The bad news was not unexpected. In its 2008 annual report, Citigroup reported a $32.1 billion loss from continuing operations, and a net loss of nearly $28 billion. However, the filing, released late last month, also revealed that the bank accumulated about $44.5 billion in net deferred tax assets (DTAs), a bit of hope for the future.

Indeed, the multibillion-dollar asset is used to reduce the amount of tax the bank will have to pay in the future, when it starts generating taxable income. Citi says that its DTAs are related to losses carried forward and “deductible temporary differences.” The asset will remain on Citi’s balance sheet until the bank generates profits to offset them.

But at least one tax expert sees a potential problem with Citi’s strategy. Robert Willens, of the eponymous tax consultancy, points out that if a corporation is uncertain about its ability to generate future taxable income, it is required to establish a valuation allowance, which is a current charge for a possible future tax benefit.

In a client advisory, Willens explains that the purpose of the value allowance is to ensure that the net DTA is reported at an amount that the company believes it is “more likely than not” able to generate. This imprecise measure usually means that a company has to be more than 50-percent sure that some or all the assets will not be realized.

Willens cites the accounting rule known as FAS 109, Accounting for Income Taxes, which in his view portends a Citi snag. FAS 109 states that “forming a conclusion that a [value allowance] is not needed is difficult when there is negative evidence such as (i) cumulative losses in recent years and (ii) unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels on a continuing basis in future years.”

Nevertheless, Citi shows no value allowance with respect to its DTAs on Dec. 31, 2008. In fact, Citi believes that “realization of the recognized net deferred tax asset of $44.5 billion is more likely than not.” (According to the filing, the total DTA comprises $36.5 billion of net federal DTA, with the remainder consisting, in equal parts, of a net state and local and a net foreign DTA.)

The filing discloses that, in general, Citi would need about $85 billion of taxable income during the carryforward period to realize its net DTAs. Citi acknowledges, as it must, that it is in a “three year cumulative pre-tax loss position,” and that status amounts to significant “negative evidence” regarding the degree of confidence it should harbor with respect to the realization of its net DTAs, Willens adds.

Even so, Citi claims that it has “positive evidence” that overcomes and outweighs the negative evidence. As a result, Citi is forecasting sufficient taxable income (exclusive of reversing taxable temporary differences) during the carryforward period “even under strained scenarios.” On top of its rosy forecast, Citi talks about “tax planning strategies” it can use if its operations do not produce the amount of taxable income it is currently forecasting. These strategies include sales of appreciated assets, which Willens suggests would be similar to the sale of its Smith Barney unit, which was completed in January.

Citi goes further, saying that it is prepared to take steps that are normally detrimental to prudent tax planning to increase taxable income during the carryforward period. For example, Willens points out that the bank has increasingly used preferred stock rather than debt to fund its operations – this increases taxable income because interest on debt is tax-deductible whereas dividends paid on preferred stock (other than “trust” preferred stock) are not.

The tax advisory points to several other tactics that Citi may want to use to increase taxable income. For instance, Citi may repatriate “low-tax” foreign earnings for which an “APB No. 23 assertion” (that the funds have been invested indefinitely outside of the U.S.) has not been made. The bank also discusses the possibility of selling assets which produce tax-exempt income and using the proceeds to acquire other assets that would produce taxable income.

Thus, despite the existence of an abundance of negative evidence, Citi has decided to avoid establishing a value allowance against its net DTA. “This is a risky strategy,” writes Willens, “and if events do not transpire the way Citi projects they will, a capital-depleting [value allowance] will have to be established in the future.”