INCOME TAXES
The Tax Cuts and Jobs Act (the "Tax Act") was enacted on December 22, 2017. The Tax Act makes broad and complex changes to the U.S. tax code, including, but not limited to, (1) a permanent reduction in the U.S. federal corporate income tax rate to 21% and (2) eliminating the corporate alternative minimum tax ("AMT") and changing how existing AMT credits can be realized.
The Company is subject to the provisions of the ASC 740-10, Income Taxes, which requires that the effect on deferred income tax assets and liabilities of a change in tax rates be recognized in the period the tax rate change was enacted. In December of 2017, the SEC staff issued Staff Accounting Bulletin 118 ("SAB 118"), which provides that companies that have not completed their accounting for the effects of the Tax Act but can determine a reasonable estimate of those effects should include a provisional amount based on their reasonable estimate in their financial statements.
Pursuant to SAB 118, the Company recorded provisional amounts for the estimated income tax effects of the Tax Act on deferred income taxes. The Company estimates that (1) the reduction in the corporate income tax rate decreased its net deferred income tax liability as of December 31, 2017 by $18.9 million and (2) the change in the AMT credit rules allowed the Company to reduce its valuation allowance against its gross deferred income tax assets by $0.1 million, for a combined Tax Act total of $19.0 million. The $19.0 million Tax Act amount was recorded as a decrease to income tax expense in the Company’s consolidated statements of operations for the year ended December 31, 2017. In addition, as result of the reduction in the corporate income tax rate, the Company provisionally reduced its December 31, 2017 net deferred income tax asset balance and the related net deferred income tax valuation allowance by $108.2 million, the net effect of which had no impact on the Company’s consolidated statements of operations for the year ended December 31, 2017.
Although the $19.0 million tax benefit represents what the Company believes is a reasonable estimate of the impact of the income tax effects of the Tax Act on the Company’s Consolidated Financial Statements as of December 31, 2017, it should be considered provisional. In light of the complexity of the Tax Act, the Company anticipates additional interpretive guidance from the U.S. Treasury. In addition, once the KAI Tax Group finalizes certain tax positions when it files its 2017 U.S. tax return, the Company will be able to conclude whether any further adjustments are required to its deferred income tax balances. Any adjustments to these provisional amounts will be reported as a component of the consolidated statements of operations during the reporting period in which any such adjustments are determined, all of which will be reported no later than the fourth quarter of 2018.
Income tax (benefit) expense consists of the following:
|
| | | | | | | | | | | | |
(in thousands) | | Years ended December 31, | |
| | 2017 |
| | 2016 |
| | 2015 |
|
| | | | | | |
Current income tax expense | | $ | 628 |
| | $ | 87 |
| | $ | 6 |
|
Deferred income tax (benefit) expense | | (18,389 | ) | | (9,807 | ) | | 87 |
|
Income tax (benefit) expense | | $ | (17,761 | ) | | $ | (9,720 | ) | | $ | 93 |
|
Income tax (benefit) expense varies from the amount that would result by applying the applicable U.S. corporate income tax rate of 34% to loss from continuing operations before income tax (benefit) expense. The following table summarizes the differences:
|
| | | | | | | | | | | | |
(in thousands) | | Years ended December 31, | |
| | 2017 |
| | 2016 |
| | 2015 |
|
Income tax benefit at U.S. statutory income tax rate | | $ | (10,001 | ) | | $ | (3,554 | ) | | $ | (3,849 | ) |
Tax Act adjustment | | (19,022 | ) | | — |
| | — |
|
Valuation allowance | | 9,092 |
| | (6,743 | ) | | 1,033 |
|
Indefinite life intangibles | | 1,071 |
| | 108 |
| | 88 |
|
Change in unrecognized tax benefits | | 490 |
| | 51 |
| | — |
|
Non-deductible compensation | | 403 |
| | 345 |
| | 273 |
|
Foreign operations subject to different tax rates | | 32 |
| | 145 |
| | 223 |
|
Deconsolidation of subsidiary | | — |
| | — |
| | 2,384 |
|
Non-taxable dividend income | | — |
| | — |
| | (415 | ) |
Other | | 174 |
| | (72 | ) | | 356 |
|
Income tax (benefit) expense for continuing operations | | $ | (17,761 | ) | | $ | (9,720 | ) | | $ | 93 |
|
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities are presented as follows:
|
| | | | | | | | |
(in thousands) | | December 31, | |
| | 2017 |
| | 2016 |
|
Deferred income tax assets: | | | | |
Losses carried forward | | $ | 193,498 |
| | $ | 301,339 |
|
Unpaid loss and loss adjustment expenses and unearned premiums | | 3,391 |
| | 5,609 |
|
Intangible assets | | 2,490 |
| | 1,135 |
|
Debt issuance costs | | 988 |
| | 1,621 |
|
Investments | | 842 |
| | 1,828 |
|
Deferred rent | | 807 |
| | 1,395 |
|
Deferred revenue | | 394 |
| | 385 |
|
Other | | 461 |
| | 1,134 |
|
Valuation allowance | | (181,222 | ) | | (276,590 | ) |
Deferred income tax assets | | $ | 21,649 |
| | $ | 37,856 |
|
Deferred income tax liabilities: | | | | |
Indefinite life intangibles | | $ | (18,005 | ) | | $ | (28,079 | ) |
Depreciation and amortization | | (16,916 | ) | | (28,620 | ) |
Fair value of debt | | (5,894 | ) | | (12,100 | ) |
Land | | (4,435 | ) | | (7,181 | ) |
Investments | | (3,991 | ) | | (5,969 | ) |
Deferred acquisition costs | | (2,739 | ) | | (4,627 | ) |
Deferred income tax liabilities | | (51,980 | ) | | (86,576 | ) |
Net deferred income tax liabilities | | $ | (30,331 | ) | | $ | (48,720 | ) |
The Company maintains a valuation allowance for its gross deferred income tax assets of $181.2 million (U.S. operations - $174.8 million; Other - $6.4 million) and $276.6 million (U.S. operations - $269.7 million; Other - $6.9 million) at December 31, 2017 and December 31, 2016, respectively. The Company's businesses have generated substantial operating losses in prior years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income; however, it is uncertain whether the Company will generate the taxable income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to place a full valuation allowance on its December 31, 2017 and December 31, 2016 net deferred income tax assets, excluding the deferred income tax liability and deferred income tax assets relating to AMT credit amounts set forth in the paragraph below. In 2017 and 2016, the Company released into income $0.4 million and $9.9 million, respectively, of its valuation allowance, as a result of its acquisition of CMC, due to net deferred income tax liabilities that are expected to reverse during the period in which the Company will have deferred income tax assets available.
