Income Taxes
Significant components of the provision (benefit) for income taxes from continuing operations are as follows (in thousands): |
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Current provision: | | | | | | |
Federal | | $ | — |
| | $ | — |
| | $ | — |
|
State | | 30 |
| | 18 |
| | 23 |
|
Foreign | | 63 |
| | 44 |
| | — |
|
Total current provision | | 93 |
| | 62 |
| | 23 |
|
Deferred provision (benefit): | | | | | | |
Federal | | 26,411 |
| | (12,630 | ) | | (17,347 | ) |
State | | 1,119 |
| | 151 |
| | (1,799 | ) |
Foreign | | — |
| | — |
| | — |
|
Total deferred provision (benefit) | | 27,530 |
| | (12,479 | ) | | (19,146 | ) |
Total income tax provision (benefit) | | $ | 27,623 |
| | $ | (12,417 | ) | | $ | (19,123 | ) |
Differences between the provision (benefit) for income taxes and income taxes at the statutory federal income tax rate are as follows: |
| | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Income tax expense (benefit) at statutory federal rate | | 34.0 | % | | 34.0 | % | | 34.0 | % |
State income tax expense, net of federal benefit | | 2.0 | % | | 4.0 | % | | 3.4 | % |
Permanent differences and other | | (0.2 | )% | | 4.3 | % | | 4.4 | % |
Goodwill | | (8.3 | )% | | — | % | | — | % |
Transaction costs | | — | % | | 2.6 | % | | 23.1 | % |
Withholding costs | | (0.8 | )% | | 2.2 | % | | — | % |
Tax credit | | — | % | | (2.6 | )% | | — | % |
Impact of 2017 Tax Act | | (143.6 | )% | | — | % | | — | % |
Change in effective federal and state tax rates | | 0.4 | % | | (0.4 | )% | | 37.6 | % |
Expiration of net operating loss and tax credit carryovers | | (0.1 | )% | | 3.4 | % | | 8.4 | % |
Stock compensation expense | | (1.0 | )% | | — | % | | — | % |
Reserve for uncertain tax positions and other reserves | | 0.6 | % | | (6.0 | )% | | 76.8 | % |
Change in valuation allowance | | (223.7 | )% | | (668.0 | )% | | (947.5 | )% |
Provision (benefit) for income taxes | | (340.7 | )% | | (626.5 | )% | | (759.8 | )% |
Our net deferred tax assets consisted of the following (in thousands):
|
| | | | | | | | |
| | December 31, |
| | 2017 | | 2016 |
Deferred tax assets (liabilities): | | | | |
Net operating loss carryforwards | | $ | 23,399 |
| | $ | 35,540 |
|
Research and development and other credits | | 44 |
| | 89 |
|
Reserves | | 567 |
| | 964 |
|
Intangibles | | — |
| | — |
|
Other, net | | 1,231 |
| | 1,980 |
|
Total deferred tax assets | | 25,241 |
| | 38,573 |
|
Deferred tax liabilities | | | | |
Fixed assets and other | | (3,489 | ) | | (6,221 | ) |
Intangibles | | (891 | ) | | (2,335 | ) |
Total deferred tax liabilities | | (4,380 | ) | | (8,556 | ) |
Valuation allowance for deferred tax assets | | (21,115 | ) | | (2,998 | ) |
Net deferred tax (liabilities) assets | | $ | (254 | ) | | $ | 27,019 |
|
The Company recognizes federal and state deferred tax assets or liabilities based on the Company's estimate of future tax effects attributable to temporary differences and carryovers. The Company records a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and judgment, are not expected to be realized. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. The Company considers projected future taxable income and planning strategies in making this assessment. As of December 31, 2017, as a result of a three-year cumulative loss and recent events, such as the unanticipated termination of the Philips distribution agreement and its effect on our near term forecasted income, we concluded that a full valuation allowance was necessary to offset our deferred tax assets. A significant piece of objective negative evidence evaluated as of December 31, 2017, was the cumulative pretax loss incurred over the three-year period ended December 31, 2017. Accordingly, additional valuation allowance of $18.1 million was recorded during the year ended December 31, 2017 for a total valuation allowance amount of $21.1 million against the Company's deferred tax assets. The Company will continue to evaluate its deferred tax balances to determine any assets that are more likely than not to be realized.
