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Corporate Tax Cuts - Are They A Double Edged Sword?

With announcements of pending corporate tax cuts by the Obama administration, you would think this may bring a sense of relief across the nation. Companies will keep more of their hard earned dollars and be blessed with the ability to reinvest their corporate profits to grow and prosper.

If only it was really that simple!

Has anyone considered the financial impact to the companies that have millions of dollars of deferred tax assets ("DTA") on their balance sheets?

First of all, let's clarify what these assets are all about to understand why it matters. DTA are recognized by companies for two main reasons. First, the company may have timing differences between when an expense is recognized for accounting purposes and when they are allowed to deduct that same expense for tax purposes. The other time companies generate DTA is when they have loss carry forwards for tax purposes that can be used to offset income taxes payable at some point in the future when they are profitable.

DTA are valued based on the aggregate amount of the losses and the timing differences which is then multiplied by the effective tax rate. With the announcement of pending tax cuts, companies with these assets on their balance sheet need to recognize the new lower value that the assets are now worth. The resulting impact is a reduction in the respective company's profitability in the period when this write-down is taken.

For companies, that have turned around already and generated profits in 2012, they will not be impacted. They are utilizing their DTA at a point in time when the tax rate in effect and the rate used to recognize their DTA are in alignment.

For the unfortunate companies, who continue to operate in loss position and will continue to carry forward the losses, they will have to bear the brunt of the negative impact that will be reflected in their earnings per share. With the proposed cut to 28% from 35%, this represents a 20% reduction in DTA and could very easily affect their stock price by that amount as well.

In terms of dollars, for every $1 million dollars of DTA, these companies will show a reduction in their earnings by $200,000. While tax reductions may be a shining star for some, it will hit those companies who have not returned to profitability hardest when they are already down.

Looking at some of the largest DTA out there, it looks quite bad for the banking industry. Here are some banks that are carrying significant amount of DTA on their balance sheets that could get adversely affected by the passing of the corporate tax law changes:

JP Morgan: $16 billion

Bank of America: $27 billion

Citigroup: $50 billion

Something to be aware of as you analyze your portfolio stock holdings at year-end!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.