Income Taxes
The Tax Cuts and Jobs Act ("the Act") was enacted on December 22, 2017. The Act reduces the U.S. federal corporate tax rate from 35% to 21% as of January 1, 2018. The income tax effects of the Act required the remeasurement of our deferred tax assets and liabilities in accordance ASC Topic 740. The Securities and Exchange Commission ('SEC') staff issued Staff Accounting Bulletin No. 118 ('SAB 118') that allows companies to record provisional estimates of the impacts of the Act during a measurement period which is similar to the measurement period of up to one year from the enactment which is similar to the measurement period used when accounting for business combinations. The Company has estimated the effects of the Act, which have been reflected in our 2017 financial statements.
The phase-in of the lower corporate tax rate has resulted in a blended rate of 33.8% for fiscal 2017, as compared to the previous 35%. At February 3, 2018 we have not fully completed our accounting for the tax effects of enactment of the Act; however, we have made a reasonable estimate of the effects on our existing deferred tax balances and valuation allowances. We remeasured U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future. The provisional net income tax expense recognized was zero, and is comprised of a tax expense of $20.7 million related to the effects of existing deferred tax asset balances and an offsetting tax benefit of $20.7 million which represents tax effects to existing valuation allowances.
The Act has eliminated the corporate Alternative Minimum Tax (AMT) and deemed accumulated AMT credits to be fully refundable by the year 2022. As of January 28, 2017 accumulated AMT tax credits totaled $0.4 million of which we now expect to be refunded.
The provision for income taxes consisted of the following for the fiscal periods identified below (in thousands):
|
| | | | | | | | | | | |
| Fiscal 2017 | | Fiscal 2016 | | Fiscal 2015 |
| (53 weeks) | | (52 weeks) | | (52 weeks) |
Current: | | | | | |
Federal tax benefit | $ | (439 | ) | | $ | — |
| | $ | — |
|
State tax (benefit) expense | (59 | ) | | (269 | ) | | 172 |
|
Current tax (benefit) expense | (498 | ) | | (269 | ) | | 172 |
|
Deferred tax (benefit) expense | (275 | ) | | 72 |
| | 37,543 |
|
Income tax (benefit) provision | $ | (773 | ) | | $ | (197 | ) | | $ | 37,715 |
|
The following presents a reconciliation of income tax computed at the U.S. statutory rate to the effective income tax rate for the fiscal periods ended:
|
| | | | | | | | |
| February 3, 2018 | | January 28, 2017 | | January 30, 2016 |
Federal income tax at statutory rate | 33.8 | % | | 35.0 | % | | 35.0 | % |
State income tax, net of federal benefit | 1.4 |
| | 1.9 |
| | 3.1 |
|
Change in valuation allowance | 56.7 |
| | (36.1 | ) | | (373.0 | ) |
Reserve for unrecognized tax benefits | 0.4 |
| | 1.3 |
| | (0.4 | ) |
Officer's compensation | 1.3 |
| | — |
| | — |
|
Impact of tax rate change on deferred taxes | (89.7 | ) | | — |
| | — |
|
Tax credits | — |
| | (0.5 | ) | | 4.8 |
|
Other | (0.5 | ) | | (0.5 | ) | | (1.0 | ) |
Effective income tax rate | 3.4 | % | | 1.1 | % | | (331.5 | )% |
Deferred income taxes are provided for temporary differences between the basis of assets and liabilities for financial reporting purposes and income tax purposes. Significant components of the Company's deferred income tax assets and liabilities are as follows (in thousands):
|
| | | | | | | |
| February 3, 2018 | | January 28, 2017 |
Deferred tax assets: | | | |
Accrued Friendship Rewards loyalty liability | $ | 773 |
| | $ | 1,283 |
|
Accrued gift card liability | 495 |
| | 599 |
|
Merchandise inventories | 845 |
| | 1,083 |
|
Deferred rent and deferred lease incentives | 4,147 |
| | 7,049 |
|
Stock-based compensation expense | 769 |
| | 2,357 |
|
Net operating loss carryforwards | 30,550 |
| | 36,565 |
|
Contribution carryforwards | 226 |
| | 249 |
|
Tax credit carryforwards | 766 |
| | 1,186 |
|
Other accrued liabilities | 1,152 |
| | 2,837 |
|
Total deferred tax assets | 39,723 |
| | 53,208 |
|
Less: Valuation allowance | (37,555 | ) | | (48,549 | ) |
Deferred tax assets, net of valuation allowance | 2,168 |
| | 4,659 |
|
Deferred tax liabilities: | | | |
Depreciation and amortization | (1,235 | ) | | (3,879 | ) |
Other | (336 | ) | | (459 | ) |
Total deferred tax liabilities | (1,571 | ) | | (4,338 | ) |
Net deferred tax assets | $ | 597 |
| | $ | 321 |
|
Deferred income tax assets represent potential future income tax benefits. Realization of these assets is ultimately dependent upon future taxable income. ASC 740 Income Taxes requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some or all of the recorded deferred tax assets will not be realized in a future period. Forming a conclusion that a valuation allowance is not needed is difficult when negative evidence such as cumulative losses exists. Based on available objective evidence and cumulative losses, management believes it is more likely than not that the deferred tax assets are not recognizable and will not be recognized until the Company has sufficient taxable income. Accordingly, the net deferred tax assets with the exception of certain deferred state benefits, have been offset by a valuation allowance. The valuation allowance decreased by $11.0 million and increased by $6.5 million during the years ended February 3, 2018 and January 28, 2017, respectively. The decrease in the valuation allowance in the current year is a result of the decrease in Federal tax rate under the Act. The valuation allowance does not have any impact on cash and does not prevent the Company from using the deferred tax assets in future periods when profits are realized.
