GRAYBAR ELECTRIC CO INC

INCOME TAXES

The TCJA was enacted on December 22, 2017. Among the provisions, the TCJA reduces the U.S. federal corporate income tax rate from a maximum of 35% to a flat 21% effective January 1, 2018, requires companies to pay a one-time transition tax on deemed repatriated earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign sourced earnings. At December 31, 2017 we have not completed our accounting for the tax effects of the enactment of the TCJA. We have made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax under Staff Accounting Bulletin No. 118. For these items for which a reasonable estimate was made, we recognized a provisional amount of $28,840, which is included as a component of provision for income taxes.

Deferred tax assets and liabilities: We remeasured domestic deferred tax assets and liabilities as of December 31, 2017 based on the expected future applicable tax rate. However, we are still analyzing certain aspects of the TCJA and refining our calculations of cumulative timing differences, which could potentially affect the remeasurement of these balances or give rise to new deferred tax amounts. Our calculations could further be impacted by the issuance of future guidance clarifying certain aspects of the TCJA and by state legislative decisions regarding conformity to federal law. U.S. GAAP requires that the effects of tax rate changes be recorded as a component of tax expense from continuing operations in the year of enactment. The provisional amount recorded related to the remeasurement of our deferred tax balances was tax expense of $22,640, consisting of $43,515 of tax expense related to items previously recorded through accumulated other comprehensive income under FASB Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - An Amendment of FASB Statements No. 87, 88, 106, and 132(R)" ("FAS 158"), and $20,875 of tax benefit related to items previously recorded through our provision for income taxes.

Foreign tax effects: The one-time transition tax is based on our total post-1986 earnings and profits ("E&P") that we previously deferred from U.S. income taxation, and the amount of those earnings held in cash and other specified assets. We have recorded a provisional amount for our one-time transition tax liability, resulting in an increase in income tax expense of $6,200. We are still finalizing our calculation of the total post-1986 E&P for these foreign subsidiaries and the amounts held in cash and other specified assets, which could change our provisional transition tax liability. Our calculations could further be impacted by the issuance of future guidance clarifying certain aspects of the TCJA and by state legislative decisions regarding conformity to federal law. No additional income taxes have been provided for any outside basis difference inherent in these foreign entities, as these amounts continue to be indefinitely reinvested in foreign operations. We have recorded $1,174 and $5,026 as a current and long-term liability, respectively, as we intend to elect to pay the federal tax over an eight-year period as allowed under the TCJA.

The FASB staff commented in January that they believe that Topic 740 is not clear it relates to the accounting for the global intangible low-taxed income (“GILTI”) provisions of the TCJA, and has concluded that an entity may elect to either provide deferred taxes related to GILTI or treat it as a period cost. Given that further guidance is expected surrounding the application of the GILTI rules and the fact that we do not believe GILTI will have a material impact on our tax provision, we have not yet made an accounting policy election as to whether we will provide deferred taxes related to GILTI or treat it as a period cost.

We determine our deferred tax assets and liabilities based upon the difference between the financial statement and tax bases of our assets and liabilities calculated using enacted applicable tax rates. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance. Changes in the valuation allowance, when recorded, are included in the provision for income taxes in the consolidated financial statements.

Our unrecognized tax benefits of $2,318, $1,755, and $2,247 as of December 31, 2017, 2016, and 2015, respectively, are uncertain tax positions that would impact our effective tax rate if recognized. We are periodically engaged in tax return examinations, reviews of statute of limitations periods, and settlements surrounding income taxes. We do not anticipate a material change in unrecognized tax benefits during the next twelve months.

Our uncertain tax benefits, and changes thereto, during 2017, 2016, and 2015 were as follows:



	2017			2016			2015
Balance at January 1,	$	1,755		$	2,247		$	3,104
Additions based on tax positions related to current year	437			397			464
Additions based on tax positions of prior years	291			—			—
Reductions for tax positions of prior years	(165		)	(889		)	(252		)
Settlements	—			—			(1,069		)
Balance at December 31,	$	2,318		$	1,755		$	2,247

We classify interest expense and penalties as part of our provision for income taxes based upon applicable federal and state interest/underpayment percentages. We have accrued $983 and $650 in interest and penalties at December 31, 2017 and 2016, respectively. Interest was computed on the difference between the provision for income taxes recognized in accordance with GAAP and the amount of benefit previously taken or expected to be taken in our federal, state, and local income tax returns.

