A deferred tax asset is a balance sheet asset that can be used to reduce a company's future tax liability. Essentially, it is a tax benefit that a company delays using until a later tax period. For example, a company may have a loss that could reduce its tax liability by about $50,000. Instead of using that loss to reduce its current tax liability, it may use it to reduce its tax liability in a future tax period when the company has positive earnings.
To fully understand how tax deferred assets work, a person may do well to think of a company's accounting and its tax responsibilities separately. Often, expenses are deducted or projected for accounting purposes before the company receives any tax relief for it. Companies figure out whether they have deferred tax assets by comparing their accounting income with their taxable income. In cases in which a company's taxable income exceeds its accounting income, the company may have a deferred tax asset situation. On the other hand, a company that has accounting income that exceeds its taxable income would have a different tax situation, which is referred to as a deferred tax liability.
There are many ways deferred tax assets can develop. They may develop, for example when a company has net operating losses or financial changes due to restructuring. In some cases, deferred tax asset situations may even develop because of something like the warranties on a product a company sells. For example, a company may sell personal digital assistants (PDAs) that come with warranties that last for several years; for each year that the warranty is in effect, the company may expect warranty expenses because of returned PDAs. When the company reports to its shareholders, it may include the warranty expense estimates, using them to decrease the shareholders income.
While this may work for decreasing shareholder income, taxing agencies usually require companies to wait until an expense has actually taken place to report and deduct it. As such, a company's taxable income can be higher than the shareholder income. This creates a deferred tax asset. The company pays higher taxes because it cannot deduct the warranty expenses in the present. Essentially, the company prepays taxes on this income and then will be able to take a future benefit in the form of lower taxes once it does have the usable warranty expenses.