Please ensure Javascript is enabled for purposes of website accessibility

Deferred Tax Assets: What Are They and Why Do They Matter for Banks?

By John Maxfield - Apr 28, 2017 at 10:41AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

These otherwise esoteric assets are a big deal right now at Bank of America and Citigroup.

A bank never wants to lose money, but there can be an upside to doing so if the loss creates a deferred tax asset, which allows a company to offset future income with previously unclaimed losses for the purposes of calculating federal income taxes.

These seemingly esoteric assets are both easy to understand and very important right now for two of the nation's biggest banks: Bank of America (BAC -1.71%) and Citigroup (C -0.06%).

Defining deferred tax assets

Deferred tax assets generally don't play a major role at consistently profitable companies. That's because they tend to materialize when a company reports more in losses than it's able to claim as a deduction on its income statement in a given year.

The unused portion of losses can be carried forward to offset a bank's net income in future years. It's the value of this carry-forward that's captured by a bank's deferred tax assets, which are recorded as intangible assets on the balance sheet.

Metal gears with the words "tax reform" etched on the front.

Image source: Getty Images.

One quality of deferred tax assets is particularly important to keep in mind: They expire if not used after a set amount of time, often 20 years. This matters because a bank that isn't able to use all of its deferred tax assets before they expire must write the remaining value off, reducing shareholders' equity.

This also matters because changes to the corporate income tax rate impact the value of deferred tax assets. When rates go up, these assets increase in value, as they shelter a larger share of income. But when rates go down, so too does the value of deferred tax assets, as a bank may not be able to realize the entire benefit before the statute of limitations expires.

Bank of America and Citigroup's deferred tax assets

The relationship between the corporate income tax rate and the value of deferred tax assets is especially relevant right now, given Trump's proposed plan to cut corporate income taxes from a top rate of 35% down to 15%.

Make no mistake about it, a tax cut this significant would be a boon to Bank of America and Citigroup, both of which rank among the 10 biggest taxpayers on the S&P 500. Based on its income and effective tax rate last year, Bank of America's tax liability would have declined by approximately $3.5 billion. Citigroup's would have dropped by around $3.2 billion.

A pair of scissors cutting through the word "taxes."

Image source: Getty Images.

But the catch is that both of these banks would also likely be forced to write off a portion of their unusually large deferred tax assets, which stem from their outsized financial crisis-related losses. At the end of last year, Citigroup reported $47 billion worth of net deferred tax assets, while Bank of America's are valued at $19 billion.

According to analysts, Trump's proposed tax cut could translate into anywhere from a $6 billion to $12 billion charge-off at Citigroup, and around $4 billion at Bank of America. That's a lot of money, regardless of these banks' multi-trillion dollar balance sheets.

Don't get me wrong, Bank of America and Citigroup would still benefit immensely from the annual tax savings of a lower rate, though they will first have to contend with the fall in value of their deferred tax assets.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Citigroup Inc. Stock Quote
Citigroup Inc.
$49.75 (-0.06%) $0.03
Bank of America Corporation Stock Quote
Bank of America Corporation
$33.86 (-1.71%) $0.59

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/22/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.