Our federal income tax returns for the tax years 2014 and forward are available for examination by the United States Internal Revenue Service (“IRS”). The statute of limitation for the 2014 federal return will expire on September 15, 2018, unless extended by consent. Our state income tax returns for 2013 through 2017 remain subject to examination by various state authorities with the latest period closing on December 31, 2022. We have not extended the statutes of limitations in any state jurisdictions with respect to years prior to 2013.

A reconciliation between the “statutory” federal income tax rate and the effective tax rate in the consolidated statements of income is as follows:



	For the Years Ended December 31,
	2017		2016		2015
“Statutory” federal tax rate	35.0	%	35.0	%	35.0	%
State and local income taxes, net of federal benefit	4.0		3.3		3.8
Deemed repatriation of foreign earnings	3.3		—		—
Effect of tax rate changes	13.5		—		—
Other, net	1.3		0.9		1.2
Effective tax rate	57.1	%	39.2	%	40.0	%

The effective tax rate increased significantly as a result of the remeasurement of deferred tax assets and liabilities and recording the one-time transition tax as a result of the TCJA. As discussed above, a significant portion of the impact of the 2017 "Effect of tax rate changes" relates to items previously recorded through accumulated other comprehensive income under FAS 158.

The components of income before taxes and the provision for income taxes recorded in the consolidated statements of income are as follows:



	For the Years Ended December 31,
Components of Income before Taxes	2017		2016		2015
Domestic	$	155,268	$	143,567	$	143,144
Foreign	12,280		9,932		9,197
Income before taxes	$	167,548	$	153,499	$	152,341



	For the Years Ended December 31,
Components of Income Tax Provision	2017			2016			2015
Current expense
U.S. Federal	$	66,475		$	33,030		$	46,174
State	11,396			4,821			7,996
Foreign	3,574			2,795			2,666
Total current expense	$	81,445		$	40,646		$	56,836
Deferred expense (benefit)
U.S. Federal	15,332			16,676			3,224
State	(1,139		)	3,008			958
Foreign	(25		)	(144		)	(9		)
Total deferred expense (benefit)	$	14,168		$	19,540		$	4,173
Total income tax provision	$	95,613		$	60,186		$	61,009

Federal and state current tax expense was increased by $5,067 and $1,133, respectively, due to recording the one-time transition tax as a result of the TCJA. Federal deferred tax expense was increased by $22,640 due to the remeasurement of deferred tax assets and liabilities as a result of the TCJA.

Deferred income taxes are provided based upon differences between the financial statement and tax bases of assets and liabilities. The following deferred tax assets (liabilities) were recorded at December 31:



Assets (Liabilities)	2017			2016
Postretirement benefits	$	19,768		$	29,788
Payroll accruals	1,866			2,618
Bad debt reserves	1,023			1,322
Other deferred tax assets	4,772			5,251
Pension	37,988			47,847
Inventory	12,123			11,336
Subtotal	77,540			98,162
Less: valuation allowances	(23		)	(136		)
Deferred tax assets	77,517			98,026
Fixed assets	(27,156		)	(40,887		)
Computer software	(3,240		)	(5,724		)
Other deferred tax liabilities	(2,622		)	(3,043		)
Deferred tax liabilities	(33,018		)	(49,654		)
Net deferred tax assets	$	44,499		$	48,372

Deferred income taxes included in non-current assets (liabilities) at December 31 were:



	2017			2016
Deferred tax assets included in other non-current assets	$	44,860		$	48,666
Deferred tax liabilities included in other non-current liabilities	(361		)	(294		)

Operating loss carryforwards included in net deferred tax assets at December 31 were:



	2017		2016
Foreign net operating losses⁽¹⁾	$	187	$	239
State net operating losses⁽²⁾	504		529

⁽¹⁾Expires in 2024

⁽²⁾Expires between 2023 and 2030

Due to uncertainties regarding the utilization of our state net operating losses, a partial valuation allowance has been applied against the deferred tax benefit at December 31, 2017.

We have no material undistributed earnings of non-U.S. subsidiaries as of December 31, 2017 due to the one-time transition tax enacted under the TCJA. A provision for federal and state income taxes of $5,067 and $1,133, respectively, has been recorded at December 31, 2017 for this one-time transition tax on undistributed foreign earnings as of December 31, 2017.