Question

How would the impacts associated with the corporate tax cut from 35% to 21% impact the manner in which an analyst would evaluate deferred taxes and reported earnings for a firm?

Answer 1

f the tax rate changes, then under the asset-liability (or balance sheet) method, all deferred tax assets and liabilities must be revaluated using the new tax rate that is expected to be in place at the time of the reversal.

An increase in the expected tax rate at time of reversal will create a larger tax burden than expected for the company once the transaction is reversed. That said, the current tax expense also increases. This will have a negative impact on current net income and decrease stockholders' equity. A decrease in the tax rate will have the opposite effect.

Impact -

Companies with large net deferred tax assets (DTAs)- These are companies that have overpaid tax in the past and therefore have will have relief on future tax bills. DTAs can come from net operating loss carryforwards, tax credits on research expenditures, changes in pension benefit obligations, and a variety of other factor. Companies with significant DTAs receive a smaller benefit from the corporate tax cut, since they were already anticipating lower tax bills in the coming years. Many companies will see their balance sheets deteriorate significantly in the coming months as they write-down the value of their DTAs now that the lower corporate rate is coming into effect.

So companies having large DTA will have less benefit from some timing differences arised in the past and recognised as DTA. but future earnings will be taxed at a lower rate which will always save the current tax of the company.

It sounds easy to just look for companies with large DTAs, but that process does not really work. Some companies don’t disclose DTAs on their balance sheet and only show them in the footnotes. Others might report DTAs on the balance sheet but also have offsetting deferred tax liabilities in the notes.

Companies with Large DTLs -

Some of the biggest winners will be companies with large deferred tax liabilities (DTLs). These are companies that have deferred paying taxes by reducing taxable income in the past with a variety of accounting techniques such as accelerated depreciation, non-deductible intangibles, or holding international profits overseas. Companies that have used these methods record DTLs on their balance sheets to account for the higher taxes they expect to pay in the future.

These companies get an extra bonus from a corporate tax cut, since it applies not only to their regular taxes but also to the deferred taxes they were obligated to pay. Companies will see their balance sheets improve significantly in the future as they decrease the value of their DTLs now that the lower corporate rate is coming into effect.

Current tax again will be lower for both the company due to rate cut.