| 8. | Income Taxes |
Effects of the Tax Cuts and Jobs Act
New tax legislation, commonly referred to as the Tax Cuts and Jobs Act (the “2017 Tax Act”), was enacted on December 22, 2017. Accounting for income taxes requires companies to recognize the effect of tax law changes in the period of enactment even though the effective date for most provisions of the 2017 Tax Act is for tax years beginning after December 31, 2017.
Given the significance of the legislation, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which allows registrants to record provisional amounts during a one year “measurement period” similar to that used when accounting for business combinations. However, the measurement period is deemed to have ended earlier when the registrant has obtained, prepared and analyzed the information necessary to finalize its accounting. During the measurement period, impacts of the law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be recognized and adjusted as information becomes available, prepared or analyzed.
SAB 118 summarizes a three-step process to be applied at each reporting period to account for and qualitatively disclose: (1) the effects of the change in tax law for which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law where accounting is not complete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with law prior to the enactment of the Tax Cuts and Jobs Act.
The 2017 Tax Act reduces the U.S. federal corporate income tax rate from 35% to 21%, provides for an indefinite carryforward of net operating losses arising from tax years ending after December 31, 2017 limited to a deduction of 80% of taxable income, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign earnings. We have not completed our accounting for the effects of the 2017 Tax Act; however, we have made a reasonable estimate of those effects. Accordingly, we have recognized a provisional income tax benefit of $71.9 million, which is included as a component of the income tax provision on our consolidated statement of operations.
Included in this provisional amount is (i) a $31.5 million benefit reflecting the revaluation of our net deferred tax liability resulting from indefinite-lived intangibles based on a U.S. federal tax rate of 21% and (ii) a $40.4 million benefit from a release of valuation allowance against net deferred tax assets. This is as a result of the provisions of the 2017 Tax Act that would extend net operating losses generated in taxable years beginning after December 31, 2017 to an unlimited carryforward period subject to an 80% utilization against future taxable earnings. The Company scheduled out the reversal of deferred tax assets and liabilities as of December 31, 2017 and determined that they would reverse into an indefinite-lived net operating loss. As a result, the Company’s indefinite-lived deferred tax liabilities could be used as a source of future taxable income in the Company’s assessment of its realization of the net indefinite-lived deferred tax asset. Our preliminary estimate is subject to the finalization of management’s analysis related to certain matters, such as developing interpretations of the provisions of the 2017 Tax Act and its effect on state income taxes. U.S. Treasury regulations, administrative interpretations or court decisions interpreting the 2017 Tax Act may require further adjustments and changes in our estimates. The final determination of the revaluation of our net deferred tax liability and release of the valuation allowance against net deferred tax assets will be completed as additional information becomes available, but no later than one year from the enactment of the 2017 Tax Act.
The new law also includes a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreign subsidiaries. The Company has performed an earnings and profits analysis, and as a result of accumulated losses since inception of the Company, there will be no income tax effect in the current or any future period.
Effects of tax law changes where a reasonable estimate of the accounting effects has not yet been made include the inclusion of commissions and performance based compensation in determining the excessive compensation limitation. Other significant provisions that are not yet effective but may impact income taxes in future years include: an exemption from U.S. tax on dividends of future foreign earnings, limitation on the current deductibility of net interest expense in excess of 30 percent of adjusted taxable income, an incremental tax (base erosion anti-abuse tax, or “BEAT”) on excessive amounts paid to foreign related parties, and a minimum tax on certain foreign earnings in excess of 10% of the foreign subsidiaries tangible assets (i.e., global intangible low-taxed income, or “GILTI”).
For the GILTI provisions of the 2017 Tax Act, a provisional estimate could not be made as the Company has not completed its assessment or elected an accounting policy to either recognize deferred taxes for basis differences expected to reverse as GILTI or to record GILTI as period costs if and when incurred.
The substantial 2017 impact of the enactment of the 2017 Tax Act is reflected in the tables below.
