Oregon Real Estate Practice Test

What does tax deferral mean?

1. Paying taxes earlier than required.

2. Postponing the payment of taxes.

3. Eliminating the need for taxes.

4. Seeking a reduction in tax rates.

The correct answer is: Postponing the payment of taxes.

Tax deferral refers to the practice of postponing the payment of taxes to a future date. This means that rather than paying taxes on income or gains in the current tax year, the individual or entity can delay the payment, allowing for potential growth of the asset or income without the immediate tax burden. For example, in certain investment accounts, earnings can grow tax-deferred until withdrawal, which can be advantageous in financial planning. In this context, tax deferral affects cash flow and allows for the compounding of returns, as the money that would typically be paid in taxes remains invested. This can be particularly significant in retirement accounts, such as IRAs or 401(k)s, where taxes on contributions and earnings can be delayed until retirement, potentially when the individual is in a lower tax bracket. While other options relate to aspects of taxation, they do not accurately capture the essence of tax deferral. Paying taxes earlier than required would not allow for the benefits associated with deferring, eliminating the need for taxes is generally not achievable, and seeking a reduction in tax rates involves different strategies that do not directly correlate with deferring the payment of taxes.