Valuation of tax loss carryforwards
Published online: 20 August 2013
Ó Springer Science+Business Media New York 2013
Abstract Tax loss carryforwards (TLC) are a valuable asset because they can potentially
reduce a company’s future tax payments. However, there is often a great deal of uncer-
tainty regarding the probability and timing of these tax savings. We propose a contingent-
claim model to value this asset. The value is determined primarily by the size of accu-
mulated carryforwards relative to earnings. We show that, for poorly performing ﬁrms with
large TLC, (1) the realizable (or fair) value of the tax losses can be signiﬁcantly smaller
than the book value, and (2) the tax losses can account for a signiﬁcant fraction of the
company’s equity value. The model is illustrated by calibrating it to a couple of companies
with large carryforwards. Finally, we show how the model can be used to compute the
marginal tax rate of a company with carryforwards.
Keywords Tax loss carryforwards Á Net operating losses Á Valuation Á
JEL Classiﬁcation G3.
The objective of this paper is to value explicitly a common intangible corporate asset—tax
loss carryforwards (TLC) or net operating losses (NOL).
This asset is valuable because of
S. Sarkar (&)
DSB 302, McMaster University, Hamilton, ON L8S 4M4, Canada
A large number of ﬁrms have accumulated tax losses (Graham 1996a; Miller and Skinner 1998; Bauman
and Das 2004); a look at the 2008–2009 annual statements in Compustat reveals that, after deleting ﬁrms
with missing data, about 75 % of US ﬁrms (3,989 out of 5,291) were carrying tax losses. Moreover, tax
losses can be signiﬁcant in terms of magnitude; for instance, tax carryforwards accounted for 30.4 % of total
assets in the Bauman and Das (2004) sample of internet ﬁrms, while ﬁrms in the Miller and Skinner (1998)
sample had average deferred tax assets of about 10 % of total assets.
Rev Quant Finan Acc (2014) 43:803–828