Tax deferral allows individuals and businesses to delay paying taxes on income that is not actively used until a later date, often related to government-approved retirement plans. Taxes are only due when the funds are withdrawn for use.
Tax deferrals are situations where the collection of taxes on generated income is delayed for a specified period of time. The primary function of the tax deferral is to create a situation in which individuals and business entities do not experience undue hardship on income that is not actively used at the time, and will not actually be available for use until a later date. . Essentially, a tax deferral ensures that taxes are not considered due until the taxpayer withdraws the funds in question.
The right of tax deferral is found in the tax 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 winnings for a period of time. In return, the government agrees not to tax those earnings until the entity or individual actually takes possession of the earnings.
The concept of tax deferral is often related to government-approved retirement plans. This means that employees can choose to defer receiving a portion of their earned income and putting it into some type of interest-bearing retirement plan. The structure and administration of the plan must meet government standards to be eligible for the deferral. As part of the deferral process, the government is notified of the amount of earnings deposited in the fund, but does not assess taxes in the period the earnings were generated.
Once the employee reaches retirement age and begins drawing on the funds placed in the retirement plan, the amount of the withdrawals is considered taxable at that time. From this perspective, this arrangement allows the individual to avoid taxes today, but it also creates a situation in which future taxes will have to be paid at a later date.
Along with earnings from employment, it is also possible to get a tax deferral on investment earnings. As with earnings from wages or salaries, the tax deferral must meet requirements set by the government and will be taxable when the funds are withdrawn for use.
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