What is a Deferred Tax Credit Noncash Charge, Anyway?

The NYT is a general-interest newspaper, which should be comprehensible to

a broad reading public. And certainly me. But even the NYT can’t seem to explain

clearly what’s

going on at GM. What does this mean?

DETROIT, Nov. 7 — General Motors reported its largest quarterly loss

ever today after it took a huge noncash charge to write down deferred tax


The NYT does note that "GM’s $39 billion overall loss equals $68.85

a share, nearly double the company’s closing stock price Monday."

So if it’s just lost $68.85 a share, how come the stock is worth anything at


This is the kind of story which journalists hate. They’re not accountants,

and when they phone up accountants to ask what’s going on, they get the kind

of answer which makes perfect sense to accountants, but which is very hard to

translate into English. And besides, they’re on deadline.

Galloping to the rescue this morning, however, is blogger extraordinaire

Steve Waldman, who does his best to explain

what’s going on. But first he makes sure to let us know that things are

actually even worse than they might seem at first glance:

Check out GM’s top-level balance

sheet last quarter (the quarter ending Jun-07). Look at the line called

"Total stockholder equity". Yes, it really does say negative 3.5

billion dollars…

A $30B net charge would bring GM’s accounting equity down to negative 33 billion


Is that a record? What’s the maximum negative accounting equity ever reported

by a going concern? Or, consider this: GM is not a penny stock. The market

imputes a lot of real value to those claims worth negative dollars on its

balance sheet. GM’s market cap as of yesterday was about $20.5B. That’s a

positive number.

Surely there comes a point where stock-market valuations and accounting valuations

have to be on at least speaking terms with each other. But in the case of GM,

at least, it seems, that point is probably a very long ways off.

But anyway, back to those deferred tax credits. Here’s Steve’s explanation

– thanks, Steve!

For those who want to know, "deferred tax assets" arise when firms

recognize expenses before they are allowed to take a tax deduction for those

expenses. Let’s say a large New York bank decides some of its assets are worth

10B less than originally thought, and writes those assets down on its balance

sheet. If the bank pays a 35% tax rate, 3.5B of that "loss" should

eventually be absorbed by the government in the form of reduced tax payments.

But companies don’t get to pay fewer taxes whenever they change their estimate

of the value of an asset. The bank gets a cash write-off on its taxes only

when the assets are actually sold and the firm realizes a loss. In the meantime,

the firm recognizes a 3.5B "tax asset", the value of the future

tax savings it expects. This is all perfectly legitimate — writing down

the assets without recognizing the expected tax-savings would badly overstate

costs. But sometimes a firm’s estimate of future tax savings turns out to

be wrong. Say the bank is forced to sell the impaired assets when it is already

losing money. Then there is no immediate tax savings, because the bank wouldn’t

have paid taxes that year anyway. The firm may still be able to "carryforward"

the loss, and recover some of the tax savings. Or it may not. Tax laws are


GM had previously estimated that it had $39B in future tax write-offs coming

to it. Its accountants now think the company might never get the chance to

use them. Though this is not a cash charge, it is not a good omen either.

Firms realize tax assets when they are profitable enough to have a large tax

bill to take deductions from. GM is basically announcing that it’s unsure

it will earn enough money to be able to take advantage of its pent-up tax

offsets before they expire. Tax asset write-offs are insult-to-injury kind

of events. Firms get hit with the accounting charge when, and precisely because,

they can’t make enough money to have a tax liability to escape from.

Tax asset write-offs might also be a signal of distress, indicating that a

firm lacks the flexibility to time its loss realizations advantageously. Tax

laws are complicated, and sometimes tax benefits expire regardless of what

a firm does. One mustn’t draw conclusions. Still, it does make you wonder.

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