As of December 31, 2017, we had federal and state income tax net operating loss carryforwards of $89.2 million and $30.2 million, respectively. Federal loss carryforwards will begin to expire in 2019 unless previously utilized. State loss carryforwards of approximately $0.1 million expired in 2017, and less than $0.1 million is set to expire in 2018, unless previously utilized. We also have federal and California research and other credit carryforwards of approximately $1.8 million and $2.1 million, respectively, as of both December 31, 2017 and 2016. The federal credits will begin to expire in 2018. The California research credits have no expiration. Pursuant to Internal Revenue Code Sections 382 and 383, use of our net operating loss and credit carryforwards may be limited because of a cumulative change in ownership greater than 50%. As of December 31, 2017, Digirad Corporation has not experienced a change in ownership greater than 50%; however, some of the tax attributes acquired with the DMS Health businesses are subject to such limitations due to ownership changes of greater than 50% which may have occurred or which may occur in the future. A valuation allowance has been recognized to offset the deferred tax assets, as realization of such assets has not met the "more likely than not" threshold required under the authoritative guidance of accounting for income taxes.
The following table summarizes the activity related to our unrecognized tax benefits (in thousands): |
| | | | | | | | | | | | |
| | December 31, |
| | 2017 | | 2016 | | 2015 |
Balance at beginning of year | | $ | 4,134 |
| | $ | 3,916 |
| | $ | 1,553 |
|
Increases related to prior year tax positions | | — |
| | 882 |
| | 2,363 |
|
Settlements with taxing authorities | | — |
| | (187 | ) | | — |
|
Expiration of the statute of limitations for the assessment of taxes | | (198 | ) | | (477 | ) | | — |
|
Balance at end of year | | $ | 3,936 |
| | $ | 4,134 |
| | $ | 3,916 |
|
Included in the unrecognized tax benefits of $3.9 million at December 31, 2017 was $3.5 million of tax benefits that, if recognized, would reduce our annual effective tax rate, subject to the valuation allowance. We do not expect our unrecognized tax benefits to change significantly over the next 12 months.
We file income tax returns in the U.S. and in various state jurisdictions with varying statutes of limitations. We are no longer subject to income tax examination by tax authorities for years prior to 2013; however, our net operating loss carryforwards and research credit carryforwards arising prior to that year are subject to adjustment. Our policy is to recognize interest expense and penalties related to income tax matters as a component of income tax expense. The accrued interest as of December 31, 2017 and 2016, and interest and penalties recognized during the years ended December 31, 2017, 2016, and 2015 were of insignificant amounts.
Tax Cuts and Jobs Act
On December 2, 2017, the U.S. Senate joined the U.S. House of Representatives in passing tax reform legislation. Reconciliation of the provisions in the U.S. House of Representatives bill and the U.S. Senate bill concluded on December 20, 2017. On December 22, 2017, the President signed into law the Tax Cuts and Jobs Act. The impact of the legislation created a tax expense of approximately $11.6 million, due to the re-measurement of our deferred tax assets and liabilities at the new U.S. federal tax rate of 21% from the previous rate of 34%, for years subsequent to 2017.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record and provisional estimate in the financial statements. The Company has recognized the provisional tax impacts related to its Internal Revenue Code Section 162(m) limitations and the potential impact on its equity compensation deferred tax assets and included these amounts in its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts, possibly materially, due to among other things, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the Tax Act.
The Tax Cuts and Jobs Act allows for one hundred percent expensing of the cost of qualified property acquired and place in service after September 27, 2017 and before January 1, 2023. The Company does not plan to take advantage of this provision in the near term and has the option of opting out of this provision. In addition, net operating losses incurred in tax years beginning after December 31, 2017 are only allowed to offset a taxpayer's taxable income by eighty percent, but those net operating losses are allowed to be carried forward indefinitely with no expiration. Also as part of the Tax Cuts and Jobs Act, the Company's net interest expense deductions are limited to 30% of earnings before interest, taxes, depreciation, and amortization through 2021 and of earnings before interest and taxes thereafter. This provision also takes effect for tax years beginning after 2017 and isn't expected to have a material impact to the Company's deferred tax asset position.
The Tax Cuts and Jobs Act also incorporates changes to certain international tax provisions. There is a one-time transition tax on foreign income earned by subsidiaries at a rate of 15.5% for cash and cash equivalents and at a rate of 8% for the remainder of the foreign earnings. There is a provision for the current inclusion in US taxable income of global intangible low-tax income and also the imposition of a tax equal to its base erosion minimum tax amount. The new laws incorporate a potential benefit for foreign derived intangible income, but the benefit only applies if the foreign derived sales and services income exceeds a calculated 'routine return' and if the Company is in taxable income. The Company does not anticipate that any of the foreign provisions will have an impact to the Company's tax accounts.