Deferred Tax Asset (Current): Future Tax Savings

Key Takeaways

• A deferred tax asset is a future tax saving created by timing differences between book and tax income.
• ASU 2015-17 reclassified all deferred tax assets as non-current on US GAAP balance sheets starting in 2017.
• A valuation allowance reduces a DTA when realization is judged less likely than not.
• IFRS still permits no current portion for deferred taxes either, but legacy filings and some non-GAAP measures still split it.

What It Is

A deferred tax asset (DTA) is a balance sheet item that represents income taxes a company expects to pay less of in future periods because of differences between accounting income today and taxable income today. Common drivers include net operating loss carryforwards, accrued expenses not yet deductible for tax, and inventory or warranty reserves.

Historically, US GAAP split DTAs into current and non-current pieces based on the classification of the underlying asset or liability. ASU 2015-17, effective for public business entities in fiscal years beginning after December 15, 2016, eliminated that split. Every DTA is now non-current. The phrase "deferred tax asset current" appears mainly in legacy filings, in IFRS analyses, and in pro-forma schedules that still separate near-term tax effects.

The Intuition

Book accounting and tax accounting often disagree about when an expense counts. A company might accrue $10 million of warranty expense on its income statement this year, but only deduct $4 million for tax because the IRS only allows the deduction when the warranty work is actually performed. The other $6 million is still deductible later.

That future deduction has economic value. The company has already taken the hit on the income statement, so when the tax deduction shows up in a future year, taxable income will be lower than book income and the cash tax bill will fall. ASC 740 makes the company recognize that future benefit today as a deferred tax asset, measured at the enacted tax rate.

How It Works

The mechanics involve three steps. First, identify every temporary difference between book and tax basis for each asset and liability. Second, multiply each difference by the enacted tax rate that will apply when the difference reverses. Third, sum the results to get the gross deferred tax asset or liability.

Gross DTA = Sum of (deductible temporary difference x enacted future tax rate)
                + Tax credit carryforwards
                + Net operating loss carryforwards x enacted future tax rate

The company then assesses whether the asset is realizable. ASC 740 requires a valuation allowance to reduce the DTA if it is more likely than not that some portion will not be realized. The judgment looks at projected future taxable income, taxable temporary differences that will reverse, tax planning strategies, and recent earnings history.

Under ASU 2015-17, the netted balance is presented as a single non-current asset or liability per tax-paying jurisdiction. Older balance sheets used to show a current DTA line tied to current liabilities like accrued expenses.

Worked Example

A retailer reports book income of $50 million for the year. It has $8 million of accrued bonuses not yet paid, a $4 million warranty reserve, and a $3 million net operating loss carryforward from last year. The federal corporate rate is 21 percent.

The accrued bonuses are deductible for tax only when paid in March of the next year. The warranty costs are deductible only when claims are settled. Both create deductible temporary differences. The total is $8M + $4M = $12 million. Multiplying by 21 percent gives $2.52 million of DTA from temporary differences. Adding $3M x 21% = $0.63 million from the NOL gives a gross DTA of $3.15 million.

If management projects strong future profits and no valuation allowance is needed, the full $3.15 million sits on the balance sheet as a non-current deferred tax asset. Under pre-2017 GAAP, the $1.68 million tied to bonuses (a current liability) would have been split out as current.

Common Mistakes

1. Assuming DTAs are real cash. A deferred tax asset is a future deduction, not money in the bank. It is worth nothing if future taxable income never materializes.
2. Missing the valuation allowance signal. A new or growing valuation allowance is a quiet warning that management has lost confidence in future profits. Read the income tax footnote.
3. Forgetting tax rate sensitivity. DTAs are remeasured when statutory rates change. A rate cut writes down DTAs and a rate hike writes them up. The 2017 US rate cut from 35 to 21 percent caused large one-time charges.
4. Treating IFRS and US GAAP the same. IFRS also requires non-current presentation, but other measurement and disclosure rules differ. Cross-border comparisons need the rate reconciliation footnote.
5. Ignoring the NOL expiration clock. US federal NOLs from 2018 onward have no expiration but cap usage at 80 percent of taxable income. State NOLs and pre-2018 federal NOLs may still expire and reduce realizable DTA.

Frequently Asked Questions

What is a deferred tax asset current in simple terms? A deferred tax asset is a future tax saving the company has already earned on its books. The word "current" once meant the portion expected to be used within twelve months, but US GAAP no longer splits DTAs that way.

How does a deferred tax asset affect investment decisions? A large DTA implies a future tax cushion if profits hold up. A valuation allowance against the DTA implies the cushion is at risk and is often a leading indicator of weak earnings ahead.

What is a real-world example of a deferred tax asset? A startup with three years of losses has a $40 million net operating loss carryforward. At a 21 percent rate, it recognizes an $8.4 million deferred tax asset, less any valuation allowance management deems necessary.

How can investors use deferred tax assets effectively? Read the tax rate reconciliation and the DTA composition footnote in the 10-K. Track the valuation allowance year over year. Watch for one-time DTA remeasurements when tax law changes.

How is a deferred tax asset different from a deferred tax liability? A DTA reflects future deductions or credits. A deferred tax liability reflects future taxable income, often from accelerated tax depreciation versus slower book depreciation. They are netted by jurisdiction on the balance sheet.

Sources

1. FASB, ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. https://www.fasb.org/page/document?pdf=ASU+2015-17.pdf&title=ACCOUNTING+STANDARDS+UPDATE+2015-17%E2%80%94INCOME+TAXES+%28TOPIC+740%29%3A+BALANCE+SHEET+CLASSIFICATION+OF+DEFERRED+TAXES
2. Deloitte DART, 13.2 Statement of Financial Position Classification of Income Tax Accounts. https://dart.deloitte.com/USDART/home/codification/expenses/asc740-10/deloitte-s-roadmap-income-taxes/chapter-13-presentation-income-taxes/13-2-statement-financial-position-classification
3. PwC Viewpoint, 16.3 Balance Sheet Presentation of Deferred Tax Accounts. https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/financial_statement_/financial_statement___18_US/chapter_16_income_ta_US/163_balance_sheet_pres.html
4. Bloomberg Tax, ASC 740 Tax Provision Guide. https://pro.bloombergtax.com/insights/provision/how-to-calculate-the-asc-740-tax-provision/

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.