Party City Holdco Inc.

Note 13 — Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“the Act”) was signed into law. The Act significantly changed U.S. tax law, including lowering the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018, and implementing a one-time “deemed repatriation” tax on unremitted earnings accumulated in non-U.S. jurisdictions since 1986 (the “Transition Tax”). Due to the complexities of accounting for the Act, the SEC issued Staff Accounting Bulletin (“SAB”) No. 118 which allows entities to include a provisional estimate of the impact of the Act in its 2017 financial statements. Therefore, based on currently available information, during the fourth quarter of 2017, the Company recorded a provisional estimate of the impact of the Act, which included an income tax benefit of $90,965 related to the remeasurement of its domestic net deferred tax liabilities and deferred tax assets due to the lower U.S. corporate tax rate. Additionally, the Company recorded a net income tax expense of $1,132 as its provisional estimate of the Transition Tax related to the deemed repatriation of unremitted earnings of foreign subsidiaries. While these amounts represent the Company’s best estimates of the impacts of the reduction in the federal corporate income tax rate and the deemed repatriation Transition Tax, the final impacts of the Act may differ from the Company’s estimates due to, among other things, changes in the Company’s interpretations and assumptions, additional guidance to be issued by the IRS, and actions the Company may take. As provided in SAB 118, any adjustments to these provisional amounts will be recorded as they are identified during the measurement period, which ends no later than December 22, 2018.

A summary of domestic and foreign income before income taxes and including noncontrolling interest follows:


	Year Ended December 31, 2017		Year Ended December 31, 2016		Year Ended December 31, 2015
Domestic	$	153,280	$	152,800	$	7,180
Foreign		34,864		33,914		10,688

Total	$	188,144	$	186,714	$	17,868

The income tax (benefit) expense consisted of the following:


	Year Ended December 31, 2017			Year Ended December 31, 2016			Year Ended December 31, 2015
Current:
Federal	$	61,890		$	50,851		$	8,137
State		6,267			8,121			2,652
Foreign		7,298			6,864			2,798

Total current expense		75,455			65,836			13,587

Deferred:
Federal		(101,774	)		3,290			(6,710	)
State		(796	)		(906	)		(1,086	)
Foreign		(81	)		1,017			1,618

Total deferred (benefit) expense		(102,651	)		3,401			(6,178	)

Income tax (benefit) expense	$	(27,196	)	$	69,237		$	7,409

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

The deferred federal income tax benefit for the year ended December 31, 2017 includes a $90,965 provisional benefit due to the Act lowering the U.S. corporate income tax rate from 35% to 21%. See above for further discussion.

Deferred income tax assets and liabilities consisted of the following:


	December 31,
	2017			2016
Deferred income tax assets:
Inventory valuation	$	7,064		$	10,138
Allowance for doubtful accounts		746			893
Accrued liabilities		8,130			10,402
Equity based compensation		3,145			3,236
Federal tax loss carryforwards		960			2,715
State tax loss carryforwards		1,726			1,070
Foreign tax loss carryforwards		14,151			13,992
Foreign tax credit carryforwards		6,412			1,418
Deferred rent		9,867			11,816
Other		166			509

Deferred income tax assets before valuation allowances		52,367			56,189
Less: valuation allowances		(24,073	)		(17,331	)

Deferred income tax assets, net	$	28,294		$	38,858

Deferred income tax liabilities:
Property, plant and equipment	$	13,855		$	24,055
Intangible assets		145,066			218,046
Amortization of goodwill and other assets		42,297			61,163
Foreign earnings expected to be repatriated		586			10,954
Other		1,176			2,655

Deferred income tax liabilities	$	202,980		$	316,873

In the Company’s December 31, 2017 consolidated balance sheet, $1,150 was included in “other assets, net” and $175,836 was included in deferred income tax liabilities. At December 31, 2016, $804 was included in “other assets, net” and $278,819 was included in deferred income tax liabilities.

Management assesses the available positive and negative evidence to estimate if sufficient taxable income will be generated to realize existing deferred tax assets. On the basis of this evaluation, a valuation allowance was recorded to reduce the total deferred tax assets to an amount that will, more-likely-than-not, be realized in the future. The valuation allowance, and the net change during the year, relate primarily to foreign net operating loss carryforwards and foreign tax credit carryforwards, the latter of which principally resulted from the Transition Tax. The estimate of foreign source income incorporated assumptions based upon the best available interpretation of the Act and may change as additional clarification and implementation guidance is made available.

