NOVATION COMPANIES, INC.

Income Taxes

The components of income tax benefit from continuing operations are (in thousands):



	For the Year Ended December 31,
	2016			2015
Current:
Federal	$	(14	)	$	(13	)
State and local	(7		)	(15		)
Total current	$	(21	)	$	(28	)

Below is a reconciliation of the expected federal income tax expense using the federal statutory tax rate of 35% to the Company’s actual income tax benefit and resulting effective tax rate (in thousands).



	For the Year Ended December 31,
	2016			2015
Income tax (benefit) at statutory rate	$	1,129		$	(977	)

State income taxes, net of federal tax benefit	211			(96		)
Valuation allowance	14,595			2,519
Change in state tax rate	(16,475		)	—
State tax credits	—			488
Adjustment to deferred tax asset	—			(1,965		)
Bankruptcy reorganization	437			—
Uncertain tax positions	(35		)	(87		)
Other	117			90
Total income tax benefit	$	(21	)	$	(28	)

Prior to 2015, the Company concluded that it was no longer more likely than not that it would realize a portion of its deferred tax assets. As such, the Company maintained a full valuation allowance against its net deferred tax assets as of both December 31, 2016 and 2015.

The Company's determination of the realizable deferred tax assets requires the exercise of significant judgment, based in part on business plans and expectations about future outcomes. In the event the actual results differ from these estimates in future periods, the Company may need to adjust the valuation allowance, which could materially impact our financial position and results of operations. The Company will continue to assess the need for a valuation allowance in future periods. As of December 31, 2016 and 2015, the Company maintained a valuation allowance of $292.2 million and $281.5 million, respectively, for its deferred tax assets.

In 2016, due to the sale of Corvisa, the Company reassessed their state apportionment rates. Based on available information, the Company changed the apportionment factors, specifically the apportionment factor used for allocation of income to the State of Missouri. In this reassessment, the Company determined that as of December 31, 2016, the federal taxable net operating loss would also be the state net operating loss allocated to Missouri based on its state tax apportionment. Based on Missouri tax code, the Company is able to utilize the full amount of federal net operating losses to reduce Missouri taxable income, subject to certain adjustments outlined in Missouri tax code. As a result of this reassessment, the Company recalculated the deferred tax assets and recognized an additional deferred tax asset related to state net operating losses totaling approximately $16.5 million in the current year. This was offset by an increase in the valuation allowance of approximately $16.5 million. In 2015, the Company had apportioned 22.57% of the total federal net operating loss to Missouri in accordance with Missouri tax code.

Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2016 and 2015 are (in thousands):



	December 31,
	2016			2015
Deferred tax assets:
Basis difference – investments	$	17,261		$	18,043
Federal net operating loss carryforwards	239,942			239,003
State net operating loss carryforwards	35,896			20,168
Other	2,816			4,882
Gross deferred tax asset	295,915			282,096
Valuation allowance	(292,214		)	(281,548		)
Deferred tax asset	3,701			548
Deferred tax liabilities:
Other	3,701			548
Deferred tax liability	3,701			548
Net deferred tax asset	$	—		$	—

As of December 31, 2016, the Company had a federal net operating loss of approximately $685.5 million, including $307.3 million in losses on mortgage securities that have not been recognized for income tax purposes. The federal net operating loss may be carried forward to offset future taxable income, subject to applicable provisions of the Internal Revenue Code (the "Code"). If not used, this net operating loss will expire in years 2025 through 2036. The Company has state net operating loss carryovers arising from both combined and separate filings from as early as 2004. The state net operating loss carryovers may expire as early as 2017 and as late as 2036.

The activity in the accrued liability for unrecognized tax benefits for the years ended December 31, 2016 and 2015 was (in thousands):



	For the Year Ended December 31,
	2016			2015
Beginning balance	$	368		$	475
Gross increases – tax positions in current period	2			19
Lapse of statute of limitations	(39		)	(126		)
Ending balance	$	331		$	368

As of December 31, 2016 and 2015, the total gross amount of unrecognized tax benefits was $0.3 million and $0.4 million, respectively, which also represents the total amount of unrecognized tax benefits that would impact the effective tax rate. The Company anticipates a reduction of unrecognized tax benefits of less than $0.1 million due the lapse of statute of limitations in the next twelve months. The Company does not expect any other significant change in the liability for unrecognized tax benefits in the next twelve months. It is the Company’s policy to recognize interest and penalties related to income tax matters in income tax expense. The benefit for interest and penalties recorded in income tax expense was not significant for 2016 and 2015. There were accrued interest and penalties of less than $0.1 million as of both December 31, 2016 and 2015. The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state and local jurisdictions. Tax years 2012 to 2016 remain open to examination for both U.S. federal income tax and major state tax jurisdictions.