Income tax expense is not always the same as income tax liability.
The amounts of income tax liability and income tax expense usually vary, because each amount is computed according to different guidelines. Income tax expense is disclosed in the income statement as an adjustment to arrive at net income for the period. Its calculation is based on financial accounting income reported, according to U.S. accounting guidelines known as GAAP, or generally accepted accounting principles. Income tax liability is calculated to determine the amount of income tax that is payable to the Internal Revenue Service and follows the IRS code.
Income Tax Expense
The total income tax expense for a period includes current income tax plus deferred income tax. The current income tax expense equals the period's financial accounting income multiplied by the current year's tax rate. The deferred income tax expense equals the change in the deferred tax liability account from the beginning to the end of the current accounting period. A deferred tax liability account is created when tax differences between taxable income and accounting income increase future taxes. For example, using different asset depreciation methods for tax and accounting purposes can cause tax differences and a deferred tax expense.
Recording Income Tax Expense
Let's use an example to illustrate how total income tax expense is calculated and recorded between current and deferred income tax. Tutu Co. reported $500 in accounting income for the year. Tutu's tax depreciation is greater than its accounting depreciation by $75; a 25 percent income tax rate is expected in current and future periods. Total income tax expense equals accounting income of $500 multiplied by 25 percent or $125. The excess tax depreciation will result in a deferred tax expense of $75 multiplied by 25 percent, or $18. When recording the expense portion of the journal entry, debit "current income tax expense" for $107 ($125 minus $18) and debit "deferred income tax expense" for $18.
Income Tax Liability
The income tax liability for the period is the amount of taxable income from the tax return multiplied by the current tax rate. Using Tutu Co. as an example, income tax payable equals taxable income of $425 ($500 minus $75) multiplied by 25 percent, or $107. The excess tax depreciation will result in a future tax liability of $75 multiplied by 25 percent, or $18. This amount is a liability because the recording of a higher tax deduction in the current period will cause taxable income to be higher in the future, since the current deduction will not be available.
Recording Income Tax Liability
When recording the liability portion of the journal entry, credit "income tax payable" for $107 and credit "deferred tax liability" for $18. In the following year, the deferred tax liability will be adjusted for the change in deferred taxes that apply to that period (new ending balance).