As of December 31, 2017, the Company had foreign tax-effected net operating loss carryforwards in Germany of $9,074, the U.K. of $4,108, and Australia of $635, all of which have an unlimited carryforward; as well as $334 from other foreign countries, which expire at different dates. In addition, the U.S. federal net operating loss carryforwards begin to expire in 2020, the U.S. state net operating loss carryforwards begin to expire in 2018 and the foreign tax credit carryforwards begin to expire in 2020.

The difference between the Company’s effective income tax rate and the U.S. statutory income tax rate is as follows:


	Year Ended December 31, 2017			Year Ended December 31, 2016			Year Ended December 31, 2015
Tax provision at U.S. statutory income tax rate		35.0	%		35.0	%		35.0	%
State income tax, net of federal income tax		1.9			2.5			5.7
Domestic production activities deduction		(1.4	)		(1.0	)		(5.1	)
Contingent consideration adjustment		0.2			(0.1	)		(6.0	)
Work Opportunity Tax Credit		(0.4	)		(0.3	)		(3.2	)
Valuation allowances		2.1			0.5			21.7
Foreign earnings		(1.7	)		2.3			9.1
U.S. — foreign rate differential		(1.9	)		(2.4	)		(13.7	)
Transition Tax on unremitted foreign earnings, net		0.6			0.0			0.0
Effect of the Act on Federal deferred income tax assets and liabilities		(48.4	)		0.0			0.0
Other		(0.5	)		0.6			(2.0	)

Effective income tax rate		(14.5	)%		37.1	%		41.5	%

Transition Tax on Unremitted Foreign Earnings: As a result of the Act, the U.S. is transitioning from a worldwide system of international taxation to a territorial tax system, thereby eliminating the U.S. federal tax on foreign earnings. However, the Act requires a one-time deemed repatriation tax on such earnings and, accordingly, during the fourth quarter of 2017, the Company provisionally recorded a Transition Tax of $11,500 related to such requirement. Of such amount, $920 will be paid in 2018 and is recorded in income taxes payable on the Company’s consolidated balance sheet. The remainder will be paid in subsequent years and is recorded in “deferred rent and other long-term liabilities” in the Company’s consolidated balance sheet. Prior to the fourth quarter of 2017, the Company recorded deferred income tax liabilities for certain foreign earnings which were expected to be remitted to the U.S. in future periods. Therefore, the expense that was provisionally recorded due to the deemed repatriation tax, $11,500, was mostly offset by the reversal of previously recorded deferred income tax liabilities on unremitted foreign earnings, $10,368. After such reversal, a deferred tax liability, in the amount of $586, remained recorded on the Company’s consolidated balance sheet due to the impact of foreign withholding taxes and state income taxes on the future repatriation of certain foreign earnings.

Effect of the Act on Federal Deferred Income Tax Assets and Liabilities: The deferred federal benefit for the year ended December 31, 2017 includes a $90,965 provisional benefit due to the Act changing the U.S. corporate income tax rate from 35% to 21%. See above for further discussion.

Other differences between the effective income tax rate and the federal statutory income tax rate are composed primarily of reserves for unrecognized tax benefits, non-deductible meals and entertainment expenses, and benefits related to the exercise of stock options.

The following table summarizes the activity related to the Company’s gross unrecognized tax benefits:


	Year Ended December 31, 2017			Year Ended December 31, 2016			Year Ended December 31, 2015
Balance as of beginning of period	$	913		$	765		$	798
Increases related to current period tax positions		100			444			130
(Decreases) increases related to prior period tax positions		(158	)		339			0
Decreases related to settlements		0			(635	)		(92	)
Decreases related to lapsing of statutes of limitations		0			0			(71	)

Balance as of end of period	$	855		$	913		$	765

The Company’s total unrecognized tax benefits that, if recognized, would impact the Company’s effective tax rate were $855 and $913 at December 31, 2017 and 2016, respectively. As of December 31, 2017, we do not believe that there are any positions for which it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or decrease within the next 12 months.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company has accrued $73 and $28 for the potential payment of interest and penalties at December 31, 2017 and 2016, respectively. Such amounts are not included in the table above.

The IRS is currently conducting an examination of the year ended December 31, 2015. For U.S. state income tax purposes, tax years 2013-2017 generally remain open; whereas for non-U.S. income tax purposes, tax years 2012-2017 generally remain open.