Tesla Inc.—by pulling an eye-popping $5.9 billion out of its tax valuation allowance—quadrupled its net income compared to the previous quarter in an otherwise disappointing fourth-quarter earnings report.

The electric vehiclemaker made clear, however, this wasn’t a case of cash infusing the bottom line as it reported results to Wall Street Wednesday evening. It was a required and long-awaited accounting maneuver following the pattern of companies like Amazon.com Inc. and others as they moved into profitability. When to pull the trigger in largely emptying the tax allowance reserve, which boosts earnings, boiled down to a judgment call up to Tesla.

“It’s hard for people to fathom, but it’s a non-cash change in an estimate,” said Edward Maydew, accounting professor at the University of North Carolina Kenan-Flagler Business School. “But it can have these huge swings on your earnings.”

Tesla executives told analysts the accounting move didn’t represent core earnings, with CFO Vaibhav Taneja emphasizing in an earnings call that it was a one-time non-cash benefit “due to our recent history of sustained profitability.” Starting in 2024, the company’s tax rate will “be more in line with other companies in the S&P 500,” he said.

Companies stockpile tax benefits like net operating losses during lean years so they can offset future tax bills. Simultaneously, they set up a tax valuation allowance, an accounting reserve that represents the best estimate of tax benefits they won’t be able to use. Companies set up these reserves in cases where they don’t expect to be profitable any time soon. By the end of 2022, Tesla was sitting on a valuation allowance of $7.35 billion.

Judgment Call

Once companies have evidence of profitabilty — and therefore bigger potential tax bills — it becomes clearer they will use their tax benefits. This requires reducing the tax valuation buffer. Tesla turned a profit according to official US generally accepted accounting principles, or GAAP, in 2019. Its earnings surged through 2022.

So why didn’t it dip into that tax reserve earlier?

Thank the flexibility of the accounting rules, Maydew said.

“It’s full of judgment,” Maydew said of the trigger to release valuation reserve allowances. “There’s no bright line test, really.”

Companies reduce the reserve they set aside to cover unrealized tax benefits when it’s “more likely than not” that they will use their tax benefits. They assess things like their loss history, tax benefits related to stock-based pay, and tax planning strategies until there’s enough evidence that they’ll take advantage of past losses to reduce their future bills.

Tesla in its year-end 2022 financial statement hinted this move was being considered. “Given the improvement in our operating results and depending on the amount of stock-based compensation tax deductions available in the future, we may release the valuation allowance associated with the U.S. deferred tax assets in the next few years,” the company disclosed at the time.

“It’s very hard to tell from the outside if they’re gaming or if they’re being completely honest,” said Michelle Hanlon, accounting professor at the MIT Sloan School of Management. “But they were being quite conservative, actually, because they didn’t book the benefit before, and they were very honest about this.”

Tesla didn’t respond to a request for comment.

Need for Transparency

Companies must clearly explain to investors that the boost doesn’t represent real money. Tesla did just that, said Jack Ciesielski, publisher of The Analyst’s Accounting Observer.

The carmaker directed analysts to the company’s unofficial, or non-GAAP earnings, for a truer picture of its financial health for the quarter. While companies typically tout adjusted accounting measures to pluck out negative news, Tesla took out the tax-related boost making its adjusted earnings less flattering.

“It’s not like they said, ‘We suddenly made our bonuses because we released this ginormous asset,’” Ciesielski said.

Still, the infusion of tax benefits helped Tesla paint a consistently rising net income picture over the past several quarters. Absent the maneuver, its net income for the fourth quarter would have been $2 billion, $5.9 billion less than the $7.9 billion it reported. That would have been a slight increase over the previous quarter’s $1.9 billion, but a 46% dip compared to profits in the fourth quarter of 2022.

Amazon.com Inc. pulled a similar move two decades ago after years of operating in the red, amassing more than $3 billion in deferred tax assets. The company was profitable by 2004, so it acknowledged that it would be able to avail of the benefits and therefore reduced the tax valuation allowance. The maneuver led to hundreds of millions of on-paper profits for the company, Maydew said.

“They were the same way. They were very transparent about it. They didn’t want to set up expectations that they couldn’t meet,” he said.


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