Deferred Taxes Could Drive Big Earnings Swing

The new tax cuts will make winners out of companies with big deferred tax liabilities and losers of those with large tax assets, an expert forecasts.
David KatzDecember 22, 2017

Companies with large deferred tax liabilities or assets will record big fourth-quarter earnings swings as they adjust to the expected lower future corporate tax rate under the Tax Cuts and Jobs Act, a leading corporate financial reporting expert predicts.

Charles Mulford

Charles Mulford

Corporations with sizable deferred tax liabilities will record big resulting profits for this quarter, and those with large deferred tax assets will report big earnings hits, forecasts Charles Mulford, an accounting professor at Georgia Tech and director of the college’s Financial Reporting and Analysis Lab.

The winners will enjoy a big, one-time earnings gain as they write down their deferred tax liabilities in line with the expected drop in corporate tax rates, according to Mulford.

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“The losers would see a big earnings hit as deferred tax assets [are] written down for the same reason,” he said in an email to CFO. Corporate taxes would be slashed from 35% to 21% under the act, which president Trump signed into law today.

Further, the winners will likely report enlarged shareholders’ equity on their balance sheets for the current quarter, with the opposite being true for the losers, wrote Mulford. Winners will also be able to report lower debt, while losers will record bigger leverage burdens.

“Deferred tax assets are the tax savings arising from future tax deductions,” notes a 2015 Georgia Tech study on the effect of tax reform on deferred taxes. “Deferred tax liabilities reflect taxes due on future taxable amounts. Both deferred tax assets and deferred tax liabilities are measured using tax rates expected to be in effect when underlying deductions or taxable amounts are realized.”

For that study, which looked at 809 U.S. public companies with reported deferred tax balances, the researchers used a rate cut of 35% to 28% because that was the rate President Obama proposed at the time.

The researchers found that under that rate, 548 companies with deferred tax liabilities would report an aggregate $142.4 billion reduction in liabilities. At the same time, the 261 firms with deferred tax assets would see their assets drop by $38.2 billion.

But given the 21% corporate tax rate under the new law, “the gains and losses will be bigger than that,” says Mulford.