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Explain the effect of various tax rates and tax rate changes on deferred income taxes.

Explain the effect of various tax rates and tax rate changes on deferred income taxes.

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Answer #1

Deferred tax assets and liabilities are determined based on current tax rates. Thus when tax rate changes the existing deferred tax assets and liabilities have to be adjusted accordingly. When the tax rate increases, deferred taxes will also increase, i.e. deferred tax assets and liabilities will also rise. On a similar pattern, if the tax rate decreases, deferred taxes also fall

Income tax expense is given as:

Tax payable + Change in deferred taxes liabilities - Change in deferred taxes assets

It is because, deferred taxes liability is the excess of income tax expense over tax payable while deferred taxes asset is the excess of tax payable over income tax expense. Thus when tax rate increases, a rise in the deferred taxes liability will result in an increase in the income tax expense, while the rise in deferred taxes asset will decrease the income tax expense.

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