Posted in Finance, Accounting and Economics Terms, Total Reads: 360
Definition: Tax Deferred
Tax deferral refers to the practice of delaying payment of taxes to the government to a future period. Taxes sometimes can be deferred indefinitely or the present taxes when deferred to future may be taxed at a lower rate.
Tax Deferral by Corporates: Corporations may defer paying taxes by various methods. One of the most popular of them is by using Accelerated depreciation method. According to this, the depreciation amount charged for an asset owned by the company is very high in the initial period of its life and gradually becomes lower as the asset’s age becomes closer to its lifespan. Since the depreciation is high in initial years, the taxable income will reduce and consequently the tax paid also reduces. When the age increases, the depreciation reduces leading to higher taxable income and higher taxes. Thus effectively the tax has been deferred to the future period by this method. There are various other methods employed which include delaying the revenues or realising expenses on the books even before they have occurred etc.
Tax Deferral by Individuals (Income tax deferral): Income can be recognised in future years and expenses can be shown in present years. Tax deferred Investment accounts allow individuals to realise income later in life. There are other plans like 401k and IRA’s (Individual Retirement Accounts) for tax deferral.
International Tax Deferral: Profits earned from foreign overseas investments if realised may be taxed in home country. Hence companies having international operations generally retain or reinvest the corporate earnings in the lower tax countries
Benefits of Tax Deferral:
1. Instead of paying taxes on income, the money can be utilised in other investments which will grow and lead to less taxes in future
2. It leads to persons with high incomes to reinvest in the economy because generally higher income population is charged a higher income tax