Last week we broke down deferred tax assets and how they can help reduce tax liability. Today, we’re breaking down its counterpart: deferred tax liabilities. But what exactly is a deferred tax liability, and how does it work? Here’s an overview of deferred tax liabilities, how they arise, and their implications for businesses and individuals.
Financial Reporting vs. Tax Reporting
Before diving into deferred tax liabilities, let’s recap how financial reporting differs from tax reporting. Financial reporting tracks information through balance sheets, income statements, and statements of cash flows. These statements give stakeholders a good idea of a company’s financial position, performance, and cash flow. Tax reporting, on the other hand, involves calculating and reporting a business’s taxable income and tax liability to the relevant tax authorities.
Financial reporting focuses on the accrual basis of accounting. This involves revenues and expenses being recognized when earned or incurred, regardless of when cash is received or paid. It aims to provide a comprehensive and long-term view of the financial performance and position of a company. Tax reporting generally follows specific rules related to the timing of revenue and expense recognition for tax purposes. Depending on the tax laws, revenue and expenses may be recognized differently from financial reporting. For example, certain expenses may be deductible for tax purposes when paid. This is even if they are not yet recognized as expenses under financial reporting.
What are deferred tax liabilities?
A deferred tax liability is a type of tax obligation that arises when a company’s taxable income is lower than its financial accounting income. It‘s the income tax that a company will owe in the future, but that‘s not yet due.
How do deferred tax liabilities arise?
Deferred tax liabilities can arise from a variety of situations, such as depreciation of assets, inventory valuation, and deferred revenue. For example, if a company depreciates an asset over a longer period of time for tax purposes than for financial accounting purposes, it may create a deferred tax liability. While the company may have lower taxable income in the short term, it will eventually have to pay more in taxes in the future when it sells the asset.
Another example of a deferred tax liability is when a company has a loss that can be carried forward to offset future taxable income. In this case, the company has a deferred tax liability because it will eventually have to pay taxes on the income that is offset by the loss carryforward.
Should I have deferred tax liabilities?
It’s important to note that deferred tax liabilities are not necessarily a bad thing. In fact, they can be a sign that a company is managing its taxes effectively. However, it’s also important to keep track of these liabilities. Make sure they are paid when they come due. In addition, companies must disclose deferred tax liabilities in their financial statements. This provides transparency and enables stakeholders to assess the entity’s financial health accurately.
Deferred tax liabilities are an essential concept in accounting, representing future tax payments resulting from temporary differences between financial statements and tax returns. Understanding the implications of deferred tax liabilities is crucial for accurate financial reporting, effective tax planning, and managing cash flow. By recognizing and accounting for these liabilities properly, businesses can navigate the complex world of taxation more effectively and optimize their financial performance.
When looking into the net worth of a business or individual, one of the first couple of things we look at are assets and liabilities. Assets are resources or properties owned by an individual, organization, or entity that have value. They can be used to generate future economic benefits. Real estate, vehicles, cash, inventory, intellectual property, software and licenses are assets. Deferred tax assets, on the other hand, are items that can be used to lower a tax liability. Here we will review what a deferred tax asset is and how it works.
Financial Reporting vs. Tax Reporting
Before diving into deferred tax assets, it’s important to first understand how financial reporting differs from tax reporting. Financial reporting tracks information through balance sheets, income statements, and statements of cash flows. These statements give stakeholders a good idea of a company’s financial position, performance, and cash flow. Tax reporting, on the other hand, involves calculating and reporting a business’s taxable income and tax liability to the relevant tax authorities.
Financial reporting focuses on the accrual basis of accounting. Revenues and expenses are recognized when earned or incurred, regardless of when cash is received or paid. It aims to provide a comprehensive and long-term view of the financial performance and position of a company. Tax reporting generally follows specific rules related to the timing of revenue and expense recognition for tax purposes. Depending on the tax laws, revenue and expenses may be recognized differently from financial reporting. For example, certain expenses may be deductible for tax purposes when paid, even if they are not yet recognized as expenses under financial reporting.
What is a deferred tax asset?
A deferred tax asset is an item on a balance sheet that was created by overpaying taxes or paying it off early. It usually represents a difference between the company’s internal accounting and taxes owed. If taxes are not yet recognized in an income statement, sometimes because of the accounting period used, a deferred tax asset can emerge. Another example would be how a company depreciates its assets. Changing the method or the rate of depreciation can result in overpayment of taxes.
Why do deferred tax assets exist?
Deferred tax assets allow individuals and businesses to reduce their taxable income in the future. One simple example would be a loss carryover. Since businesses are able to use a loss to reduce their taxable income in later years, the loss can essentially be viewed as an asset. Deferred tax assets never expire. That said, they can be used whenever it’s most convenient for the business. This is as long as they are not applied to past tax filings.