The components of loss before taxes by jurisdiction are as follows:
| For the
Year Ended December 31, 2017 |
For the
Year Ended December 31, 2016 |
For the
Year Ended December 31, 2015 |
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U.S. |
$ | (154,065 | ) | $ | (353,038 | ) | $ | (161,513 | ) | |||
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Foreign |
443 | 2,988 | 8,004 | |||||||||
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Loss before taxes |
$ | (153,622 | ) | $ | (350,050 | ) | $ | (153,509 | ) | |||
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Total income taxes by jurisdiction are as follows:
| For the
Year Ended December 31, 2017 |
For the
Year Ended December 31, 2016 |
For the
Year Ended December 31, 2015 |
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Income tax expense (benefit) |
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U.S. |
$ | (50,122 | ) | $ | (66,677 | ) | $ | (21,956 | ) | |||
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Foreign |
(313 | ) | 1,185 | 2,316 | ||||||||
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| $(50,435) | $(65,492) | $(19,640) | ||||||||||
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Significant components of the (benefit) expense for income taxes attributable to loss from continuing operations consist of the following:
| For the
Year Ended December 31, 2017 |
For the
Year Ended December 31, 2016 |
For the
Year Ended December 31, 2015 |
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Current |
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Foreign |
$ | (259 | ) | $ | 437 | $ | 1,413 | |||||
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U.S.—Federal |
— | 92 | (9,917 | ) | ||||||||
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U.S.—State and other |
(930 | ) | 2,320 | (59,296 | ) | |||||||
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Total current |
(1,189 | ) | 2,849 | (67,800 | ) | |||||||
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Deferred |
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Foreign |
(54 | ) | 748 | 903 | ||||||||
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U.S.—Federal |
(54,666 | ) | (63,422 | ) | 28,937 | |||||||
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U.S.—State and other |
5,474 | (5,667 | ) | 18,320 | ||||||||
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Total deferred |
(49,246 | ) | (68,341 | ) | 48,160 | |||||||
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Income tax (benefit) expense |
$ | (50,435 | ) | $ | (65,492 | ) | $ | (19,640 | ) | |||
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The reconciliation of the income tax rate computed at the statutory tax rate to the reported income tax expense (benefit) attributable to continuing operations is as follows:
| For the
Year Ended December 31, 2017 |
For the
Year Ended December 31, 2016 |
For the
Year Ended December 31, 2015 |
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Statutory rate |
(35.0 | )% | (35.0 | )% | (35.0 | )% | ||||||
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Permanent items |
4.0 | 0.8 | 1.8 | |||||||||
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Release/(accrual) of uncertain tax positions |
0.2 | (0.3 | ) | (33.6 | ) | |||||||
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Foreign rate differential |
0.3 | (0.1 | ) | (0.2 | ) | |||||||
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State and local taxes |
(18.3 | ) | (5.9 | ) | (10.9 | ) | ||||||
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State and local net operating loss re-establishment |
— | (3.3 | ) | — | ||||||||
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Increase in valuation allowance |
72.2 | 25.9 | 71.6 | |||||||||
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Change in valuation allowance due to 2017 Tax Act |
49.0 | — | — | |||||||||
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Impact of federal rate change on deferred tax assets and liabilities due to 2017 Tax Act |
(95.9 | ) | — | — | ||||||||
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Tax credits |
(1.3 | ) | (0.8 | ) | (6.5 | ) | ||||||
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Adoption of 2016 Accounting Standard related to accounting changes for certain aspects of share-based payments to employees (1) |
(8.0 | ) | — | — | ||||||||
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Effective tax rate |
(32.8 | )% | (18.7 | )% | (12.8 | )% | ||||||
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The significant components of the net deferred tax assets and liabilities are shown in the following table:
| 2017 | 2016 | |||||||
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Tax assets related to |
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Net operating loss and other carryforwards |
$ | 229,595 | $ | 199,008 | ||||
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Returns reserve/inventory expense |
40,687 | 64,736 | ||||||
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Pension benefits |
6,977 | 12,184 | ||||||
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Postretirement benefits |
6,285 | 9,988 | ||||||
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Deferred interest (2) |
280,246 | 428,346 | ||||||
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Deferred revenue |
122,192 | 182,051 | ||||||
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Stock-based compensation |
3,992 | 7,808 | ||||||
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Deferred compensation |
5,872 | 4,557 | ||||||
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Other, net |
8,875 | 12,127 | ||||||
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Valuation allowance |
(571,653 | ) | (759,887 | ) | ||||
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| 133,068 | 160,918 | |||||||
| 2017 | 2016 | |||||||
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Tax liabilities related to |
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Indefinite-lived intangible assets |
(62,593 | ) | (71,380 | ) | ||||
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Definite-lived intangible assets |
(45,644 | ) | (82,225 | ) | ||||
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Depreciation and amortization expense |
(43,426 | ) | (75,236 | ) | ||||
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Other, net |
(81 | ) | — | |||||
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| (151,744) | (228,841) | |||||||
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Net deferred tax liabilities |
$ | (18,676 | ) | $ | (67,923 | ) | ||
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| (1) | In March 2016, the FASB issued guidance that changes the accounting for certain aspects of shared-based payments to employees. The guidance requires the recognition of the income tax effects of awards in the income statement when the awards vest or are settled, thus eliminating additional paid-in capital pools. The guidance became effective January 1, 2017 which resulted in the recognition of $12.3 million of previously unrecorded additional paid-in capital net operating losses at that time. The additional net operating losses were offset by an increase in the valuation allowance, accordingly no net income tax benefit was recognized as a result of the adoption. |
