Table of Contents

Understanding Deferred Tax Liability: Definition and Examples

By

The Investopedia Team

Updated October 01, 2025

Reviewed by

Lea D. Uradu

Fact checked by

Suzanne Kvilhaug

What Is a Deferred Tax Liability?

A deferred tax liability is taxes owed but payable in the future and is recorded on a balance sheet.
It's due to timing differences between tax accrual and payment date. Common scenarios leading to deferred tax liabilities include installment sales and varying depreciation methods. For individuals, contributions and returns earned in a 401(k) represent a deferred tax liability since the saver will pay taxes on the them at withdrawal.

Key Takeaways

Deferred tax liabilities arise from differences in timing between when a tax expense is recognized in accounting and when it is actually paid, often due to varying tax and accounting rules.
Common scenarios that create deferred tax liabilities include installment sales and different depreciation methods used for tax and accounting purposes.
Companies record deferred tax liabilities to account for taxes that are incurred but not yet payable, ensuring accurate reflection of financial obligations without immediate cash outflow.
Recognizing deferred tax liabilities allows businesses to maintain a clear record of future tax obligations, helping them manage cash flow and plan for future expenses.

How Deferred Tax Liabilities Are Calculated and Reported

The deferred tax liability on a company balance sheet represents a future tax payment the company must pay.It is calculated as the company's anticipated tax rate times the difference between its taxable income and accounting earnings before taxes.

Deferred tax liability is the tax amount a company will pay in the future. This doesn't mean the company has missed paying its taxes; it's just acknowledging a future payment.

For example, a company with net income must pay corporate income taxes. This liability is for the current year but paid the next year. This timing difference is recorded as a deferred tax liability.

Real-World Example of Deferred Tax Liabilities in Depreciation

A common source of deferred tax liability is the difference in depreciation expense treatment by tax laws and accounting rules. The depreciation expense for long-lived assets for financial statement purposes is calculated using a straight-line method, while tax regulations allow companies to use an accelerated depreciation method.

Since the straight-line method produces lower depreciation when compared to that of the under-accelerated method, a company's accounting income is temporarily higher than its taxable income. The company recognizes the deferred tax liability on the differential between its accounting earnings before taxes and taxable income.

As the company continues depreciating its assets, the difference between straight-line depreciation and accelerated depreciation narrows, and the amount of deferred tax liability is gradually removed through a series of offsetting accounting entries.

Is Deferred Tax Liability a Good or Bad Thing?

Deferred tax liability is a record of taxes incurred but not yet paid. This line item on a company's balance sheet reserves money for a known future expense that reduces the cash flow a company has available to spend. The money has been earmarked for a specific purpose, i.e. paying taxes the company owes. The company could be in trouble if it spends that money on anything else.

What Is an Example of Deferred Tax Liability?

An installment sale is a common example. This revenue is recognized when a company sells its products on credit to be paid off in equal amounts in the future.Under accounting rules, the company recognizes full income from the installment sale of general merchandise, while tax laws require companies to recognize the income when installment payments are made.This creates a temporary positive difference between the company's accounting earnings and taxable income, as well as a deferred tax liability.

How Is Deferred Tax Liability Calculated?

A company might sell a piece of furniture for $1,000 plus a 20% sales tax, payable in monthly installments by the customer. The customer will pay this over two years ($500 + $500). In its financial records, the company will record a sale of $1,000. In its tax records, it will be recorded as $500 per year for two years. The deferred tax liability would be $500 x 20% = $100.

The Bottom Line

A deferred tax liability represents taxes owed but payable at a future date. It's due to a timing difference between the point of the accrual of the tax liability and the date by which it must be paid. This is eventually reconciled. Deferred tax liabilities occur with installment sales and through certain depreciation methods. Businesses should regularly review their balance sheet and other financial statements for accurate deferred tax liability reporting, which affects future cash flow management.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

U.S. Securities and Exchange Commission. "Traditional and Roth 401(k) Plans."
Financial Accounting Standards. "Summary of Statement No. 96."
Internal Revenue Service. "Business Taxes."
Internal Revenue Service. "Publication 537 Installment Sales."

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