How to Handle Deferred Taxes on Corporate Returns - Is It Deductible?

The deferred tax liability itself isn't a deductible expense. It's more of an accounting mechanism that recognizes future tax obligations due to timing differences between book and tax treatment. When tax depreciation exceeds book depreciation, you're essentially deferring tax payments to future periods. The deferred tax liability account on the balance sheet represents this future obligation. But this isn't an expense you can deduct on your current tax return - it's just tracking the future impact of today's timing differences. For the state portion specifically, it follows the same principle. The state component of your deferred tax liability isn't deductible as an expense either. However, in future years when this timing difference reverses, the state taxes you'll actually pay will be deductible on your federal return for that year (assuming no tax law changes). The M-2 comes into play when reconciling book income to taxable income, but the deferred tax liability itself isn't part of this reconciliation - it's the underlying timing difference (the depreciation difference) that requires the M-2 adjustment.

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To answer your original question more directly - the temporary difference that creates the deferred tax liability (tax depreciation > book depreciation) is what gets handled on your M-3 (not M-2), specifically in Part III, Line 31. The deferred tax expense/benefit itself that hits your income statement is never deductible - it's a financial reporting concept, not a tax concept. Think of it this way: your tax return doesn't "see" deferred taxes at all. It only sees actual depreciation deductions. The deferred tax accounting is happening in your financial statements to reconcile the two different sets of books.

Just to add something that might be helpful - the reason this gets confusing is because we're mixing book accounting (GAAP) concepts with tax concepts. When calculating the deferred tax liability, you're using your effective tax rate which includes state tax. But this calculation is purely for financial reporting purposes. When you actually file your tax returns, you'll take the higher tax depreciation deduction now (which is why you have the deferred tax liability in the first place), and you'll pay less tax now. In future years when the timing difference reverses, you'll have higher taxable income and pay more tax. So bottom line - no, the deferred state tax isn't a deductible expense. It's just part of your GAAP financial reporting.

This is a great question that trips up a lot of people working on corporate returns! The key insight is that deferred tax liabilities (including the state portion) are purely financial accounting entries - they never appear as deductible expenses on your actual tax returns. When you calculate that deferred tax liability using your 24.5% effective rate, you're creating a balance sheet entry that tracks future tax obligations due to timing differences. But the IRS doesn't recognize "deferred tax expense" as a legitimate deduction because it's not an actual cash payment or legal obligation in the current year. For your specific situation with equipment depreciation differences, here's what's actually happening tax-wise: You're taking higher depreciation deductions now on your federal return (reducing current taxes), and the state portion of future taxes will be deductible on federal returns when those taxes are actually paid in future years - but only as they're paid, not as deferred amounts now. The M-3 reconciliation you mentioned is the right track - you'll report the temporary difference between book and tax depreciation there, but the deferred tax liability calculation itself stays in the financial statement world and doesn't flow through to your tax return at all.