CENVEO, INC

Income Taxes

Income Tax Expense

Income (loss) from continuing operations before income taxes was as follows for the years ended (in thousands):



	2016		2015
Domestic	$	74,288	$	(17,196	)
Foreign	816		2,128
	$	75,104	$	(15,068	)

Income tax expense on income (loss) from continuing operations consisted of the following for the years ended (in thousands):



	2016			2015
Current tax expense:
Federal	$	—		$	—
Foreign	1,230			592
State	1,748			1,058
	2,978			1,650
Deferred tax expense:
Federal	1,165			1,109
Foreign	(279		)	270
State	394			1,364
	1,280			2,743
Income tax expense	$	4,258		$	4,393

A reconciliation of the expected tax benefit based on the federal statutory tax rate to the Company’s actual income tax expense is summarized as follows for the years ended (in thousands):



	2016			2015
Expected tax expense (benefit) at federal statutory income tax rate	$	26,286		$	(5,274	)
State and local income tax expense (benefit)	5,917			(3,295		)
State net operating loss adjustments	1,273			2,259
Change in valuation allowance	(35,659		)	5,914
Change in contingency reserves	(132		)	(118		)
Non-U.S. tax rate differences	665			116
Non-deductible expenses	4,325			3,094
Change in state tax rates	99			802
Other	1,484			895
Income tax expense	$	4,258		$	4,393

Deferred Income Taxes

Deferred taxes are recorded to give recognition to temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. The tax effects of these temporary differences are recorded as deferred tax assets and deferred tax liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years. Deferred tax liabilities generally represent items that have been deducted for tax purposes, but have not yet been recorded in the consolidated statement of operations. The Company has not recorded a U.S. deferred tax liability with respect to its unremitted foreign earnings as the Company’s intention is to permanently reinvest those earnings in the local jurisdiction, as these amounts are not material.

The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities of the Company, were as follows (in thousands):



	2016			2015
Deferred tax assets:
Net operating loss carryforwards	$	81,949		$	128,232
Compensation and benefit related accruals	50,261			50,255
Alternative minimum tax credit carryforwards	7,307			7,450
Accounts receivable	1,004			2,679
Inventory	2,083			2,816
Restructuring accruals	8,158			8,810
Accrued tax and interest	2,015			1,882
Other	6,292			4,022
Valuation allowance	(129,159		)	(163,225		)
Total deferred tax assets	29,910			42,921

Deferred tax liabilities:
Property, plant and equipment	(19,771		)	(27,850		)
Goodwill and other intangible assets	(48,744		)	(52,438		)
Other	(630		)	(553		)
Total deferred tax liabilities	(69,145		)	(80,841		)
Net deferred tax liability	$	(39,235	)	$	(37,920	)

The net deferred tax liability included the following (in thousands):



	2016			2015
Current deferred tax asset (included in prepaid and other current assets)	$	3,382		$	4,116
Long-term deferred tax liability (included in other liabilities)	(42,617		)	(42,036		)
Total	$	(39,235	)	$	(37,920	)

The Company has federal and state net operating loss carryforwards. The tax effect of these attributes was $81.9 million as of the year ended 2016. Federal net operating loss carryforwards of $220.0 million will expire from 2025 through 2034 and alternative minimum tax credit carryforwards of $7.3 million do not have an expiration date.

The Company reviews the likelihood that it will realize the benefit of its deferred tax assets and therefore the need for valuation allowances on a quarterly basis, or more frequently if events indicate that a review is required. In determining the requirement for a valuation allowance, the historical and projected financial results of the legal entity or consolidated group recording the net deferred tax asset is considered, along with all other available positive and negative evidence. The factors considered in the determination of the probability of the realization of the deferred tax assets include, but are not limited to: recent historical financial results, historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences, the duration of statutory carryforward periods and tax planning strategies. If, based upon the weight of available evidence, it is more likely than not that the deferred tax assets will not be realized, a valuation allowance is recorded.

