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How do you calculate deferred tax

how do you calculate deferred tax

Online Tutorial #7: How Do You Calculate A Company's Cash Tax Rate?

In this session, we focus on defining cash tax rate, explaining where to obtain data to calculate it, and walk through a sample calculation. As with previous sessions, we will use Gateway, Inc. as of April 21, 2000, as a case study. Readers who want to calculate cash tax rates while reading this tutorial may wish to download the accompanying spreadsheet.

What Does "Cash Tax Rate" Mean?

To understand what we mean by "cash tax rate," let's break this phrase down into its component parts:

  • Cash . This means that we want to look at the cash a company pays annually in taxes. This may differ from the income tax provision companies report on their income statements.
  • Tax . This means we look at the amount a company pays to governments in exchange for the privilege of doing business in their jurisdictions.
  • Rate . This means that we want to calculate the percent of pre-tax profit that a company pays in cash taxes.

Also, though it is not explicitly in the phrase, we need to consider one more word:

  • Unlevered . A company's taxes are influenced by how much debt a company has, as interest payments on that debt shield pre-tax profit from taxation. When calculating cash taxes, we remove this distortion by calculating a company's tax burden assuming a company was 100% equity financed with no debt.

Putting this together, we can define "cash tax rate" as "the percent of pre-tax operating profits a company would pay in cash taxes to governments assuming it was 100% equity financed."

How Do We Calculate a Company's Cash Tax Rate?

We can use two methods:

A. Simplified Approach. This approach just substitutes a company's book tax rate as a proxy for its cash tax rate. However, as we note in the book on page 23:

The tax expenses in the income statement, book taxes. is generally greater than the actual payments, or cash taxes. during a given period. Why? Because companies can recognize some revenue and expense items at different times for book versus tax purposes.

In addition, as we noted above, the book tax rate reflects a company's use of leverage. An unlevered cash tax rate removes the influence of debt on a company's tax


B. Advanced Approach. In this approach, we make a number of detailed adjustments.

1. Book taxes. We start with a company's income tax provision found on the income statement.

2. Change in deferred taxes. Next, we add the year-to-year increase in a company's deferred income tax liability (or subtract the increase in a company's deferred tax asset ). These line items can be found on a company's balance sheet. However, sometimes, this liability is not separately broken out. In those cases, there are two alternate sources for a company's change in deferred taxes:

  • "Adjustments to reconcile net income to net cash provided by operating activities" in the "Cash flows from operating activities" section of the Cash Flow Statement. A deferred tax liability occurs when a company pays less in cash taxes than it reports in book taxes. Thus, an increase in a company's deferred tax liability represents a source of cash. Conversely, a deferred tax asset occurs when a company pays more in cash taxes than it reports in book taxes. Thus, an increase in a company's deferred tax asset represents a use of cash.
  • The Income Taxes section of the Notes to the Consolidated Financial Statements, where the 10-K will list the "components of the provision for income taxes". We subtract the sum of the annual U.S. and Foreign deferred income taxes from a company's income tax provision. When annual U.S. and foreign deferred taxes are positive, the company has increased its net deferred tax liability, which reduces the tax onus. Conversely, when annual U.S. and foreign deferred taxes are negative, the company has increased its net deferred tax asset, which increases the tax onus. (Note: the sum of U.S. and Foreign deferred income taxes should be identical to the number in the Cash Flow Statement.)

3. "Unlevering" income taxes. Finally, we remove taxes paid (in the case of positive interest income) or add back taxes shielded by debt (in the case of interest expense). For example, if a company had $100 million in interest income and an estimated 35% marginal tax rate, we would subtract $35 million. If a company had $100 million interest expense, we would add back $35 million in taxes (that would have been paid if that interest expense had not shielded the company from paying taxes).

We can see how all this fits together by returning to our Gateway case study:

Category: Taxes

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