation or revenue recognition. If you’re looking to stay organized while managing payroll, employee taxes, and financial records, Homebase payroll can help simplify things.
How deferred income tax works
Let’s say your business recognizes income in one year for financial reporting but isn’t required to pay tax on that income until the next year. In that case, you record a deferred income tax liability—a tax bill you’ll pay later. The opposite is also true: If you pay more tax now than your accounting records show, you may have a deferred income tax asset, which reduces future taxes.
These tax deferrals are temporary. Over time, the differences between accounting income and taxable income reverse.
Deferred tax liabilities vs. deferred tax assets
- Deferred tax liability – You’ve reported more income (or fewer expenses) for financial accounting than for taxes. You’ll owe more tax later.
- Deferred tax asset – You’ve reported less income (or more expenses) for taxes than for financial accounting. You’ll owe less tax later.
Example of a liability: Accelerated tax depreciation lets you deduct more upfront, lowering taxable income now. But your books show smaller depreciation over time, so you’ll pay more tax in future periods.
Example of an asset: You report an expense on your tax return this year that’s not yet shown in your financials. This can lead to a deferred tax asset that reduces your tax burden in the future.
Common causes of deferred income tax
Deferred income tax often comes from timing differences like:
- Depreciation – Different schedules for financial and tax purposes
- Revenue recognition – Recording income now for financials but later for taxes (or vice versa)
- Allowance for doubtful accounts – An expense recognized on financial statements but not deductible for tax until it’s written off
- Prepaid expenses – May be deductible now for taxes, but expensed later on books
- Warranty or legal reserves – Recorded as liabilities in accounting but not deductible until incurred
These are all examples of temporary differences, which eventually resolve over time.
Why deferred income tax matters for small businesses
Understanding deferred income tax helps you:
- Better forecast tax obligations – Avoid surprises from future tax liabilities
- Accurately value your business – Deferred tax items are part of your financial position
- Improve financial transparency – Investors, lenders, and buyers may scrutinize deferred tax balances
- Work smarter with your accountant – Know which timing differences affect your year-end numbers
Even if you outsource your bookkeeping, understanding the basics gives you more control over your long-term planning.
How to track and manage deferred income taxes
You don’t need to calculate deferred income taxes manually, but you should:
- Keep detailed records of asset purchases, depreciation methods, and expense recognition
- Use consistent accounting methods so you can identify timing differences
- Review financial statements annually to see how deferred tax balances change
- Ask your CPA to explain differences between your book income and taxable income
For small businesses using cash-basis accounting, deferred taxes are less common—but they become more relevant as you grow or switch to accrual-based reporting.
When to involve a tax professional
Because deferred income tax is tied closely to tax law and accounting standards, it’s best to consult a CPA or financial advisor when:
- You switch from cash to accrual accounting
- You’re investing in equipment or property
- You’re preparing for an audit or financing
- You’re planning a business sale or succession
The stakes can get high, and expert guidance helps ensure you’re not missing out on deductions or creating liabilities you didn’t anticipate.
How Homebase helps you stay organized for tax season
Homebase makes it easy to manage one of the biggest business expenses: payroll. While your accountant handles the ins and outs of deferred income tax, Homebase keeps you on track with payroll tax filings, wage reporting, and labor cost tracking—all in one place.
With Homebase payroll, you can:
- Automate payroll calculations and tax filings
- Track wages, hours, and withholdings by employee
- Maintain clean records for audits and tax prep
- Reduce the risk of payroll tax errors
Explore Homebase payroll to simplify payroll and stay ready for anything tax season throws your way.