GM Posts $39 billion loss. World Yawns. GM's tax benefits equal to twice the value of the company!

[HamdenRice]

General Motors reported a loss of $39 billion dollars for the third quarter of 2007 or about $68.85 per share. But GM stock was only trading at around $33.50 per share. In other words, in a world in which accounting reflected the value and profitability of corporations, such a loss would have wiped out the entire value of the company twice. GM's total market value is only about $19 billion. How could they survive a "loss" of almost twice their market value?

More importantly, as a result of the reported loss, the financial world basically yawned. GM shares fell only $2.21 per share.

How is this possible?

Welcome to the wacky world of tax accounting, which permits corporations to accumulate massive amounts of tax benefits, but which sometimes forces these same corporations to recognize that some tax benefits are make believe. Examining GM's "paper loss" sheds a great deal of light on what is wrong with the corporate tax system.

First the news:

http://news.yahoo.com/s/nm/20071107/bs_nm/gm_charge_dc

DETROIT (Reuters) - General Motors Corp (GM.N) on Wednesday posted a record loss for the third quarter, reflecting a $39-billion charge related to unclaimed tax credits and a loss at its former finance subsidiary GMAC.

The largest U.S. automaker posted a net loss of $39 billion, or $68.85 per share, compared with a loss of $147 million, or 26 cents per share a year earlier.

<end quote>

Of that $39 billion, however, only a small part was really an operating loss; that same news article states:

"Excluding one-time items, GM reported a net loss of $1.6 billion, or $2.80 per share."

In other words of the $39 billion dollar loss, according to Bloomberg financial news service, $38.6 billion was a "non-cash" or paper one time charge related to tax accounting:

http://www.bloomberg.com/apps/news?pid=20601087&sid=aolYQjn2Ubao&refer=home

"The non-cash charge of $38.6 billion is related to deferred tax assets in the U.S., Canada and Germany, the automaker said in a statement today."

<end quote>

To understand how this works, imagine a corporation, let's call it Acme Corporation. Let's also imagine that Acme has profits of exactly $100,000 year in and year out, every year, like clockwork. Let's also imagine that Acme pays a corporate tax rate of 35%. Let's also assume it distributes all of its after tax profits to its shareholders.

The result is that Acme pays $35,000 to the IRS and then distributes $65,000 to its shareholders.

Now, however, imagine that Acme has one terrible year in 2005. Instead of profits, it has losses of $100,000. Because it has no profits, it pays no taxes. You have to have profits to owe taxes.

The next year, 2006, Acme is back to its healthy self and earns pretax profits of $100,000.

Because corporations are allowed to carry forward losses in some circumstances, Acme is allowed to carry forward the loss from 2005 to 2006. When we match its loss of $100,000 in 2005 against its profits of $100,000 in 2006, Acme's taxable profits in 2006 are actually zero. It made real profits of $100,000 in 2006 but was able to shelter all of it.

That means that the old loss in 2005 had a lot of value. It enabled Acme to distribute not the usual $65,000 to shareholders, but $100,000 to shareholders.

In other words, the carried forward loss was worth $35,000!

Imagine that! A loss became a tax asset. In fact, going into 2006, Acme was able to put on its balance sheet an asset worth $35,000.

But remember, in order to use that tax asset, Acme has to have income to shelter. So let's change our scenario a little. Suppose after its horrible year of the $100,000 loss, Acme has several years of just breaking even -- no profits, no losses. That would mean that Acme would continue to carry forward a $35,000 tax asset year after year, but would not be able to use it.

If the tax agency decides, however, that there is a limit on how many years a corporation can carry forward a loss, then someday, that asset would disappear. If the IRS said, for example, that Acme could only carry forward the loss for three years, and Acme continued to just break even, then in 2008 (three years after the loss), Acme's tax asset would disappear and it would report a $35,000 write down in assets.

The disappearance of Acme's $35,000 tax asset would be a loss, just like if a $35,000 uninsured factory burned down.

We can even go further and say that accounting standards might require Acme to value its tax assets based on the likelihood that the tax asset will ever be able to shelter income.

Carried forward losses, however, are only one kind of tax asset. The Congress and the United States Treasury Department under George Bush and his predecessors has been very kind to corporations. There are all sorts of goodies in the tax code -- accelerated depreciation, tax credits, and a wild ever growing array of deducations! Corporations are very happy under the administration of George W. Bush.

There's just one problem with all these "tax assets," however, that makes corporations sad. You have to have taxable income in order for your tax assets to have value.

GM has had a bad year and expects to have several more bad years. Not catastrophic, but sort of like Acme, breaking even or perhaps making modest losses, without having profits to shelter for several years to come.

So, yesterday, GM decided that many of its accumulated tax assets would never be used, and it "wrote off" about $38 billion in tax assets. But that loss had nothing to do with making cars and selling cars and pocketing the difference.

The moral of the story, however, isn't that GM is in catastrophic financial condition; it isn't.

It's that GM had accumulated $39 billion in tax assets. To put this in perspective, GM's tax assets were nearly double the value of the entire company. If GM had become very profitable suddenly, it could have earned $38 billion in profits that it would not have had to pay taxes on. (There are limits on timing and amounts per year, but the idea is still that it could shelter $38 billion.)

Congress and the administration have been very, very good to corporations throught the tax code!

[Astrad]

1. That's a fascinating explanation

thank you. :)

[HamdenRice]

2. Thanks

But it can't compete with posts about whether Kucinich believes in UFOs or whether Hillary left a tip!

[Selatius]

3. We should eliminate as many of these ridiculous tax loopholes as possible.

It'll make accounting that much easier without them.