Deferred income tax liabilities are easiest to understand conceptually by looking at revenues and gains. Assume
that a business reports revenue of $100 on its Year One income statement. Because of certain tax rules and
regulations, assume that this amount will not be subject to income taxation until Year Six. The $100 is referred
to as a temporary tax difference. It is reported for both financial accounting and tax purposes but in two different
time periods.
If the effective tax rate is 40 percent, the business records a $40 ($100 × 40 percent) deferred income tax liability
on its December 31, Year One, balance sheet. This amount will be paid to the government but not until Year Six
when the revenue becomes taxable. The revenue is recognized now according to U.S. GAAP but in a later year
for income tax return purposes. Net income is higher in the current year than taxable income, but taxable income
will be higher by $100 in the future. Payment of the $40 in income taxes on that $100 difference is delayed until
Year Six.
Simply put, a deferred income tax liability1 is created when an event occurs now that will lead to a higher amount
of income tax payment in the future.