Note 12. Income Taxes
We are subject to federal and state income taxes in the United States and in Canada. For the years ended December 31, 2017, 2016 and 2015, we did not have a material amount of current taxable income.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation under the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including but not limited to: (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain untaxed earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) eliminating the corporate alternative minimum tax (“AMT”) and how AMT credits are utilized; and (5) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017. Shortly after enactment, implementation guidance was released by the Securities and Exchange Commission that requires a company to reflect the income tax effects of those aspects of the Tax Act for which the accounting under the accounting rules is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but the company is able to determine a reasonable estimate, it should record a provisional estimate in the financial statements. Further, the implementation guidance also provides for a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete their accounting pursuant to the accounting rules.
We recorded an income tax benefit of $89.6 million for the year ended December 31, 2017. Approximately $66.0 million of the income tax benefit relates to a $174.0 million non-cash impairment we recorded during the year ended December 31, 2017 related to the $351.0 million indefinite-lived intangible asset that we recorded in connection with our February 2015 acquisition of Trulia for Trulia’s trade names and trademarks. For additional information about the non-cash impairment, see Note 9 to our consolidated financial statements. The remaining $23.6 million of the income tax benefit primarily relates to our initial analysis of the impact of the rate decrease included in the Tax Act for the impact of the reduction in our net deferred tax liability related to our indefinite-lived intangible asset. As of December 31, 2017, we have not completed our accounting for the income tax effects of certain elements of the Tax Act and we have recorded provisional adjustments where we were able to make reasonable estimates of the effects of elements for which our analysis is not yet complete, including as related to the deduction limitations on compensation.
Income tax expense was not material for the year ended December 31, 2016. We recorded an income tax benefit of $4.6 million for the year ended December 31, 2015 due to a deferred tax liability generated in connection with Zillow’s August 20, 2015 acquisition of DotLoop, Inc. that can be used to realize certain deferred tax assets for which we had previously provided a full allowance.
The following table summarizes the components of our income tax (benefit) expense for the periods presented (in thousands):
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Federal |
$ | (84,238 | ) | $ | 1,248 | $ | 2,838 | |||||
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State |
(5,348 | ) | (1,378 | ) | 1,807 | |||||||
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Deferred income tax (benefit) expense |
$ | (89,586 | ) | $ | (130 | ) | $ | 4,645 | ||||
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The following table presents a reconciliation of the federal statutory rate and our effective tax rate for the periods presented:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Tax expense at federal statutory rate |
(35.0 | )% | (35.0 | )% | (35.0 | )% | ||||||
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State income taxes, net of federal tax benefit |
(4.4 | ) | (1.9 | ) | (2.3 | ) | ||||||
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Nondeductible expenses |
0.8 | 4.9 | 2.8 | |||||||||
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Share-based compensation |
(20.6 | ) | (0.2 | ) | 1.2 | |||||||
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Research and development credits |
(6.3 | ) | (1.5 | ) | (4.1 | ) | ||||||
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Divestiture of businesses |
— | — | 2.3 | |||||||||
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Enactment of Tax Act |
(13.1 | ) | — | — | ||||||||
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Other |
2.2 | (0.9 | ) | (1.0 | ) | |||||||
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Valuation allowance |
27.7 | 34.7 | 33.1 | |||||||||
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Effective tax rate |
(48.7 | )% | 0.1 | % | (3.0 | )% | ||||||
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Deferred federal, state and foreign income taxes reflect the net tax impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and such amounts for tax purposes. The following table presents the significant components of our deferred tax assets and liabilities as of the dates presented (in thousands):
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Deferred tax assets: |
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Federal and state net operating loss carryforwards |
$ | 234,316 | $ | 208,029 | ||||
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Share-based compensation |
47,655 | 67,482 | ||||||
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Depreciation and amortization |
— | 3,123 | ||||||
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Start-up and organizational costs |
146 | 300 | ||||||
