In accounting, Prepaid Income Tax is defined as an asset listed on the balance sheet that represents taxes that have been already paid despite not yet having been incurred. It is also called a deferred income tax asset.
Prepaid Income Tax Explanation
Prepaid income tax is a form of prepaid expense. The most common reason why prepayment on income taxes occurs is due to over-estimation of tax deposits. In this situation, taxes are estimated from the financial records of the previous year. These estimated taxes are paid. Then, when the year-end taxes are found to be less than the taxes paid earlier, prepayment on income taxes has occurred. This prepayment can create one of two results. Either it results in a tax refund or the credit written off towards the tax liability of the next period.
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The difference between prepaid income tax and a deferred tax asset is that prepaid income tax occurs within one year. Conversely, a deferred income tax asset can occur for a period of longer than one year.
Often, prepaid income taxes are the result of poor assumptions. Generally, company controllers overestimate the needed tax deposits. In conclusion, this is one of the most common cases leading to prepaid income taxes.
Prepaid Income Tax Journal Entry
The following is what the prepaid income tax journal entry may look like:
Prepaid Income Tax $100,000
Income Tax Expense $25,000
Prepaid Income Tax $25,000
Result: Prepaid income tax balance = $75,000
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