Key Takeaways

  • Accrued taxes are unpaid tax liabilities recorded before actual payment, reflecting expenses the company is obligated to pay.
  • These taxes are treated as current liabilities under the accrual method of accounting.
  • Common examples include payroll taxes, income taxes, and property taxes.
  • Accrued taxes differ from deferred taxes in timing and financial treatment.
  • Businesses must meet IRS standards for deductibility of accrued taxes under the “all events test.”
  • Accurate tax accruals are essential for financial compliance, reporting, and audit preparedness.

Accrued taxes are taxes that have been assessed against a company's earned revenue or property value that has not been paid yet.

Definition of Accrued Taxes

In simple terms, accrued taxes refers to taxes assessed against a company that have not yet been paid, whether those taxes are on the company's earned revenue or on the value of any property the company owns. If a company fails to pay accrued taxes by a specific due date, additional penalties and interests may be applied to the total amount owed. Accrued taxes are also listed as liabilities on the company's books.

Legal and Contractual Definition of Accrued Taxes

In legal contracts, accrued taxes generally refer to tax obligations that have been incurred by an entity but remain unpaid as of a specified date. These liabilities are considered due and payable, even though the actual payment might occur later. A standard clause might define accrued taxes as “the tax obligations of an organization, unpaid and accumulated up to a specific date”. This distinction ensures transparency and proper risk allocation in mergers, acquisitions, or financial reporting contexts.

Definition of Accrued Expenses

Accrued expenses are expenses that are related to accounting and are listed on the company's books before they are paid. Accrued expenses are also listed as a liability and are typically current. These expenses are usually periodic in nature, and they should be documented on the company's books because there's a good chance that they're going to be collected. An accrued expense is the opposite of a prepaid expense. Companies usually accrue periodic expenses, such as:  

  • Employee wages  
  • Interest  
  • Taxes

Although these expenses are going to be paid at some point in the future, they're listed on the company's books, starting from the date that the company can reasonably expect them to be paid until they're actually paid in full. For example, interest built up on a loan acquired from the bank would be considered an accrued expense.

Common Types of Accrued Taxes

Businesses typically accrue various types of taxes during operations, including:

  • Payroll Taxes – Social Security, Medicare, and unemployment taxes owed but not yet remitted.
  • Income Taxes – Corporate income taxes accrued but unpaid by the fiscal period end.
  • Property Taxes – Taxes based on property value, accrued over time and paid in scheduled installments.
  • Sales and Use Taxes – Taxes collected or owed on goods/services sold or used.
  • Franchise Taxes – Levied by some states for the privilege of doing business as a corporation.

These taxes are generally recorded as current liabilities and settled during the following accounting period.

Accrued Income Taxes vs. Deferred Taxes

These days, most companies use an accrual accounting structure. With this model,  they make journal entries using deferrals and accruals to indicate expenses and revenue based on the Generally Accepted Accounting Principles, or GAAP. These deferrals and accruals should reflect their associated principles and realization principles for the purposes of accounting. Matching principles state that expenses need to be recognized at the same time as the revenues that they relate to.

Realization principles state that revenue needs to be recognized once the earning process has been completed and there is reasonable cause to hope for a payment to be collected from clients. Deferrals, otherwise known as "prepayments," are transactions that involve the flow of cash preceding the time at which expenses are recognized. Some examples of deferrals include:  

  • Prepaid insurance  
  • Prepaid supplies  
  • Unearned revenue

Accruals are the transactions in which revenue or expenses are recognized before funds are transferred from one party to another. Examples of accruals can include:  

  • Accrued rent  
  • Accrued salaries  
  • Accrued taxes

Accrued taxes can be thought of as liability accounts that reflect the total amount of taxes that are owed within a specific period of time. In other words, it's the amount the company currently owes in taxes that they have not yet paid. Deferred taxes, on the other hand, are considered to be asset accounts that provide an economic benefit to the organization at some point in the future. Basically, they're taxes that the company has prepaid but hasn't been billed for yet.

Whether you're dealing with deferred taxes or accrued taxes, they should both be adjusted once you reach the end of a period. This means you'll need to make entries for these adjustments on your company's books based on established accrual accounting practices. Due to the fact that prepaid expenses are considered assets, these adjustment entries should be treated as debits to their associated expenses and credits on associates assets. In the case of accrued taxes, however, the adjustment entry is treated as a debit on related expenses and a credit on related liabilities.

Accrued Taxes and the All Events Test

Under IRS rules, a business using the accrual method must meet the “all events test” to deduct accrued taxes. The test requires that:

  1. All events have occurred to establish the liability.
  2. The amount of liability can be determined with reasonable accuracy.
  3. Economic performance has occurred, meaning the taxpayer has received the goods/services or otherwise satisfied performance-based conditions.

These rules ensure accrued tax deductions are justified, reducing the risk of IRS disputes or audits.

Tax Accruals

The Internal Revenue Service received almost 2.5 million tax returns from corporate entities in 2010. Every one of the filing companies was required to prepare tax accrual accounts in order to determine how much they owed in taxes. If you are a business owner and you or any of the other company members don't have a solid understanding of tax accruals, it's likely that you're going to encounter problems with the Internal Revenue Service.

Tax accruals are the establishment of tax liabilities and obligations that you enter into, whether it's because you have collected sales tax or as a result of self-assessing your use taxes.

Importance of Accrued Taxes in Financial Reporting

Accurately recording accrued taxes is vital for:

  • Complying with GAAP or IFRS standards.
  • Presenting a true picture of financial obligations to investors and regulators.
  • Forecasting cash flows and planning for upcoming tax liabilities.
  • Preparing for audits, as discrepancies in tax accruals often trigger red flags.

Incorrect tax accruals may lead to restatements of financials or penalties. Therefore, maintaining detailed records and reviewing accruals regularly is essential for businesses of all sizes.

Frequently Asked Questions

  1. What are accrued taxes in simple terms?
    Accrued taxes are taxes that a business owes but hasn't paid yet. They're recorded as liabilities because the company is obligated to pay them.
  2. How do accrued taxes differ from deferred taxes?
    Accrued taxes are current liabilities due soon, while deferred taxes are future liabilities or assets arising from timing differences in financial and tax reporting.
  3. Can a business deduct accrued taxes?
    Yes, if it meets the IRS “all events test,” which ensures the liability is definite, the amount is reasonably estimable, and economic performance has occurred.
  4. Are accrued taxes included on the balance sheet?
    Yes, accrued taxes appear under current liabilities on the balance sheet.
  5. Why is accurate tax accrual important?
    It ensures compliance with tax laws, accurate financial statements, and preparedness for audits or financial reviews.

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