How are deferred tax assets calculated?
Calculating a deferred tax asset can vary depending on the type of asset. For example, let’s assume a business uses a depreciation rate of 20% for tax purposes, but 15% for their own accounting purposes. If their taxable income is $10,000, they would pay $2,000 (20% of $10,000) to the appropriate taxing authority. However, the taxes on their income statement would be $1,500 (15% of $10,000). The difference in actual tax paid and the tax reported on the income statement is a deferred tax asset on their balance sheet, or $500 ($2,000 – $1,500).
In another example, there may be some expenses that a business records on their income statement but not on their tax statement because they are not able to. This would result in more taxes actually paid and a deferred tax asset on the balance sheet.
Should I have deferred tax assets?
Deferred tax assets represent tax benefits that can be used to offset taxes owed in the future. It’s important to note that deferred tax assets are also not always guaranteed. If a company experiences financial difficulties or does not generate enough taxable income in the future, the deferred tax asset may not be used. Additionally, deferred tax assets must be periodically reviewed to ensure that they are still valid and should not be written off. It goes without saying that deferred tax assets can get very complicated. However, Optima Tax Relief has over a decade of experience helping taxpayers with the toughest tax situations.
Tax time can be a stressful period for individuals and businesses alike. However, maintaining accurate and organized tax records throughout the year can make the process much smoother and alleviate unnecessary headaches. Whether you’re a freelancer, small business owner, or an individual taxpayer, this guide will provide you with valuable tips on how to keep good tax records, ensuring compliance, minimizing errors, and maximizing deductions.
Organize Your Documents
The best way to get started with keeping good tax records is to create a system to help you stay organized. To some, this may look like a filing system, either physical or digital. However, if you do go with a physical cabinet, you should still keep digital backup files. You can start organizing by labeling all documents by category, from income to expenses to deductions and credits. Then you may want to take it a step further and include subdivisions of each category. For example, you can break these down by month, expense type, or project.
Utilize Technology
Some of us are old school and that’s okay. However, working technology into your system can make things much more efficient. For example, if you’re looking for a specific file, doing a quick search on your computer will be a whole lot easier than digging through paper files. You may also want to consider using accounting software to track expenses and income. These tools can streamline the record-keeping process significantly, especially if you are running a business.
Separate Business and Personal Records
Speaking of business, always remember to keep your personal and business income and expenses completely separate from each other. This includes documentation and receipts.
Keep Records of All Relevant Information
It’s better to keep more records than you need just to be on the safe side. At the very least, you should keep the following for a minimum of three years:
Income records, including bank statements, W-2s, 1099s, receipts from rental income, etc. If you file jointly with your spouse, you’ll also need their records.
Expense documents, like receipts, invoices, checks, etc. Be sure these are categorized so it’s easier to claim certain deductions at tax time.
Investment records, such as purchase and sale details, dividend payments, capital gains and losses, etc.
Real estate records, including purchase agreements, mortgage interest statements, property tax records and more.
Track Your Deductions and Credits
During tax time, you’ll want to maximize your refund and savings by taking advantage of tax deductions and credits. Be sure to only claim the credits and deductions you qualify for and can substantiate with proof. For example, if you plan to deduct contributions made to charity, you should keep receipts and acknowledgements for donations you make. These will allow you to calculate your deductions. If you have education-related expenses, records of tuition payments, student loan interest, or materials can help prove your eligibility for education tax credits.
Get Tax Help
Keeping good tax records is essential for legal compliance, minimizing errors, maximizing deductions, making the audit process smoother, and gaining valuable financial insights. By investing time and effort in maintaining accurate and organized records, you can navigate tax season with confidence, minimize tax liabilities, and ensure smooth interactions with the IRS. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
Last week, we discussed the tax benefits of health savings accounts (HSAs). HSAs are tax-advantaged savings accounts specifically designed for individuals with high-deductible health plans (HDHPs). For those who do not have an HDHP, there are other options when it comes to paying for medical expenses. Enter flexible savings accounts, or FSAs. These can help cover the cost of health care expenses, all while saving you money during tax time. Here’s an overview of flexible spending accounts, including what they are, how they work, and their tax benefits that can save you money.
What is a Flexible Spending Account (FSA)?
