Not investment advice. Educational reading. See Disclaimer.
L.12 · INTERMEDIATE · 2 MIN
Deferred Taxes: Why Tax Expense Differs from Taxes Paid
A company's income tax expense on the income statement almost never equals what it actually pays the IRS. The difference creates deferred tax assets and liabilities.
§ 01What creates deferred tax assets and liabilities
Situation
Creates
Example
Tax expense > cash taxes paid
Deferred Tax Liability (DTL)
Accelerated depreciation for tax purposes
Tax expense < cash taxes paid
Deferred Tax Asset (DTA)
Warranty reserves, bad debt estimates
Large NOL carryforward
Deferred Tax Asset
Years of losses that can offset future income
§ 02Why loss carryforwards create a tax asset
A large DTA from net operating losses means the company can earn future profits tax-free until the DTA is used up. This can be very valuable, but only if the company actually becomes profitable.
§ 03Why the effective tax rate aids comparison
Effective tax rate (tax expense / pre-tax income) is more useful than the statutory rate for comparing companies. Rates below 15% may indicate aggressive tax planning or large DTA offsets.
§ 04Reading a gap between book and cash taxes
Company reports tax expense $100M. Cash taxes paid: $60M. Difference?
Check your understanding
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Sit with the ideas.
A company has $200M in deferred tax assets from NOL carryforwards. It has lost money for three consecutive years. Its new CEO announces the DTA is 'more likely than not' to be realized and releases the valuation allowance, boosting net income by $200M. Should you trust this?
