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Understanding Income Tax Deferral

22 Pages Posted: 9 Jan 2014 Last revised: 12 Mar 2014

Daniel I. Halperin

Harvard Law School

Alvin C. Warren Jr.

Harvard Law School

Date Written: January 8, 2014

Abstract

The goal of this brief note is to clarify the role of deferral in income taxation by introducing a distinction between pure deferral and counterparty deferral. Pure deferral (such as a current deduction for a capital expenditure) is equivalent to an interest-free loan from the government and, under certain assumptions, to a tax exemption for investment income. Counterparty deferral (such as qualified or nonqualified deferred compensation) shifts taxation of investment income to another party or account, so the advantage depends on the counterparty’s tax rate. Failure to understand these relationships can lead to erroneous conclusions. For example, it is sometimes said that capital gain property will suffer a tax disadvantage if placed in a qualified retirement account because the gain will be subject to full ordinary rates on withdrawal. Similarly, deferral of the employer’s deduction is often said to offset the benefit of deferring an employee’s inclusion of nonqualified deferred compensation. The note demonstrates that both of these statements are erroneous under standard assumptions.

Suggested Citation

Halperin, Daniel I. and Warren, Alvin C., Understanding Income Tax Deferral (January 8, 2014). Tax Law Review, Forthcoming; Harvard Public Law Working Paper No. 14-06. Available at SSRN: https://ssrn.com/abstract=2376314

Daniel I. Halperin (Contact Author)

Harvard Law School ( email )

1575 Massachusetts
Hauser 406
Cambridge, MA 02138
United States
(617) 495-3100 (Phone)
(617) 495-1110 (Fax)

Alvin C. Warren Jr.

Harvard Law School ( email )

1575 Massachusetts
Hauser Hall 308
Cambridge, MA 02138
United States

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