Like a health savings account (HSA), a flexible spending account (FSA) is a tax-advantaged savings account used to pay for qualified medical expenses. In addition, FSA contributions are made with pre-tax dollars. This basically means contributions are not included in your taxable income, thus reducing your tax liability for the year. Unlike an HSA, contributions made to your FSA do not carry over to the next year. Instead, they use a “use it or lose it” policy. This means that anyfunds that are unspent by the end of each plan year are forfeited to your employer. However, your employer may offer some exceptions to this rule. For example, some employers might give you an additional grace period of an extra 2.5 months to use the funds or allow up to $610 to carry over into the following year.
In 2023, the IRS allows you to contribute up to $3,050 to your FSA if you’re a single person. If you are married, your spouse may also contribute the same amount through their own employer. Although they are not required to, your employer may also contribute to your personal FSA. FSAs can cover things like medical deductibles, first aid supplies, eyeglasses, contact lenses, some dental expenses, copayments, some prescriptions drugs, and coinsurance. However, note that all FSA-eligible expenses are determined by the IRS. Unlike HSAs, FSAs are typically owned by the employer or the FSA administrator. When you leave your job, you generally lose access to your FSA.
How Does an FSA Work?
During your employer’s open enrollment, you can sign up for an FSA. You’ll need to decide how much money you want to contribute to the account for the upcoming plan year. Once you’ve enrolled in the FSA, your chosen contribution amount will be deducted from your paycheck on a pre-tax basis. As you incur eligible medical expenses throughout the year, you access your FSA funds to pay for them. Your employer will typically provide you with a payment card, which is similar to a debit card. Alternatively, they may have a reimbursement procedure to access the funds. You are liable for paying back your account if the benefits card is unintentionally or knowingly used for ineligible costs. Any unspent funds in your FSA at the end of the plan year may be forfeited.
Pre-Tax Contributions
While contributions to your FSA are not tax-deductible like those of an HSA, they are deposited pre-tax. So, contributions lower your total tax liability. For example, let’s say your annual salary is $50,000 and you contribute $3,000 to your FSA. Consequently, your gross income would then be $47,000. Any taxes owed, whether they are federal, state, or local, would be based on the gross amount. Because these funds are not taxed, you cannot claim a tax deduction for your contributions. However, FSA participants have an average 30% tax savings on the total amount they contribute to their account.
FSAs vs. HSAs
HSAs and FSAs are both popular tools for managing healthcare expenses, but they have some key differences.
FSAs
Generally available to employees with employers who offer these accounts
FSAs have lower contribution limits, with the maximum annual contribution limit of $2,850 per individual in 2023. This limit applies to each employee and is not based on family coverage.
No rollover, so “use it or lose it” policy, with some exceptions.
Contributions are made with pre-tax dollars, reducing your taxable income.
Contributions are tax-deductible.
Withdrawals for qualified medical expenses are generally tax-free.
HSAs
Designed for individuals with high-deductible health plans (HDHPs)
In 2023, the maximum annual contribution for individuals with self-only HDHP coverage is $3,650, while for family coverage, it’s $7,300. Individuals aged 55 or older can make an additional $1,000 catch-up contribution.
HSAs offer the advantage of rollover.
Contributions are made with pre-tax dollars, reducing your taxable income.
Contributions are tax-deductible.
Withdrawals for qualified medical expenses are generally tax-free.
If you’re thinking about getting an HSA or FSA, you should consider your specific circumstances, healthcare needs, and employer offerings to determine which option is best suited for you.
In today’s world, where healthcare costs are constantly rising, finding smart and effective ways to save money is crucial. One such method that has gained popularity in recent years is the Health Savings Account (HSA). Not only does an HSA allow individuals to set aside funds for medical expenses, but it also offers significant tax advantages. In this article, we will explore the tax benefits of Health Savings Accounts and how they can help individuals save money while maintaining their health and financial wellbeing.
What is a Heath Savings Account (HSA)?
A Health Savings Account (HSA) is a tax-advantaged savings account specifically designed for individuals with high-deductible health plans (HDHPs). HDHPs generally have low monthly premiums but higher deductibles compared to traditional health insurance plans. In 2023, these plans include deductibles of at least $1,500 for individuals and at least $3,000 for families. HSAs help these individuals save money for qualified medical expenses that their health insurance provider does not cover.
HSAs allow you to carry over any unused funds from year to year. Unlike other accounts that often have a “use it or lose it” policy, HSAs offer the flexibility of accumulating funds over time. In 2023, the IRS allows you to contribute up to $3,850 to your HSA if you’re a single person. This amount increases to up to $7,750 for families. Your HSA belongs to you, even if you change jobs.This makes them an attractive choice for individuals who want to save for future medical expenses or even use the funds as a retirement savings tool.
