Example of a Deferred Tax Liability

We have the following information about an asset of a company.

Original cost: $1,500,000

Useful life of the asset: 3 years

Salvage value: $0

Depreciation for accounting purpose: $500,000 per year using straight line method

Depreciation for taxation purpose: $600,000 in year 1, $500,000 in year 2, and $400,000 in year 3.

EBITDA: $1,000,000

Tax rate: 40%

We can calculate the firm’s income tax expense, taxes payable, and deferred tax liability as follows:

Income Statement

	Year 1	Year 2	Year 3
EBITDA	1,000,000	1,000,000	1,000,000
Depreciation	$500,000	$500,000	$500,000
Income before tax	500,000	500,000	500,000
Income tax expense	200,000	200,000	200,000

 

Income Tax Returns

	Year 1	Year 2	Year 3
EBITDA	1,000,000	1,000,000	1,000,000
Depreciation	$600,000	$500,000	$400,000
Income before tax	400,000	500,000	600,000
Tax payable	160,000	200,000	240,000

In year 1, income tax expense is $200,000 but the tax payable is only $160,000. The difference of $40,000 is deferred to future period and reported on balance sheet as Deferred Tax Liability (DTL).