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Research and development credits |
35,793 | 24,295 | ||||||
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Other tax credits |
910 | 1,358 | ||||||
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Accruals and reserves |
2,729 | 1,814 | ||||||
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Deferred rent |
5,484 | 5,882 | ||||||
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Other deferred tax assets |
8,342 | 14,544 | ||||||
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Total deferred tax assets |
335,375 | 326,827 | ||||||
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Deferred tax liabilities: |
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Website and software development costs |
(13,202 | ) | (15,851 | ) | ||||
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Goodwill. |
(688 | ) | (363 | ) | ||||
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Intangible assets |
(69,241 | ) | (192,830 | ) | ||||
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Discount on 2021 Notes not deductible for tax |
(19,374 | ) | (34,384 | ) | ||||
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Depreciation and amortization |
(2,425 | ) | — | |||||
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Total deferred tax liabilities |
(104,930 | ) | (243,428 | ) | ||||
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Net deferred tax assets before valuation allowance |
230,445 | 83,399 | ||||||
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Less: valuation allowance |
(274,810 | ) | (217,351 | ) | ||||
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Net deferred tax liabilities |
$ | (44,365 | ) | $ | (133,952 | ) | ||
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Realization of deferred tax assets is dependent upon the generation of future taxable income, if any, the timing and amount of which are uncertain. We have provided a full valuation allowance against the net deferred tax assets as of December 31, 2017 and 2016 because, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some or all of the deferred tax assets will not be realized. The valuation allowance increased by $57.5 million and $54.6 million, respectively, during the years ended December 31, 2017 and 2016.
We have accumulated federal tax losses of approximately $1,014.0 million and $893.3 million, respectively, as of December 31, 2017 and 2016, which are available to reduce future taxable income. We have accumulated state tax losses of approximately $21.4 million and $13.5 million (tax effected), respectively, as of December 31, 2017 and 2016. Additionally, we have net research and development credit carryforwards of $35.8 million and $24.3 million, respectively, as of December 31, 2017 and 2016, which are available to reduce future tax liabilities. The tax loss and research and development credit carryforwards begin to expire in 2025. Under Sections 382 and 383 of the Internal Revenue Code, if a corporation undergoes an ownership change, the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes, such as research tax credits, to offset its post-change income or income tax liability may be limited. In connection with our August 2013 public offering of our Class A Common stock, we experienced an ownership change that triggered Sections 382 and 383, which may limit our ability to utilize net operating loss and tax credit carryforwards. In connection with our February 2015 acquisition of Trulia, Trulia experienced an ownership change that triggered Section 382 and 383, which may limit Zillow Group’s ability to utilize Trulia’s net operating loss and tax credit carryforwards.
We are currently not under audit in any tax jurisdiction. Tax years from 2014 through 2017 are currently open for audit by federal and state taxing authorities.
Changes for unrecognized tax benefits for the periods presented are as follows (in thousands):
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Balance at January 1, 2015 |
$ | 6,493 | ||
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Gross increases—prior and current period tax positions |
3,577 | |||
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Gross increases—assumed in connection with February 2015 acquisition of Trulia |
3,910 | |||
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Balance at December 31, 2015 |
$ | 13,980 | ||
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Gross increases—current period tax positions |
2,619 | |||
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Gross decreases—prior period tax positions |
(1,204 | ) | ||
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Balance at December 31, 2016 |
$ | 15,395 | ||
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Gross increases—current period tax positions |
5,216 | |||
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Gross increases—prior period tax positions |
1,002 | |||
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Balance at December 31, 2017 |
$ | 21,613 | ||
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At December 31, 2017, the total amount of unrecognized tax benefits of $21.6 million is recorded as a reduction to our deferred tax asset. We do not anticipate that the amount of existing unrecognized tax benefits will significantly increase or decrease within the next 12 months. Accrued interest and penalties related to unrecognized tax benefits are recorded as income tax expense and are zero.