Contributions are 100% Tax-Deductible
Any money you contribute to your HSA is tax-deductible, even if you do not itemize your deductions. So, your contributions can be deducted from your taxable income during tax time, which lowers your tax liability and can potentially push you into a lower tax bracket. In addition, if you make contributions through payroll, this money is deposited pre-tax, which also lowers your total tax liability. In other words, these contributions can be excluded from your total gross income.
Contributions and Distributions are Tax-Free
Just like a brokerage account or an IRA, you can invest through your HSA. Once you fund your account, you can choose your own investments or allow the experts to do it for you. The best part is that these contributions grow tax-free. This means that you pay no taxes on the interest the account earns. On top of that, any distributions you use to pay for qualified medical expenses are also tax-free. If you use your HSA to pay for non-medical expenses, you’ll be subject to income taxes and an additional 20% penalty. If you are 65 years old or older, non-medical expenses will not incur the 20% penalty, but the income taxes will still need to be paid. This is also true if an individual suddenly becomes disabled or if they die.
HSAs Can Be a Last-Ditch Effort to Lower Your Tax Liability During Tax Season
As tax season approaches and we start receiving our income documents, we might want last-minute ways to lower our tax liability. Contributing to an HSA is a great way to do this for several reasons. One reason is again the fact that contributions to an HSA reduces your taxable income, which in turn reduces your tax liability. Secondly, you can continue to contribute to your HSA all the way up until the April tax deadline. This means that you have an additional few months of contributions to reduce your taxable income from the prior year.
Should I open an HSA?
Health Savings Accounts provide individuals with a unique opportunity to save money on a pre-tax basis, enjoy tax-free growth, and use the funds tax-free for qualified medical expenses. That said, they are definitely worth looking into. To qualify, you must be covered by a high-deductible health plan (HDHP) and have no other health insurance, except for worker’s compensation, specific illness-related insurance, or a fixed coverage per day if you are hospitalized. You cannot be enrolled in Medicare, and you cannot be claimed as a dependent by anyone else. By leveraging the benefits of an HSA, individuals can effectively manage their healthcare costs while maximizing their tax savings.
Marriage can be a wonderful milestone in life. But in the midst of planning a wedding and a future with your significant other, you may not be thinking about how your new union will affect your tax bill. One critical tax factor to examine is the concept of marriage bonuses and marriage penalties. These terms refer to how marriage can affect a couple’s tax liability. In this post, we will look at the fundamentals of marriage bonuses and marriage penalties, as well as how they might affect a couple’s tax situation as a whole.
What is a marriage bonus?
A marriage bonus happens when a married couple’s combined tax liability is less than the sum of their individual tax liabilities if they filed as single individuals. This is most common when one spouse earns much more than the other. By combining their wages, the couple can take advantage of reduced tax brackets, tax credits, and deductions that they might not have had access to as single filers.
Here’s an example. Let’s say an unmarried couple has a combined income of $120,000, one person earning $0 and the other earning $120,000 in 2023. As single filers, the first person would have a $0 tax liability, while the second higher-earning person would have a tax bill of $18,876. If this same couple got married and filed jointly, their combined tax liability would be just $10,921 because they would be able to claim a larger standard deduction and would be taxed at a lower marginal tax rate.
What is a marriage penalty?
Conversely, a marriage penalty arises when a couple’s combined tax liability as a married couple is higher than their total tax liability if they were still filing as single individuals. Because merging incomes in joint filing can drive both spouses into higher tax brackets, couples with similar incomes are more likely to pay marriage penalties than couples with one spouse earning the majority of the income.
Another factor to consider when calculating the marriage penalty for high-income earners is the net 3.8% investment income tax. This tax is levied on single filers with an adjusted gross income of $200,000 or more, as well as married filers with an adjusted gross income of $250,000. In addition, these same taxpayers will also be subject to an additional Medicare tax of 0.9% on earnings over $200,000 for single filers, and over $250,000 for married couples filing jointly.
Beyond federal marriage penalties, some states also impose their own marriage penalties, including California, Georgia, Maryland, Minnesota, New Mexico, New Jersey, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, Vermont, Virginia, and Wisconsin.
How can I avoid a marriage penalty?
Understanding your tax situation as a married couple is essential for efficient tax planning. For example, you can always calculate different scenarios to estimate your tax liability before filing. Filing separately rarely results in a more advantageous outcome for couples, but you may find yourself under these special circumstances. You should also explore all eligible deductions and credits to reduce your overall tax liability. Married couples who file jointly have access to several tax credits, including the Earned Income Tax Credit, education credits, and the Child and Dependent Care Tax Credit. Be aware of phase-out limits that might affect your eligibility. If you’re still unsure how to navigate marriage penalties and bonuses, consider consulting a tax professional. Doing so can provide valuable insights tailored to your specific situation. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers just like you.