The Company carries net deferred income tax liabilities of $30.3 million at December 31, 2017, $8.0 million of which relates to deferred income tax liabilities that are scheduled to reverse in periods after the expiration of the KAI Tax Group's consolidated U.S. net operating loss carryforwards, $22.4 million of which relates to deferred income tax liabilities related to land and indefinite life intangible assets, and $0.1 million of which relates to deferred income tax assets relating to AMT credits. The Company carries net deferred income tax liabilities of $48.7 million at December 31, 2016, $13.4 million of which relates to deferred income tax liabilities that are scheduled to reverse in periods after the expiration of the KAI Tax Group's consolidated U.S. net operating loss carryfowards and $35.3 million of which relates to deferred income tax liabilities related to land and indefinite life intangible assets. The Company considered a tax planning strategy in arriving at its December 31, 2017 and December 31, 2016 net deferred income tax liabilities.
The Tax Act modified the U.S. net operating loss deduction, effective with respect to losses arising in tax years beginning after December 31, 2017. The Tax Act, however, did not limit the utilization, in 2018 and later tax years, of U.S. net operating losses generated in 2017 and prior tax years.
Amounts, originating dates and expiration dates of the KAI Tax Group's consolidated U.S. net operating loss carryforwards, totaling $882.4 million, are as follows:
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| | | | | | |
Year of net operating loss | | Expiration date | | Net operating loss (in thousands) |
| |
2006 | | 2026 | | 8,321 |
| |
2007 | | 2027 | | 62,308 |
| |
2008 | | 2028 | | 53,895 |
| |
2009 | | 2029 | | 512,499 |
| |
2010 | | 2030 | | 92,058 |
| |
2011 | | 2031 | | 45,238 |
| |
2012 | | 2032 | | 33,756 |
| |
2013 | | 2033 | | 30,780 |
| |
2014 | | 2034 | | 7,245 |
| |
2016 | | 2036 | | 17,389 |
| |
2017 | | 2037 | | 18,897 |
| |
In addition, not reflected in the table above, are net operating loss carryforwards of (i) $6.5 million relating to separate U.S. tax returns, which losses will expire over various years through 2037; (ii) $25.7 million, relating to operations in Barbados, of which, $24.2 million will expire in 2018 and $1.5 million will expire over various years through 2026; and (iii) $24.1 million relating to operations in Canada, which losses will expire over various years through 2037.
A reconciliation of the beginning and ending unrecognized tax benefits, exclusive of interest and penalties, is as follows:
|
| | | | | | | | | | | | |
(in thousands) | | December 31, | |
| | 2017 |
| | 2016 |
| | 2015 |
|
Unrecognized tax benefits - beginning of year | | $ | 1,274 |
| | $ | — |
| | $ | — |
|
Gross additions - current year tax positions | | — |
| | — |
| | — |
|
Gross additions - prior year tax positions | | 93 |
| | 1,274 |
| | — |
|
Gross reductions - prior year tax positions | | — |
| | — |
| | — |
|
Gross reductions - settlements with taxing authorities | | — |
| | — |
| | — |
|
Impact due to expiration of statute of limitations | | — |
| | — |
| | — |
|
Unrecognized tax benefits - end of year | | $ | 1,367 |
| | $ | 1,274 |
| | $ | — |
|
The amount of unrecognized tax benefits that, if recognized as of December 31, 2017, 2016 and 2015 would affect the Company's effective tax rate, was an expense of $0.5 million, $0.1 million and zero, respectively.
As of December 31, 2017 and December 31, 2016, the Company carried a liability for unrecognized tax benefits of $1.4 million and $1.3 million, respectfully, that is included in income taxes payable in the consolidated balance sheets. The Company classifies interest and penalty accruals, if any, related to unrecognized tax benefits as income tax expense. During the years ended December 31, 2017, 2016 and 2015, the Company recognized an expense for interest and penalties of $0.5 million, $0.1 million and zero, respectively. At December 31, 2017 and December 31, 2016, the Company carried an accrual for the payment of interest and penalties of $0.9 million and $0.4 million, respectively.
The federal income tax returns of the Company's U.S. operations for the years through 2013 are closed for Internal Revenue Service ("IRS") examination. The Company's federal income tax returns are not currently under examination by the IRS for any open tax years. The federal income tax returns of the Company's Canadian operations for the years through 2012 are closed for Canada Revenue Agency ("CRA") examination. Kingsway's 2015 and 2014 Canadian federal income tax returns are currently under examination by the CRA. No material audit adjustments have been proposed by the CRA.