As of February 3, 2018, the Company has federal and state net operating loss carryforwards which will reduce future taxable income. Approximately $26.1 million in net federal tax benefits are available from these federal loss carryforwards of approximately $124.2 million, and an additional $0.8 million is available in net federal tax credit carryforwards. We adopted ASU 2016-09 in fiscal 2017. As a result of this adoption, Federal net operating losses on the balance sheet now reflect carry forwards on the tax return, as there is no longer a prohibition against net operating losses related to excess benefits of stock compensation. This adjustment resulted in a $1.7 million increase to the Federal net operating loss in fiscal 2017. The state loss carry forwards will result in net state tax benefits of approximately $4.5 million. The federal net operating loss carryovers will expire in October 2032 and beyond. The Company has analyzed equity ownership changes and determined its net operating losses will not be limited under IRC Section 382. The state net operating loss carryforwards will expire in November 2018 and beyond. Additionally, the Company has charitable contribution carryforwards that will expire in 2018 and beyond.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows (in thousands):
|
| | | |
Balance at January 31, 2015 | $ | 876 |
|
Additions based on tax positions related to the current year | 329 |
|
Additions for tax positions of previous years | 16 |
|
Reductions for tax positions of previous years | (70 | ) |
Reductions for tax positions of previous years due to lapse of applicable statute of limitations | (42 | ) |
Balance at January 30, 2016 | 1,109 |
|
Additions based on tax positions related to the current year | 108 |
|
Additions for tax positions of previous years | 143 |
|
Reductions for tax positions of previous years | — |
|
Reductions for tax positions of previous years due to lapse of applicable statute of limitations | (327 | ) |
Balance at January 28, 2017 | 1,033 |
|
Additions based on tax positions related to the current year | 55 |
|
Additions for tax positions of previous years | — |
|
Reductions for tax positions of previous years | (300 | ) |
Reductions for tax positions of previous years due to lapse of applicable statute of limitations | (161 | ) |
Balance at February 3, 2018 | $ | 627 |
|
The Company's liability for unrecognized tax benefits is recorded within other non-current liabilities. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate as of February 3, 2018 and January 28, 2017 were $0.3 million and $0.4 million, respectively.
Interest and penalties related to unrecognized tax benefits of approximately $27 thousand, $39 thousand and $64 thousand were recognized as components of income tax expense in fiscal 2017, fiscal 2016 and fiscal 2015, respectively. At February 3, 2018 and January 28, 2017, approximately $0.1 million and $0.1 million, respectively, were accrued for the potential payment of interest and penalties.
The Company and its subsidiaries are subject to U.S. federal income taxes and the income tax obligations of various state and local jurisdictions. In April 2015, the Company settled the IRS examination of the fiscal 2011 tax year. In March 2017, the Company settled the IRS examination of the Fiscal 2013 tax year. Both settlements were related to certain issues which the Company had previously reflected net of tax within deferred tax assets. The settlements did not result in any cash payments nor any impact to tax expense. Periods after fiscal 2013 remain subject to examination by the Internal Revenue Service. With few exceptions, the Company is not subject to state income tax examination by tax authorities for taxable years prior to fiscal 2012. As of February 3, 2018, the Company had no other ongoing audits and does not expect the liability for unrecognized tax benefits to significantly increase or decrease in the next twelve months.