Deferred Tax Assets: How They Reduce Your Future Tax Bill

If you’ve ever wished you could “save” a tax deduction for a future year, good news, you can. That’s essentially what a deferred tax asset is: a future tax deduction or future tax credit that reduces your company’s income taxes down the road.

If you know how deferred tax assets work, it can make a major difference in your long-term tax strategy. These assets represent money you’ve already paid (or overpaid) to the IRS that will eventually come back to you in the form of lower tax bills or credits in future years.

At OTB Tax, we help business owners use tools like deferred tax assets to create proactive strategies that don’t just minimize income tax expense today but free up cash flow for tomorrow, too.

Understanding Future Tax Savings

A deferred tax asset (DTA) exists when your company has paid more in taxes for accounting purposes than it owes for tax purposes. These differences arise because accounting rules (used for financial reporting) and tax rules (used by the IRS) don’t always line up perfectly.

Here’s the basic idea:

• For accounting, you record taxable income and expenses based on when they’re earned or incurred.
• For taxes, you often follow different rules set by the IRS about when income is taxable and when deductions are allowed.

That mismatch creates what’s called a temporary difference—and it’s those differences that give rise to deferred taxes, including both deferred tax assets and deferred tax liabilities.

When your business pays more tax now but expects to receive that benefit later, the difference becomes a deferred tax asset. When it’s the other way around—when you owe taxes in the future because you’ve deferred paying them—that’s a deferred tax liability.

For growing businesses, understanding how these deferred tax assets appear on your balance sheet (under non-current assets) is key to planning for future taxable income and improving cash flow.

Tip: A DTA represents a future financial benefit. It’s an indicator that your company has already “prepaid” some of its tax burden—and will owe less in the future.

What Creates a Deferred Tax Asset?

Timing is everything when it comes to tax accounting. A deferred tax asset arises because of temporary differences between the timing of when revenue or expenses are recognized in your financial statements versus when they’re recognized for tax purposes.

Here are a few simple examples to illustrate:

• Net Operating Losses (NOLs): If your business posts a loss this year, that net operating loss can often be carried forward to offset future profits. That carryforward creates a deferred tax asset because it represents a future tax deduction waiting to be used when you return to profitability.
• Estimated Bad Debts: You might record an expense today for unpaid invoices (based on accounting rules), but the IRS won’t let you deduct those bad debts until they’re officially uncollectible. That future deduction is also a deferred tax asset.
• Prepaid Taxes or Overpayments: Sometimes, companies prepay taxes that end up exceeding what’s actually owed. The excess can be recorded as a deferred tax asset and applied to future periods.

You’ll find deferred tax assets recorded on your company’s balance sheet under non-current assets because they represent benefits expected in future periods rather than the current year.

Common Sources of Deferred Tax Assets for Small Businesses

Deferred tax assets can come from numerous sources, especially for small and mid-sized companies navigating complex tax laws and accounting standards.

Some of the most common include:

• Unused Tax Credits: If you qualify for federal tax credits—like research and development (R&D) credits or clean energy incentives—but can’t use them this year, they can often be carried forward to offset future taxes payable.
• Warranty or Reserve Expenses: Businesses that set aside money for future warranty claims record an expense now for accounting purposes, but that deduction may not apply for tax purposes until customers actually make a claim. That creates a DTA tied to warranty expense.
• Depreciation Differences: Tax law allows accelerated depreciation (deducting asset costs faster), while financial accounting often uses straight-line depreciation. In some cases, this timing difference can generate a deferred tax asset or liability, depending on which schedule results in higher deductions earlier.
• Excess Retirement Contributions: Contributions to employee pension or retirement plans may be recognized as an expense now under accounting rules but deductible later under IRS rules—another source of a DTA.
• Intangible Assets and Amortization: Differences in how intangible assets like trademarks or goodwill are amortized for tax versus book purposes can also create deferred tax balances.

These timing differences aren’t mistakes—they’re part of normal tax accounting and can significantly impact income taxes and cash flow in future years.

