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Surprise! Low Tax Rates May Mean Lower Valuations

Dec 21, 2016

Any future reduction in business tax rates could have a beneficial impact on most corporations’ bottom lines. The post-election run-up in stock prices likely indicates Wall Street’s expectations of increased corporate and investor profits. However, there is a downside. Corporations that have net-deferred tax assets (DTAs) recorded in their balance sheets could experience a substantial one-time hit to their P&Ls. 

Determining Asset Value

Companies record assets for future tax savings they will realize from the utilization of net operating loss (NOL) carryforwards and other tax deductions that have already been recognized for book purposes. You can determine the value of these assets by multiplying the amount of the NOL carryforward and deferred tax deductions by the expected tax rate at utilization. This tax rate must be based on enacted law; you cannot speculate as to what rate might be enacted in the future. 

For Example

Currently the highest effective U.S. corporate tax rate is 35% and is used by large corporations to value their DTAs. If the Republican-controlled Congress and President Trump reduce this rate to 15%, the value of these assets will decrease. For example, a company with a $1 million federal NOL carryforward could value the DTA under current law at $350K. If the 15% rate becomes law, then the potential future value of the NOL will be $150K. This $200K reduction in value is charged to tax expense during the period in which the law is signed by the president—assuming the new rate takes effect immediately. 


Conversely, profitable companies that have been successful in deferring revenue and/or accelerating deductions for tax purposes will have to, someday, pay that liability.  Corporations in this situation will have deferred tax liabilities (DTLs) recorded on their balance sheets. DTLs are computed in the same manner as DTAs above. A reduction in the tax rate will cause the value of the liability to decrease and the recognition of gain in the P&L. In a period of decreasing tax rates, clearly those with DTAs are losers in the short term and those with DTLs are winners from day one. 

CFOs need to understand the impact of this and other proposals on their financial statements, debt covenants, cash flows and other key financial reports.

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Anthony DiGiacinto

Anthony DiGiacinto is a Tax Director and member of the Cleantech Group with expertise in corporate and partnership tax planning, ASC 740 (FAS 109), FIN 48, consolidated returns, as well as mergers and acquisitions.

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