Maximizing Benefits: How to Use and Calculate Deferred Tax Assets

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A deferred tax asset (DTA) is a balance sheet item representing income tax a company expects to save in future periods. It arises when the company has paid tax earlier than its financial statements recognize it, or holds deductions, losses or credits it can use against future taxable income. The tax return and the books disagree on timing, and that disagreement will eventually lower the tax bill.

What Is a Deferred Tax Asset?

Financial statements follow accounting standards (US GAAP or IFRS), while tax returns follow tax law, and the two often recognize the same revenue or expense in different years. When the books record an expense before tax law allows the deduction, taxable income is temporarily higher than book income. The company pays more tax now and gets the deduction later. The deferred tax asset records that future deduction at its tax value.

The asset holds no cash. It works like a prepayment: the money has already left the business, but the right to a lower future tax bill has value, which is why accounting standards treat it as an asset.

How Firms Get Deferred Tax Assets

1. Expenses accrued before they are deductible. Warranty costs, legal settlements and bad debt reserves are booked when estimated but deducted only when cash is paid or the debt is written off.
2. Revenue taxed before it is earned for accounting. Some advance payments are taxable when received but recognized as revenue over time on the books.
3. Net operating losses. A tax loss carried forward offsets future taxable income, so the expected saving becomes an asset.
4. Unused tax credits. Credits carried forward reduce future tax directly.
5. Asset and liability basis gaps. A deductible temporary difference exists when an asset’s book carrying value is below its tax base, or a liability’s is above its tax base. A warranty provision, for example, has a carrying value but a tax base of zero, which is why it creates a DTA.

Depreciation usually works the other way. Tax rules often allow faster depreciation than the books record, which creates a deferred tax liability. A DTA from depreciation appears only when book depreciation runs ahead of tax depreciation.

How to Calculate a Deferred Tax Asset

Deferred tax asset = Deductible temporary difference × Enacted tax rate expected when it reverses

A step-by-step approach:

1. Identify the differences between the book carrying value and tax base of each asset and liability, and list unused losses and credits.
2. Separate deductible differences, which create DTAs, from taxable differences, which create DTLs.
3. Apply the enacted rate for the years the differences will reverse. In the US, the federal corporate rate has been a flat 21% since 2018, plus state taxes where they apply.
4. Assess realizability and record a valuation allowance for any part unlikely to be used.
5. Record the movement. The year’s change in the net deferred tax balance becomes deferred tax expense or benefit on the income statement.

Hypothetical example. A manufacturer accrues $100,000 of warranty expense this year. None of it is paid in cash, so none is deductible yet. Assuming a 21% rate, the deferred tax asset is $100,000 × 21% = $21,000. Next year, when the company pays $60,000 of claims and takes the deduction, $60,000 × 21% = $12,600 of the asset reverses, leaving $8,400.

Loss example (also hypothetical). A company has a $500,000 federal NOL carryforward. At 21%, the potential deferred tax asset is $105,000. Whether it can carry that full amount depends on the realizability test below.

Recognition and the Valuation Allowance

A deferred tax asset is only worth recording if the company will have enough taxable income to use it. Under US GAAP (ASC 740), the full asset is recorded and then reduced by a valuation allowance for any portion that is not more likely than not (over 50%) to be realized. IFRS (IAS 12) recognizes the asset only to the extent future taxable profit is probable.

Evidence considered includes scheduled reversals of deferred tax liabilities, projected profits, tax planning strategies and recent history. A pattern of cumulative losses is significant negative evidence. In the NOL example above, a company expecting only $200,000 of future taxable profit before the losses would be exhausted might carry a valuation allowance against much of the $105,000. Releasing an allowance later, once profitability returns, produces a deferred tax benefit that raises net income without any change in cash.

Tax Rate Changes

Because the asset is measured at the enacted future rate, a rate change remeasures it immediately. If rates rise, the same deductions save more tax and the DTA grows. If rates fall, the asset shrinks and the write-down hits income tax expense in the period the law is enacted. The Tax Cuts and Jobs Act of 2017 cut the US federal corporate rate from 35% to 21%. As a result, companies with large deferred tax assets recorded write-downs and companies with large net deferred tax liabilities recorded gains.

Carryforward Rules for Losses

Tax law, not accounting standards, sets expiration dates. Under the Tax Cuts and Jobs Act, federal NOLs from tax years beginning after December 31, 2017 carry forward indefinitely but generally offset only up to 80% of taxable income in a given year. Carrybacks were eliminated for most taxpayers, though farming losses can still be carried back two years, and the CARES Act temporarily allowed a five-year carryback for losses from 2018 through 2020. Older NOLs from before 2018 kept their 20-year carryforward period. Credits and state losses follow their own rules, and many do expire, which puts direct pressure on the valuation allowance assessment.

Where It Appears on the Financial Statements

Under US GAAP (since ASU 2015-17) and under IFRS, deferred tax assets are classified as noncurrent, regardless of when they reverse. They are generally netted against deferred tax liabilities within the same tax jurisdiction. Analysts treat DTAs cautiously when judging net worth or book value, since the asset cannot be sold and has value only if future profits materialize. For this reason, bank capital rules limit how much of it counts toward regulatory capital.

Deferred Tax Asset vs. Deferred Tax Liability vs. Current Tax Asset

• Deferred tax asset: tax paid earlier than the books recognize it, or future deductions and losses still available. It lowers future tax payments.
• Deferred tax liability: tax postponed because taxable income is temporarily lower than book income, often from accelerated tax depreciation. It raises future tax payments.
• Current tax asset: a refund or overpayment receivable for the current or prior period, such as estimated tax payments exceeding the year’s liability. It is a near-term claim, not a timing difference.

Individual tax deferral, such as pre-tax contributions to a traditional 401(k), postpones personal income tax. It is a related idea but not a balance sheet deferred tax item.

FAQs

The Bottom Line

Investors, analysts and accountants reading a company's balance sheet should treat deferred tax assets as conditional value. The asset holds no cash, cannot be sold and pays off only if the company earns enough future taxable income to use it. Checking the valuation allowance, the history of losses and the expiration rules on credits and state losses shows how much of the recorded asset is likely to turn into real tax savings.