» tax loss carryforwards PRACTICAL STOCK INVESTING

There are likely to be losers from corporate income tax reform. They’re likely to be of two types:

–companies that currently have sweetheart tax deals, which, as things stand now (meaning: subject to the success of intensive lobbying), will go away as part of reform. A related group is multinationals who’ve twisted their corporate structures into pretzels to locate taxable income outside the US

–companies making losses currently and/or that have unused tax-loss carryforwards. The value of those unused losses will likely be reduced by a lot. This is a somewhat more complicated issue than it seems. In their reports to public shareholders, money-losing firms can use anticipated future tax benefits to reduce the size of current losses. The ins-and-outs of this are only important in isolated cases, so I’ll just say that for such firms book value is likely overstated

Another potential consequence of tax reform is that investors may begin to take a harder look at tax-related items on the income and cash flow statements. Could markets will begin to apply a discount to the stocks of firms that use gimmicks to depress their tax rate? Thinking some what more broadly, it may mean the markets will take a dimmer view of other sorts of financial engineering (share buybacks are what I personally hope for). It might also be that companies themselves will reemphasize operation experience rather than financial sleight of hand when choosing their CEOs.

To summarize yesterday’s post:

firms with taxable income

Lowering the corporate tax rate in the US, while eliminating special interest tax preferences/exemptions, will benefit companies that have a high current tax rate. It will boost such a firm’s earnings by as much as 30%.

On the other hand, companies that have a low income tax rate will receive little or no benefit. Continuing to spend resources on what are in effect tax shelters for themselves will make no sense. To the extent that they are able to unwind these arrangements, they will benefit by doing so. If, however, they are recipients of special interest tax reduction deals, they may be absolute losers, as well as relative ones, if/when these special preferences are eliminated.

The greatest uncertainty here is whether industries that are recipients of large tax breaks, like real estate and oil and gas, will have their special interest preferences eliminated. This will be a key indicator of whether the “Drain the Swamp” rhetoric is more than an empty slogan.

firms with losses

This case is not as straightforward, thanks to wrinkles in the Generally Accepted Accounting Principles used by publicly traded companies in their reports to shareholders.

for the IRS

Let’s assume a firm makes a pre-tax loss in the current year.

The company has a limited ability to use this loss to offset taxes paid in past years ( it carries the loss back). It restates its past returns and gets a refund.

If it still has a portion of the loss that can’t be used in this way, it carries the loss forward to potentially use to shield income in future years from tax.

If the corporate income tax rate drops from 35% to 15%, the amount of pre-tax income that can be sheltered from tax by loss carryforwards remains the same. But the value of the carryforward is reduced by 60%.

for financial reporting

That’s tomorrow’s topic.

PRACTICAL STOCK INVESTING

Helping the Owl of Minerva catch an earlier flight

Tag Archives: tax loss carryforwards

US corporate tax reform (ii)

US corporate income tax reform (ii)