NOTE 15. INCOME TAXES
On December 22, 2017, the Tax Reform Act was signed into law by President Trump. The Tax Reform Act significantly revised the U.S. corporate income tax code by, among other things, lowering the U.S. corporate tax rate from 35% to 21% effective January 1, 2018. On the same date, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 which specifies, among other things, that reasonable estimates of the income tax effects of the Tax Reform Act should be used, if determinable. GAAP requires that the impact of tax legislation be recognized in the period in which the law was enacted. The Company recorded an income tax provision of $19.4 million for the year ended December 31, 2017, including a charge of $25.9 million due to a remeasurement of deferred tax assets and liabilities resulting from the tax rate reduction. The year 2017 tax provision represents the Company’s current best estimate based on management’s current interpretation of the Tax Reform Act and may change as the Company receives additional clarification and implementation guidance.
The income tax provision included in the consolidated statements of operations consists of the following for the years ended December 31, 2017 and 2016:
| (in thousands) | ||||
| 2017 | 2016 | |||
| Current | $ | 70 | $ | 143 |
| Deferred | 19,308 | 999 | ||
| Income tax provision | $ | 19,378 | $ | 1,142 |
The income tax provision differs from the amount computed by applying the federal income tax statutory rate of 35 percent on income before income tax expense. A reconciliation of income tax at the statutory rate to income tax provision for the years ended December 31, 2017 and 2016 is presented in the table below.
| (in thousands) | ||||
| 2017 | 2016 | |||
| Federal tax based on statutory rate applicable for each year | $ | 984 | $ | 1,539 |
| State income tax | 157 | 245 | ||
| Reduction of deferred tax asset due to enacted decrease in future tax rates | 25,852 | - | ||
| Reduction of deferred tax asset valuation allowance | (7,628) | (780) | ||
| Other | 13 | 138 | ||
| Income tax provision | $ | 19,378 | $ | 1,142 |
Deferred tax assets consisted of the following as of December 31, 2017 and 2016:
| (in thousands) | |||||
| 2017 | 2016 | ||||
| Deferred tax assets: | |||||
| Net operating loss carryforwards | $ | 59,691 | $ | 96,500 | |
| Orchid Island Capital, Inc. common stock | 2,349 | 3,291 | |||
| MBS | 1,038 | 1,425 | |||
| Management agreement | 813 | 1,267 | |||
| Tax hedges | 49 | 366 | |||
| Accrued expenses | 148 | 330 | |||
| Other | 661 | 697 | |||
| 64,749 | 103,876 | ||||
| Valuation allowance | (20,224) | (40,043) | |||
| Net deferred tax assets | $ | 44,525 | $ | 63,833 | |
As of December 31, 2017 and 2016, Bimini Capital had tax capital loss carryforwards of approximately $0.3 million and $0.3 million, respectively, which can be used to offset future realized tax capital gains. The capital loss carryforwards will begin to expire in 2019. In addition, as of December 31, 2017 and 2016, Bimini Capital had estimated federal NOL carryforwards of approximately $19.1 million and $19.3 million, respectively, and estimated Florida NOL carryforwards of $18.5 million and $18.6 million, respectively. The NOL carryforwards can be used to offset future taxable income and will begin to expire in 2028.
As of December 31, 2017, Royal Palm had tax capital loss carryforwards of approximately $0.1 million which can be used to offset future realized tax capital gains. The capital loss carryforwards will begin to expire in 2022. In addition, as of December 31, 2017, Royal Palm had estimated federal NOL carryforwards of approximately $253.5 million and estimated available Florida NOLs of approximately $26.0 million. As of December 31, 2016, Royal Palm had estimated federal NOL carryforwards of approximately $257.0 million and estimated available Florida NOLs of approximately $29.5 million. These NOLs can be used to offset future taxable income and will begin to expire in 2025.
In connection with Orchid’s 2013 IPO, Bimini Advisors paid for, and expensed for GAAP purposes, certain offering costs totaling approximately $3.2 million. For tax purposes, these offering costs created an intangible asset related to the management agreement with a tax basis of $3.2 million. The deferred tax asset related to the intangible asset at December 31, 2017 and 2016 totaled approximately$0.8 million and $1.3 million, respectively.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of capital loss and NOL carryforwards is dependent upon the generation of future capital gains and taxable income in periods prior to their expiration. The valuation allowance relates primarily to the ability to utilize the NOL carryforwards of Bimini Capital and Royal Palm in future periods and is based on management’s estimated projections of future taxable income. With respect to the utilization of NOL carryforwards at Bimini, management must estimate the dividends the Company will receive on its Orchid share holdings as well as the management fees and overhead sharing payments it will receive from Orchid. With respect to the MBS portfolio at Royal Palm, management makes estimates of various metrics such as the yields on the assets it will acquire, its future funding costs, future prepayment speeds and net interest margin, among others. Management must also estimate the dividends it will receive on its Orchid shares and the cash flows it will receive on the retained interests. Utilization of the NOLs is based on these estimates and the assumptions that management will be able to reinvest retained earnings in order to grow the MBS portfolio going forward and that market value will not be eroded due to adverse market conditions or hedging inefficiencies. These estimates and assumptions may change from year to year to the extent Orchid grows, thus increasing projected management fees and overhead sharing payments, and/or market conditions change such that estimates with respect to the portfolio metrics warrant revisions.
Royal Palm holds residual interests in various real estate mortgage investment conduits (“REMICs”), some of which generate excess inclusion income (“EII”), a type of taxable income pursuant to specific provisions of the Code. During 2010 (as part of the filing of its 2009 tax returns), Royal Palm reached a tax filing position related to the EII taxable income that was different from what was reported in previous periods, and included a notice of inconsistent treatment in its tax returns. Royal Palm continues to file its tax returns following its 2009 tax filing position, and it continues to include a notice of inconsistent treatment in each return.
The Company does not believe it has any unrecognized tax benefits included in its consolidated financial statements. The Company has not had any settlements in the current period with taxing authorities, nor has it recognized tax benefits as a result of a lapse of the applicable statute of limitations.