Deferred Tax Assets

What are Deferred Tax Assets?

Deferred tax assets refer to a future tax liability or asset, which exist due to temporary differences and carry-forwards between the companies book value of assets (which they report to shareholders) and the value of their assets which they report on the balance sheet to the IRS.  They essentially exist due to a timing difference in the recognition of the gains and losses.  Remember, it is every companies goal to reduce their tax burden as far as they can and therefore, companies will paint a much better picture to their shareholders than they do to the IRS.

What are Deferred Tax Liabilities?

Deferred tax liabilities occur due to "temporary differences" that will create a tax burden for future periods.  For example, assume that company xyz purchases office space and uses an accelerated method of depreciation in comparison to what the tax code allows.  Essentially, company xyz is assuming tax benefits in advance of what the tax code calls for.  Company xyz will now increase their deferred tax liability account and have to pay up down the road when the tax value of the asset becomes higher than the accounting value.  Companies may prefer DTLs if they are strapped for cash or if they believe that they can do more with the money now and make up the tax differences in the future and then some. 

Deferred tax assets, on the other hand, occur AFTER expenses are deducted for accounting purposes.  A good example of this can be seen with capital loss carryover.  For instance, assume a corporation has $100,000 in capital losses and also assume that the tax code only allows for a $3,000 tax deduction on these losses, yearly.  Therefore, the corporation will deduct $3,000 every year until that $100,000 balance has been erased or until the corporation recovers those losses.  The carry forward amount each year is a deferred tax asset as it allows the corporation to realize tax benefits in future periods for losses or expenses that were taken/paid upfront.  The problem arises when companies cannot generate enough income to offset against the DTA. 

In Recent News

Ambac which is a large bond insurance corporation was hit with a $3.6 billion dollar deferred tax asset on their balance sheet.  With the disaster in the credit markets, there is concern that they will will suffer more losses and not have enough income to utilize these DTAs.  In the event that they cannot generate the income, these DTAs will be written down on their balance sheet as valuation adjustments and could essentially create a negative net worth which would necessitate capital infusions.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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