[malccounting]

I am working on Future Income Taxes and having trouble fully understanding what they fundamentally mean. I know that with Timing differences you create a debit account for future income tax (expense) and credit a future income tax liability account. But what does this mean? Are you actually paying out any money or does the liability mean you are expensing it but not paying? Can someone please explain in lamen terms how Future Income Taxes work? Textbooks are really confusing.

[malccounting]

I am working on Future Income Taxes and having trouble fully understanding what they fundamentally mean. I know that with Timing differences you create a debit account for future income tax (expense) and credit a future income tax liability account. But what does this mean? Are you actually paying out any money or does the liability mean you are expensing it but not paying? Can someone please explain in lamen terms how Future Income Taxes work? Textbooks are really confusing.

[morgaine300]

Please do not double post like that. It just confuses things and takes up more of our time. We are all volunteers with real lives and you cannot expect to necessarily get a response that fast.

I have merged your two posts together into one thread.

[morgaine300]

You're calling it "future income taxes," but I'm not sure if you just mean a plain old accrual of current taxes, or if you're getting into deferred tax liabilities, which is a bit more advanced thing.

First, ALL payable accounts mean you're paying something later. That's why they're payables. And an expense account is not "future." So I'm losing what you're meaning there. Expense is current. That's why it is expensed even though it hasn't been paid, because the expense belongs to the current period, not a future period.

If you're actually getting into deferred taxes, that's a bit different, and then you may be expensing something that is "future" as far as the IRS is concerned, but an expense is never future as far as the books are concerned, for the reason I gave above.

If you are simply referring to a debit to Income Tax Expense and a credit to Income Tax Payable, then you're making something more complicated than it needs to be. That is just an accrued expense, and no different than debiting Utilities Expense and crediting Accounts Payable. They both recognize the expense now, but are not going to be paid until the future, hence the payable. All accrued expenses work that way.

If by chance you're getting into deferred taxes -- um, you're going to have to say so.

[malccounting]

Yeah, sorry about that. I only double posted because I saw the link saying that we should be posting under the homework section. My apologies, won't happen again.

Thank you for your response. I did mean deferred income taxes. I was just trying to grasp the fundamentals of them. Looking at examples I noticed that a deferred income tax expense is setup offset by a deferred income tax payable account. So is what you're saying then that as far as the company is concerned they are paying these taxes now even though the IRS may not require them to? I guess what I'm really asking is why do you expense something that you're not required to pay out to someone/where does this money go if it is an expense? I understand I think that it is just trying to account for differences between things like how the company depreciates and how tax is calculated with regards to depreciation. But I just can't seem to get my head around following where this money is going if it is an expense.

DR Future Income Tax
DR Income tax (current)
CR Future income tax payable
CR Income tax (current) payable

[morgaine300]

You wouldn't have all four of those accounts at once, or I should say you won't have both the asset and liability for the taxes. It's one or the other. And it's called Deferred Income Tax Liability, which can be either an asset or a liability. (Actually, I suppose you would use both in a year that it flips the other direction but I'm not going into that.)

Firstly, the reason you would record an expense that the IRS doesn't want yet is because it should match your book income. Book income follows GAAP, and therefore book taxes will follow it as well. And this is the matching concept - match the tax to the revenues of the current year.

GAAP rules and IRS rules don't always sync. Depreciation is a good example, and the best thing to do is an example. So let's say you have a 2000 piece of office equipment. Let's say the company chooses to use straight-line depreciation for 5 years, which is 400 per year. Let's further say that there are no other differences and that income before depreciation is 5000 and tax is 10%. (A bit unrealistic but whatever. ;))

So on your books you subtract the 400 and that leaves income before taxes as 4600. Tax for book would then be 460. That is your expense -- period. You match the expense to book. As of yet, we do not know what the liability or asset accounts might do.

Now let us say that MACRS tells us we need to do 20% the first year. Rats. That's 400 as well. OK, duh, if there's no salvage, first year comes out the same. OK, forget MACRS. :p Just pretend tax depreciation came out to 500. So we subtract from the pre-depreciation income of 5000 and get 4500. That's taxable income. That is not book income, but what the IRS says is taxable income. And 10% of that is 450.

So the IRS wants $450. But we recorded $460 as the expense to match book income. Note that the difference in depreciation is a temporary difference. This means somewhere this is going to turn around. The easiest way to do a temporary difference: plug in the expense that matches book, plug in a current payable for what the IRS wants, and the difference is your deferral:
Income Tax Expense (Dr) 460
Income Tax Payable (Cr) 450
Well, we're missing a credit, not to mention that we still (will) owe that extra $10 at some point in the future - so we have a liability:
Deferred Income Tax Liability (Cr) 10

And you're done. And that deferred account is long term cause it's not going anywhere "within a year."

Now, nothing is due ahead of time if it's under $500, but let's pretend you've already made 3 $100 estimated payments. Each quarter you record the $100 as debit to the expense and credit to cash. So when we get to year-end, $300 is already recorded as expense as well as already having been paid. So basically you just reduce the expense and the current payable by the $300. You only have $160 more of expense to record, and there's $150 the IRS still wants. Same $10 difference:
Income Tax Expense (Dr) 160
Income Tax Payable (Cr) 150
Deferred Income Tax Liability (Cr) 10

If this were turned around and the expense were higher for book, leaving less income and therefore less tax for book, the deferral goes the other way. It's kind of like a deposit on future tax, which is an asset. It'd be like flipping it:
Deferred Income Tax Liability (Dr - asset) 10
Income Tax Expense (Dr) 450
Income Tax Payable (current)( Cr) 460

So plug in the expense, based on book income. Plug in the current payable based on IRS taxable income. The difference is the deferral.

If you have a permanent difference -- for instance, something deductible for book but not deductible for taxes, you have to let it go for book and just match taxes, cause it's never going to count. Like if you have $100 entertainment and can only count $50 for taxes (if that rule hasn't changed), then you'd have to adjust book to be $50 for the sake of figuring the taxes, cause that won't ever make up for itself.

I'm not going to go into what happens when the next year comes and you have to re-adjust, unless you need to do that, cause it's icky. Also do keep in mind that this entry is actually the NET of all differences between book and tax, and not just one thing. Unless of course... there's only one difference.

Oh, and no you're not paying something that the IRS doesn't want yet. Expensing isn't paying, remember?

[mccoolr901]

So your saying that is like, having an expense that is not paid for so you put it under an accounts payable? Jw