Deferred Tax Valuation Allowance
Since I am not a tax expert any comments from tax professionals, CPAs, etc would be appreciated.
Copying
@st_lopes
TL;DR:
It is possible that Tesla may have Tax Losses even when they report GAAP pre-tax Income due to the fact that employee stock options generate higher tax deductions than GAAP expenses. As such, the Deferred Tax Benefit of $1.9B may not be recognized in Q4 2020. I am leaving the Tax Benefit out of my estimates to be conservative.
Background
From 2004 to 2019, Tesla accumulated pretax losses of $6.9B which means that future tax profits of $6.9B will not be taxed as Tesla can offset the 2004-2019 losses against the future income.
This creates a tax benefit of $1.9B as follows (the numbers are approximate):
Accumulated Net Operating Losses $6.9B
US Federal & State Tax Rate x 28%
Income Tax Benefit $1.9B
Accounting
Normally a company would take the tax benefit each year as the losses were incurred (in Tesla's case, from 2004 to 2019).
But because it was not assured that Tesla would ever be tax profitable, this benefit was not taken (this is not uncommon for start-ups). Once it becomes "more likely than not" that Tesla will generate future taxable income, the benefit comes to the income statement immediately (all or a portion).
GAAP Profits vs Tax Profits
I was convinced that Tesla would realize this benefit in Q4 with the expected strong earnings but now I am not certain.
This is because you can realize GAAP profits but still have a tax loss on your Tax Return.
One big difference between GAAP accounting and Tax Accounting is the way Stock options are treated.
For GAAP, they are valued at the time of grant using a model (usually the Black Scholes model). For Tax purposes, the expense is the actual FMV less the strike price when exercised. With the run up in the stock price, these will generate large tax deductions.
Let's look at Elon's comp award.
View attachment 624558
The first Tranche of Elon's award had a GAAP expense of $277m but if Elon was to exercise today at $730 a share, the Tax deduction is a whopping $5.6B ($5.3B higher than GAAP).
The reason for this is that Tesla will take a deduction that equals the income that Elon will report.
For Tranche 1 with a $730 exercise price, Elon would report income of $5.6B if exercised today and pay tax on that while Telsa would take the $5.6B deduction.
Recognizing the $1.9B Benefit
Elon won't likely exercise his options soon but there are many employees with stock options exercising each quarter generating large tax deductions and if that number is large enough, Tesla may delay recognizing this tax benefit. See Tesla's comment from the 10K:
We continue to monitor the realizability of the U.S. deferred tax assets taking into account multiple factors, including the results of operations and magnitude of excess tax deductions for stock-based compensation.
I believe the likelihood of recognizng the benefit in Q4 2020 is 50/50 but I am keeping it out my Q4 model to be conservative.