We file income tax returns in the U.S. for federal and various state jurisdictions as well as in foreign jurisdictions including Canada, the United Kingdom, Australia and Ireland. We are generally subject to U.S. federal income tax examination for calendar tax years 2014 through 2017 as well as state and foreign income tax examinations for various years depending on statutes of limitations of those jurisdictions.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as 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% to 21%, effective January 1, 2018; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries (the "Transition Tax"); (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations; (5) eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized; (6) creating the base erosion anti-abuse tax (BEAT), a new minimum tax; (7) creating a new limitation on deductible interest expense; and (8) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.
Under GAAP, we use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Due to the reduction in the federal corporate tax rate from 35% to 21%, we revalued our net deferred tax assets and deferred tax liabilities and recorded a discrete tax benefit to expense of $20.0 million in 2017.
The Transition Tax is a tax on previously untaxed accumulated and current earnings and profits of certain of our foreign subsidiaries. We were able to make a reasonable estimate of the Transition Tax and determined that it was insignificant.
The Tax Act eliminates the exceptions for performance-based compensation and CFO compensation from the 162(m) calculation. A transition rule allows for the grandfathering of performance-based compensation pursuant to a written binding contract in effect as of November 2, 2017. While there is negative discretion inherent in our performance-based compensation plans, it is our position that the intent is for historic contracts to be written and binding. As a result, we have not adjusted the ending deferred tax asset for the performance-based stock compensation or the bonus accrual in our 2017 tax provision.
The Tax Act includes a new provision, referred to as Global Intangible Low-Taxed Income (“GILTI”), which provides for a 10.5% tax on certain income of controlled foreign corporations. We have elected to account for GILTI as a period cost if and when occurred, rather than recognizing deferred taxes for basis differences expected to reverse. As a result of this policy election, there is no impact to our 2017 deferred tax calculation.
Our estimates of the impact of the Tax Act may change due to a number of additional considerations including, but not limited to, the issuance of additional regulations or guidance and our ongoing analysis of the new law. Any subsequent adjustment to these amounts will be recorded to tax expense in 2018 when the analysis is complete.
The following summarizes the components of income tax expense:
|
| | | | | | | | | |
| Years ended December 31, | |
(dollars in thousands) | 2017 |
| 2016 |
| 2015 |
|
Current taxes: | | | |
U.S. Federal | $ | 2,632 |
| $ | 4,655 |
| $ | 5,890 |
|
U.S. State and local | (144 | ) | 1,670 |
| 2,215 |
|
International | 101 |
| 53 |
| 33 |
|
Total current taxes | 2,589 |
| 6,378 |
| 8,138 |
|
Deferred taxes: | | | |
U.S. Federal | (13,843 | ) | 2,544 |
| 2,702 |
|
U.S. State and local | 398 |
| 304 |
| 585 |
|
International | (883 | ) | 185 |
| (122 | ) |
Total deferred taxes | (14,328 | ) | 3,033 |
| 3,165 |
|
Total income tax provision | $ | (11,739 | ) | $ | 9,411 |
| $ | 11,303 |
|
The following summarizes the components of income before provision for income taxes: |
| | | | | | | | | |
| Years ended December 31, | |
(dollars in thousands) | 2017 |
| 2016 |
| 2015 |
|
U.S. | $ | 54,634 |
| $ | 49,320 |
| $ | 37,523 |
|
International | (440 | ) | 1,606 |
| (571 | ) |
Income before provision for income taxes | $ | 54,194 |
| $ | 50,926 |
| $ | 36,952 |
|
A reconciliation between the effect of applying the federal statutory rate and the effective income tax rate used to calculate our income tax provision is as follows:
|
| | | | | | |
| Years ended December 31, | |
| 2017 |
| 2016 |
| 2015 |
|
Federal statutory rate | 35.0 | % | 35.0 | % | 35.0 | % |
Effect of: | | | |
State income taxes, net of federal benefit | 1.6 |
| 4.1 |
| 5.7 |
|
Change in federal income tax rate applied to deferred tax balances | (36.9 | ) | — |
| — |
|
Change in state income tax rate applied to deferred tax balances | — |
| 0.2 |
| 2.1 |
|
Fixed assets | — |
| — |
| (0.1 | ) |
Unrecognized tax benefit | 1.6 |
| 0.2 |
| (1.1 | ) |
State credits, net of federal benefit | (1.5 | ) | (0.1 | ) | 6.0 |
|
Change in valuation reserve (primarily state credit reserves) | (1.1 | ) | (1.6 | ) | (8.6 | ) |
Federal credits generated | (6.2 | ) | (6.2 | ) | (6.1 | ) |
Foreign tax rate | 0.2 |
| (0.4 | ) | (0.7 | ) |
Acquisition costs | 2.4 |
| 0.1 |
| 0.1 |
|
Section 162(m) limitation | 2.7 |
| 1.7 |
| 0.1 |
|
Loss from sale of foreign subsidiary | — |
| — |
| 1.9 |
|
Domestic production activities deduction | — |
| (1.2 | ) | (1.8 | ) |
Stock-based compensation | (20.3 | ) | (13.6 | ) | — |
|
Other | 0.8 |
| 0.3 |
| (1.9 | ) |
Income tax provision effective rate | (21.7 | )% | 18.5 | % | 30.6 | % |
As discussed above, due to the reduction in the federal corporate tax rate from 35% to 21%, we revalued our net deferred tax assets and deferred tax liabilities as of December 31, 2017, and recorded a discrete tax benefit to expense of $20.0 million in 2017.