Understanding the Valuation Allowance

Not all deferred tax assets are guaranteed future savings. A deferred tax asset is only valuable if your business expects to generate enough future taxable income to use it. If your company doesn’t project sufficient profits to offset those deferred deductions, then some or all of that benefit may never materialize.

That’s where the valuation allowance comes in.

Think of a valuation allowance as a reality check. It’s an adjustment made by your accountant when there’s uncertainty about whether the business will be able to use all of its deferred tax assets in future years. By recording this allowance, your financial statements present a more accurate and conservative picture of your tax assets and liabilities.

Essentially, the valuation allowance acts like a safety net that keeps your books honest. If your accountant determines it’s unlikely you’ll generate enough future taxable profits, they’ll record an allowance that reduces the total value of your deferred tax assets on the balance sheet. This doesn’t erase the potential benefit; it simply adjusts expectations to match your business’s current outlook.

In simpler terms:

• No allowance = confidence. Your accountant believes your business will earn enough future income to use the DTA.
• Allowance applied = caution. Your future profitability is uncertain, so only part of your deferred tax asset is likely to be realized.

For example, imagine your company has $100,000 in deferred tax assets from net operating losses carried forward. If your accountant estimates that you’ll only generate $60,000 in taxable income in the near term, a valuation allowance of $40,000 may be applied. That means only $60,000 of your deferred tax asset is expected to reduce future tax bills.

A large, unreserved DTA (one with little or no valuation allowance) is often a positive sign. It shows confidence in your company’s ability to generate future taxable income and continue growing. On the other hand, if your business is experiencing irregular revenue or is still recovering from prior losses, a valuation allowance provides a safeguard against overstating assets that may not be realized.

Your accountant will typically reassess this allowance every year. If your financial performance improves or stabilizes, part—or all—of that allowance may be reversed, immediately strengthening your balance sheet and lowering income tax expense in that period.

Reminder: Deferred tax assets and liabilities are part of your company’s broader tax assets and liabilities picture. Reviewing them annually as part of a Tax Strategy Session helps ensure your financial statements accurately reflect your business’s true future tax obligations and potential savings.

Maximizing the Benefit of Deferred Tax Assets

Knowing that deferred tax assets exist is one thing, but using them effectively is another. Here’s how to make the most of them:

1. Track and Report Accurately

Accurate financial statements and well-organized accounting records are crucial for identifying temporary differences and tracking your tax assets year over year. Misreporting DTAs can lead to errors in your income statement and affect your company’s cash flow.

2. Engage in Proactive Planning

Working with a tax strategist (not just a tax preparer) makes a huge difference. At OTB Tax, we focus on tax strategy, not just compliance. We help you identify deferred tax assets, deduct expenses in the right period, and plan for future tax liability reductions.

• Strategic planning for net operating losses (NOLs)
• Analysis of accelerated depreciation schedules
• Tracking unused tax credits and carryforwards
• Reviewing your balance sheet for opportunities to improve future financial benefit

Want to see where you stand? Book a Tax Strategy Session to uncover hidden tax-saving opportunities in your financials.

3. Consider the Cash Flow Impact

A deferred tax asset represents a promise of lower cash taxes in the future. This can impact decisions around reinvestment, payroll, and financing. Smart business owners use their DTAs as part of their financial modeling to plan growth while keeping future tax obligations low.

By taking advantage of accounting rules and tax law timing differences, your company’s taxable income in future years can be reduced, freeing up more capital for expansion or savings.

Looking Ahead to Future Tax Savings

A deferred tax asset might sound technical, but it’s simply a future financial benefit that can lower your income taxes when used strategically. It’s one of those quiet but powerful tools that can influence how your business grows, spends, and saves.

For any company looking to strengthen its financial foundation, properly tracking and valuing deferred tax assets is non-negotiable. When managed correctly, they help reduce your future tax liability, improve cash flow, and create a clearer picture of long-term profitability.

Don’t leave those future tax savings sitting on the table. Schedule a Tax Strategy Session with OTB Tax to review your financial statements, identify potential deferred tax assets, and build a strategy that minimizes income tax expense while maximizing future profits.