| (2) | The deferred interest tax asset represents disallowed interest deductions under IRC Section 163(j) (Limitation on Deduction for interest on Certain Indebtedness) for the current and prior years. At December 31, 2017 and 2016, we had gross deferred interest deductions totaling $1,042.1 million and $1,079.0 million, respectively. The disallowed interest is able to be carried forward indefinitely and utilized in future years pursuant to IRC Section 163(j). A full valuation allowance has been provided against deferred tax assets, excluding $3.6 million of foreign deferred tax assets which are expected to be realized, net of deferred tax liabilities resulting from indefinite-lived intangibles. |
The net deferred tax liability balance is stated at prevailing statutory income tax rates. Deferred tax assets and liabilities are reflected on our consolidated balance sheets as follows:
| 2017 | 2016 | |||||||
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Non-current deferred tax assets |
$ | 3,593 | $ | 3,458 | ||||
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Non-current deferred tax liabilities |
(22,269 | ) | (71,381 | ) | ||||
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| $(18,676) | $(67,923) | |||||||
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A reconciliation of the gross amount of unrecognized tax benefits, excluding accrued interest and penalties, is as follows:
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Balance at December 31, 2014 |
$ | 78,634 | ||
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Reductions based on tax positions related to the prior year |
(62,323 | ) | ||
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Additions based on tax positions related to the current year |
— | |||
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Balance at December 31, 2015 |
16,311 | |||
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Reductions based on tax positions related to the prior year |
(855 | ) | ||
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Additions based on tax positions related to the current year |
52 | |||
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Balance at December 31, 2016 |
15,508 | |||
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Reductions based on tax positions related to the prior year |
— | |||
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Additions based on tax positions related to the prior year |
172 | |||
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Balance at December 31, 2017 |
$ | 15,680 | ||
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For the year ended December 31, 2017, the Company recorded $0.2 million of uncertain tax benefits due to its uncertainty around net operating losses that were generated in tax years ended December 31, 2014 and 2015. For the year ended December 31, 2016, the Company recognized $0.9 million of uncertain tax benefits (excluding interest and penalties) due to the expiration of the statute of limitations. We are currently open for audit under the statute of limitation for Federal, state and foreign jurisdictions for years 2011 to 2016. However, carryforward attributes from prior years may still be adjusted upon examination by tax authorities if they are used in a future period.
We report penalties and tax-related interest expense on unrecognized tax benefits as a component of the provision for income taxes in the accompanying consolidated statement of operations. At December 31, 2017 and 2016, we had $0.02 million and $0.02 million, respectively, of accrued interest and penalties in the accompanying consolidated balance sheet. Interest and penalties included in the provision for income taxes for the years ended December 31, 2017, 2016 and 2015 were $0.002 million, $0.02 million and $0.2 million, respectively.
On January 1, 2013, as part of the 2012 Chapter 11 Reorganization, we realized approximately $1.3 billion of cancellation of debt income. We excluded cancellation of debt income of $1.3 billion from taxable income since the Company was insolvent (liabilities greater than the fair value of its assets) by this amount at the time of the exchange. Although we did not need to pay current cash taxes from this transaction, we were required to reduce our tax attributes, such as net operating loss carryovers and tax credit carryovers and our tax basis of our assets to offset the $1.3 billion of taxable income that did not have to be recognized due to insolvency. As a result, our net operating losses and credit carryforwards were reduced on January 1, 2013, and a portion of our tax basis in our assets were reduced at that time. The Company completed an analysis of the state-by-state attribute reduction as of December 31, 2016 and as a result re-established $11.4 million of state net operating loss carryforwards (net of federal benefit) for states that decouple from IRC Sec. 1502.
As of December 31, 2017, we have approximately $602.3 million of Federal tax loss carryforwards, which will expire between 2034 and 2037. The Company has approximately $1,189.6 million of state tax loss carryforward, which will expire between 2019 and 2037. In addition, we have foreign tax credit carryforwards of $11.9 million and research and development credit carryforwards of $4.2 million, which will expire between 2018 and 2027, and 2032 and 2036, respectively. The Company’s Irish net operating losses of $26.1 million are not subject to expiration. The Canadian losses ($2.2 million federal and $1.2 million provincial) will expire between 2033 and 2037. The Puerto Rico alternative minimum tax credit carryforwards of $2.8 million are not subject to expiration.
Under Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in the Company’s ownership may limit the amount of net operating loss carryforwards that could be utilized annually in the future to offset taxable income. Specifically, this limitation may arise in the event of a cumulative change in ownership of the Company of more than 50% within a three-year period. Any such annual limitation may significantly reduce the utilization of net operating loss carryforwards before they expire. The Company performed an analysis through December 31, 2016, and determined any potential ownership change under Section 382 during the year would not have a material impact on the future utilization of U.S. net operating losses and tax credits. However, future transactions in the Company’s common stock could trigger an ownership change for purposes of Section 382, which could limit the amount of net operating loss carryforwards and other attributes that could be utilized annually in the future to offset taxable income, if any. Any such limitation, whether as the result of sales of common stock by our existing stockholders or sales of common stock by the Company, could have a material adverse effect on results of operations in future years.
U.S. income taxes on the undistributed earnings of the Company’s non-U.S. subsidiaries have not been provided for as the Company currently plans to indefinitely reinvest these amounts and has the ability to do so. There are no cumulative undistributed and untaxed foreign earnings at December 31, 2017 and 2016.
Based on our assessment of historical pre-tax losses and the fact that we did not anticipate sufficient future taxable income in the near term to assure utilization of certain deferred tax assets, the Company recorded a valuation allowance at December 31, 2017 and 2016 of $571.7 million and $759.9 million, respectively. We have decreased our valuation allowance by $188.2 million in 2017 with $186.7 million of benefit as a component of continuing operations and $1.5 million of benefit as a component of other comprehensive income.