The discrete tax benefit to expense relating to stock-based compensation items was $12.5 million in 2017. We recorded a discrete tax benefit to expense relating to stock-based compensation of $7.7 million during the year ended December 31, 2016. Prior to the adoption of ASU 2016-09 in 2016, we recorded excess tax benefit from the exercise and vesting of stock-based compensation of $5.5 million in additional paid in capital during the year ended December 31, 2015.
The significant components of our deferred tax assets and liabilities were as follows: |
| | | | | | |
| December 31, | |
(dollars in thousands) | 2017 |
| 2016 |
|
Deferred tax assets relating to: | | |
Federal and state and foreign net operating loss carryforwards | $ | 13,597 |
| $ | 12,906 |
|
Federal, state and foreign tax credits | 14,389 |
| 9,924 |
|
Intangible assets | 693 |
| 652 |
|
Stock-based compensation | 9,611 |
| 11,480 |
|
Accrued bonuses | 1,001 |
| 7,426 |
|
Deferred revenue | 859 |
| 5,371 |
|
Allowance for doubtful accounts | 1,379 |
| 1,294 |
|
Other | 5,440 |
| 6,781 |
|
Total deferred tax assets | 46,969 |
| 55,834 |
|
Deferred tax liabilities relating to: | | |
Intangible assets | (47,997 | ) | (44,885 | ) |
Fixed assets | (4,552 | ) | (9,200 | ) |
Deferred sales commissions | (9,354 | ) | (6,347 | ) |
Capitalized software development costs | (14,012 | ) | (14,832 | ) |
Other | (995 | ) | (755 | ) |
Total deferred tax liabilities | (76,910 | ) | (76,019 | ) |
Valuation allowance | (7,205 | ) | (6,994 | ) |
Net deferred tax liability | $ | (37,146 | ) | $ | (27,179 | ) |
As of December 31, 2017, our federal, foreign and state net operating loss carryforwards for income tax purposes were approximately $33.5 million, $31.2 million and $36.9 million, respectively. The federal and state net operating loss carryforwards are subject to various Internal Revenue Code limitations and applicable state tax laws. If not utilized, the federal net operating loss carryforwards will begin to expire in 2028 and the state net operating loss carryforwards will expire over various periods beginning in 2018. Our foreign net operating loss carryforwards have an unlimited carryforward period. As of December 31, 2017, our foreign tax credit carryforwards for income tax purposes were insignificant. Our federal tax credit carryforwards for income tax purposes were approximately $3.6 million. Our state tax credit carryforwards for income tax purposes were approximately $13.5 million, net of federal benefit. If not utilized, the federal tax credit carryforwards will begin to expire in 2036 and the state tax credit carryforwards will begin to expire in 2018. A portion of the foreign and state net operating loss carryforwards and state credit carryforwards have a valuation reserve due to management's uncertainty regarding the future ability to use such carryforwards.
The following table illustrates the change in our deferred tax asset valuation allowance:
|
| | | | | | | | | |
Years ended December 31, | Balance at beginning of year |
| Charges to expense |
| Balance at end of year |
|
(dollars in thousands) |
2017 | $ | 6,994 |
| $ | 211 |
| $ | 7,205 |
|
2016 | 7,911 |
| (917 | ) | 6,994 |
|
2015 | 11,161 |
| (3,250 | ) | 7,911 |
|
The following table sets forth the change to our unrecognized tax benefit for the years ended December 31, 2017, 2016 and 2015:
|
| | | | | | | | | |
| Years ended December 31, | |
(dollars in thousands) | 2017 |
| 2016 |
| 2015 |
|
Balance at December 31, 2016 | $ | 3,145 |
| $ | 3,024 |
| $ | 3,564 |
|
Increases from prior period positions | 1,860 |
| 23 |
| 129 |
|
Decreases in prior year positions | (238 | ) | (17 | ) | (651 | ) |
Increases from current period positions | 404 |
| 358 |
| 257 |
|
Settlements (payments) | — |
| — |
| (274 | ) |
Lapse of statute of limitations | (11 | ) | (243 | ) | (1 | ) |
Balance at December 31, 2017 | $ | 5,160 |
| $ | 3,145 |
| $ | 3,024 |
|
The total amount of unrecognized tax benefit that, if recognized, would favorably affect the effective tax rate was $4.6 million at December 31, 2017. Certain prior period amounts relating to our 2014 acquisitions are covered under indemnification agreements and, therefore, we have recorded a corresponding indemnification asset. We recognize accrued interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense. The total amount of accrued interest and penalties included in the consolidated balance sheet as of December 31, 2017 was $0.8 million. The total amount of accrued interest and penalties included in the consolidated balance sheet as of December 31, 2016 was insignificant. The total amount of interest and penalties included in the consolidated statements of comprehensive income as an increase or decrease in income tax expense for 2017, 2016 and 2015 was insignificant.
We have taken federal and state tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits might decrease within the next twelve months. This possible decrease could result from the expiration of statutes of limitations. The reasonably possible decrease at December 31, 2017 was $1.6 million.
For our undistributed earnings of foreign subsidiaries, which we do not consider to be significant, we concluded that these earnings would be permanently reinvested in the local jurisdictions and not repatriated to the United States. Accordingly, we have not provided for U.S. state income taxes and foreign withholding taxes on those undistributed earnings of our foreign subsidiaries. If some or all of such earnings were to be remitted, the amount of taxes payable would be insignificant.