Concluding that a valuation allowance is not required is difficult when there is significant negative evidence which is objective and verifiable, such as cumulative losses in recent years. The Company utilizes a rolling twelve quarters of pre-tax income or loss adjusted for significant permanent book to tax differences, as well as non-recurring items, as a measure of its cumulative results in recent years. In the United States, the Company's analysis indicates that it has cumulative three year historical losses on this basis. While there are significant impairment, restructuring and refinancing charges driving the cumulative three year loss, this is considered significant negative evidence which is objective and verifiable and therefore, difficult to overcome. However, the three year loss position is not solely determinative and accordingly, the Company considers all other available positive and negative evidence in its analysis. Based upon the Company's analysis, which incorporated the excess capacity and pricing pressure experienced in certain product lines, the Company believes it is more likely than not that the net deferred tax assets in the United States will not be fully realized in the future. Accordingly, the Company has a valuation allowance related to those net deferred tax assets of $117.8 million as of the year ended 2016. Deferred tax assets related to certain state net operating losses also did not reach the more likely than not realizability criteria and accordingly, were subject to a valuation allowance, the balance of which, as of the year ended 2016 was $11.4 million.

There is no corresponding income tax benefit recognized with respect to losses incurred and no corresponding income tax expense recognized with respect to earnings generated in jurisdictions with a valuation allowance. This causes variability in the Company's effective tax rate. As a result of generating an estimated $112.5 million of federal taxable income for the year ended 2016, primarily as a result of the gain on early extinguishment of debt and the sale of the Packaging Business, there is no federal income tax expense recognized for the year ended 2016. The significant reduction in the valuation allowance for the year ended 2016 is related to these transactions. The Company intends to maintain the valuation allowances until it is more likely than not that the net deferred tax assets will be realized. If operating results improve on a sustained basis, or if certain tax planning strategies are implemented, conclusions regarding the need for valuation allowances could change, resulting in a decrease of the valuation allowances in the future, which could have a significant impact on income tax expense in the period recognized and subsequent periods.

Uncertain Tax Positions

The Company accounts for uncertain tax positions by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. During 2016 and 2015, the Company did not reduce its liability for uncertain tax positions. The Company does not anticipate significant changes to its unrecognized tax benefits in the next twelve months. The balance of the Company’s remaining unrecognized tax benefits as of the year ended 2016 includes $2.2 million of tax benefits that, if recognized would affect the effective tax rate. These amounts are included in other liabilities. The Company recognizes interest accrued related to unrecognized tax benefits and penalties as income tax expense. Related to the uncertain tax benefits noted above, the Company accrued interest of $0.4 million for the year ended 2016 and, in total, as of the year ended 2016, has recognized no liabilities for penalties and has recognized liabilities of $3.2 million for interest.

The Company’s unrecognized tax benefit activity for the years ended 2016, 2015 and 2014 was as follows (in thousands):



Unrecognized tax benefit – As of year end 2014	$	2,226
Gross decreases – tax positions in prior period	—
Gross decreases – expiration of applicable statute of limitations	—
Unrecognized tax benefit – As of year end 2015	2,226
Gross decreases – tax positions in prior period	—
Gross decreases – expiration of applicable statute of limitations	—
Unrecognized tax benefit – As of year end 2016	$	2,226

The Internal Revenue Service ("IRS") has examined the Company’s federal income tax returns through 2010. The Company’s federal income tax returns for tax years 2004 through 2006, 2009 through 2010, and 2012, remain subject to examination by the IRS due to a federal net operating loss generated in those years. Federal tax returns filed for 2013 forward remain subject to examination by statute. The various states in which the Company is subject to income tax audits are generally open for the tax years after 2011. The Company does not believe that the outcome of any examination will have a material impact on its consolidated financial statements.

Current Taxes

As of the years ended 2016 and 2015, the Company had income tax receivables of $2.0 million and $0.3 million, respectively, included in other current assets.