What are deferred taxes? How do deferred taxes occur?

Taxes due for payment in future years as a result of timing differences when different depreciation methods are used for financial reporting and tax purposes are deferred taxes.  When different depreciation methods are used, the amount of depreciation expense in the firm’s income statement and tax returns will be different.  Tax expense relates to the income reported in the income statement (book income), while taxes due and payable relate to income reported in tax returns (taxable income).  Deferred tax items are netted, resulting in either a deferred tax asset or deferred tax liability.

Deferred Tax = Δ(Tax Expense - Tax Payable)

A deferred tax asset is the balance sheet asset account reporting the amount of taxes paid or carried forward for tax purposes but not yet expensed and recognized in the income statement for accounting purposes.  The balance sheet liability account showing the estimated amount of taxes on income earned and recognized for accounting purposes but not yet due and payable for income tax purposes is deferred tax liability.  A deferred income tax liability results from the use of accelerated depreciation for tax purposes, such as allowed by MACRS, and straight-line depreciation for accounting purposes.