Deferred Tax Asset: Future Tax Savings on the Balance Sheet

Key Takeaways

• All deferred tax assets and liabilities are classified non-current under ASC 740, since ASU 2015-17 eliminated current and noncurrent splits.
• The asset arises from deductible temporary differences, carryforwards, and tax credits that will reduce future tax payments.
• A valuation allowance reduces the asset when it is more likely than not some portion will not be realized.
• Sustained losses or expiring carryforwards often trigger full valuation allowances, producing large non-cash hits to earnings.

What It Is

The deferred tax asset noncurrent line captures three core items: deductible temporary differences, net operating loss (NOL) carryforwards, and tax credit carryforwards. Each represents tax that the company has effectively prepaid relative to its book accounting, or losses and credits available to offset future tax.

For a particular tax-paying component within a particular jurisdiction, ASC 740 requires deferred tax assets and liabilities, plus any valuation allowance, to be offset and presented as a single non-current amount on the balance sheet.

The Intuition

Book income and taxable income rarely match. A company might recognize a warranty expense for book purposes when a product ships, but get a tax deduction only when warranty claims are paid. The deduction is delayed, so taxable income today is higher than book income today. That overpayment of tax relative to book becomes a future benefit, a deferred tax asset.

The asset is valuable only if future taxable income exists to absorb the deduction. If a company keeps losing money, its NOLs and timing differences can pile up without ever producing cash savings. ASC 740 captures this risk through the valuation allowance.

How It Works

A deferred tax asset is measured by applying the enacted tax rate to the underlying deductible temporary difference or carryforward. Common sources include accrued liabilities, allowance for credit losses, deferred revenue, share-based compensation, lease liabilities (often offset by ROU asset DTL), and NOL carryforwards.

DTA = deductible temporary difference x enacted future tax rate

ASC 740-10-30-5(e) requires the company to reduce the DTA by a valuation allowance if, based on all available evidence, it is more likely than not (greater than 50 percent probability) that some portion or all of the DTA will not be realized.

Four sources of taxable income support realization:

1. Future reversals of existing taxable temporary differences (deferred tax liabilities)
2. Future taxable income exclusive of reversals and carryforwards
3. Taxable income in prior carryback years if allowed
4. Tax planning strategies

Three years of cumulative book losses is treated by ASC 740 as significant negative evidence, often producing a full valuation allowance regardless of other factors.

US tax reform also matters: under the 2017 Tax Cuts and Jobs Act, post-2017 NOLs carry forward indefinitely but only offset 80 percent of taxable income in any given year. That cap changes the realization analysis.

Worked Example

A software startup has accumulated $200 million in US federal NOL carryforwards over five years. At a 21 percent federal rate, the gross deferred tax asset is $42 million. The company has also generated $15 million of DTAs from share-based compensation timing differences.

The company has three consecutive years of book losses but has just launched a product that generated $20 million in operating income in the most recent year, with management projecting accelerating profitability. Auditors review evidence: the three-year cumulative loss is strong negative evidence, but the recent quarter of profitability, a signed multi-year customer contract, and conservative forecasts are positive.

The company concludes it is more likely than not that only $25 million of total DTAs will be realized over the next decade. It records a valuation allowance of $32 million, presenting a net deferred tax asset noncurrent of $25 million. If profitability accelerates faster than expected, releasing part of the valuation allowance later would produce a one-time benefit in tax expense, lifting reported earnings.

Common Mistakes

1. Treating the DTA as a cash asset. It produces cash savings only when future taxable income materializes. Without income, the asset is paper.
2. Ignoring the valuation allowance. Net DTA reported on the balance sheet often differs sharply from gross DTA. The footnote shows both.
3. Missing the earnings volatility. Initial recording of a valuation allowance, or its later release, can swing tax expense by hundreds of millions in a single quarter.
4. Forgetting NOL expiration rules. Pre-2018 US NOLs expire after 20 years and require careful tracking. Post-2017 NOLs are indefinite but capped at 80 percent of taxable income.
5. Comparing DTAs across jurisdictions naively. Each jurisdiction has separate rules. Aggregated DTA disclosures hide concentration in countries where realization is uncertain.

Frequently Asked Questions

What is a deferred tax asset noncurrent in simple terms? It is the expected future tax savings a company has earned by paying tax sooner than its accounting expense, or by accumulating losses and credits that can offset future tax. ASC 740 classifies it entirely as non-current.

How does a deferred tax asset noncurrent affect investment decisions? The size of the asset and the valuation allowance reveal management's view of future profitability. A growing allowance is a quiet admission that earnings are unlikely to recover soon.

What is a real-world example of a deferred tax asset noncurrent? Pre-profit growth companies often carry billions in DTAs tied to NOLs and stock-based compensation. Reaching sustained profitability can trigger valuation allowance releases that boost reported earnings.

How can investors avoid being misled by deferred tax assets? Compare gross DTA to net DTA in the income tax footnote, track changes in valuation allowance, and stress test realization assumptions against actual taxable income trends.

How is a deferred tax asset different from a deferred tax liability? A deferred tax asset is a future tax reduction. A deferred tax liability is a future tax payment. Both arise from timing differences, but they sit on opposite sides of the balance sheet and net within a single jurisdiction.

Sources

1. 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
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. Bloomberg Tax. ASC 740 Valuation Allowances for Deferred Tax Assets. https://pro.bloombergtax.com/insights/provision/asc-740-valuation-allowances-deferred-tax-assets/
4. RSM US. Accounting for Income Taxes Current and Deferred Taxes. https://rsmus.com/content/dam/rsm/insights/financial-reporting/1pdf/Accounting-for-income-taxes-Current-and-deferred-taxes.pdf

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.