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What is a Tax Deferral?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 17 September 2016
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Tax deferrals are situations in which the collection of taxes on generated revenue is delayed for a specified period of time. The main function of the tax deferral is to create a situation where individuals and business entities do not experience undue hardship on income that is not being actively used at the time, and will not actually be made available for use until a later date. Essentially, a tax deferral ensures that no taxes are considered due until the funds in question are withdrawn by the taxpayer.

The right of tax deferral is found in the taxation systems of many countries around the world. Generally, the deferral is related to income earned through employment or investment. The individual or business entity chooses to forego receiving the earnings for a period of time. In exchange, the government agrees to not assess taxes on those earnings until the entity or individual actually takes possession of the earnings.

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The concept of tax deferral is often involved with government approved retirement plans. This means that employees can choose to defer receipt of a portion of their earned income and have it placed into some sort of interest bearing retirement plan. The structure and management of the plan must comply with government standards in order to be eligible for the deferment. As part of the deferral process, the government is notified of the amount of earnings placed into the fund, but does not assess taxes in the period where the earnings were generated.

Once the employee reaches retirement age and begins to draw on the funds placed in the retirement plan, the amount of the withdrawals are considered to be taxable at that time. From this perspective, this arrangement allows the individual to avoid taxation during the present, but also creates a situation where future taxes will be due at a later date.

Along with earnings from employment, it is also possible to be awarded a tax deferral on any profits from investments. As with the earnings from salaries or wages, the tax deferral must meet requirements put in place by the government, and will be subject to taxes when the funds are withdrawn for use.

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