14. Income Taxes
Tax Cuts and Jobs Act
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act that significantly reforms the Code. The TCJA, among other things, contains significant changes to the determination of partnership taxable income, including: (i) a partial limitation on the deductibility of business interest expense, (ii) immediate deductions for certain new investments instead of deductions for depreciation expense over time, (iii) the cessation of like-kind exchange treatment for exchanges of tangible personal property, (iv) the cessation of technical terminations and (v) the modification or repeal of many business deductions and credits.
For U.S. federal income tax purposes we are treated as a partnership and are not subject to U.S. federal income tax at the entity level. As such, the corporate tax rate change is not applicable to us and no remeasurement of our deferred tax liabilities was necessary.
Current and Deferred Tax Provision
As a partnership, we are generally not subject to income taxes at the entity level because our income is included in the tax returns of our partners. However, certain states impose an entity-level income tax on partnerships.
The provision for state income taxes consisted of the following (in thousands):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 |
| 2016 | | 2015 |
Current tax provision: | | | | | |
State | $ | (2 | ) | | $ | (32 | ) | | $ | 1,195 |
|
Total current | (2 | ) | | (32 | ) | | 1,195 |
|
Deferred tax provision: |
|
| |
|
| |
|
|
State | 3,384 |
| | 1,444 |
| | (160 | ) |
Total deferred | 3,384 |
| | 1,444 |
| | (160 | ) |
Provision for income taxes | $ | 3,382 |
| | $ | 1,412 |
| | $ | 1,035 |
|
Deferred income tax balances are the direct effect of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities at the enacted tax rates expected to be in effect when the taxes are actually paid or recovered.
The tax effects of temporary differences that give rise to deferred tax liabilities are as follows (in thousands):
|
| | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 |
Deferred tax liabilities: | | | |
Property, plant and equipment (1) | $ | — |
| | $ | 2,500 |
|
Total deferred tax liabilities | — |
| | 2,500 |
|
Net deferred tax liabilities | $ | — |
| | $ | 2,500 |
|
——————
| |
(1) | We released $2.5 million of our deferred state tax liability in 2017 due to the remeasurement of our uncertain tax positions. |
Unrecognized Tax Benefit
A reconciliation of the beginning and ending amount of unrecognized tax benefits is shown below (in thousands):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 |
| 2016 |
| 2015 |
Beginning balance | $ | 1,882 |
| | $ | 1,962 |
| | $ | 1,650 |
|
Additions based on tax positions related to current year | 1,625 |
| | 121 |
| | 312 |
|
Additions based on tax positions related to prior years | 3,395 |
| | — |
| | — |
|
Reductions based on settlement with government authority | — |
| | (201 | ) | | — |
|
Ending balance | $ | 6,902 |
| | $ | 1,882 |
| | $ | 1,962 |
|
Appellate court decisions in 2017 required us to remeasure certain of our uncertain tax positions and increase our unrecognized tax benefit for these positions during the year ended December 31, 2017. We had $6.9 million, $1.9 million and $2.0 million of unrecognized tax benefits at December 31, 2017, 2016 and 2015, respectively, of which $3.6 million, $1.9 million and $2.0 million, respectively, would affect the effective tax rate if recognized.
We recorded $1.0 million and $0.1 million of potential interest expense and penalties related to unrecognized tax benefits associated with uncertain tax positions during the years ended December 31, 2017 and 2016, respectively, in our consolidated balance sheets. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as reductions in income tax expense. During the years ended December 31, 2017 and 2016, we recorded $0.9 million and $0.1 million of potential interest expense and penalties in our consolidated statements of operations. We recorded immaterial amounts of potential interest expense and penalties related to unrecognized tax benefits associated with uncertain tax positions as of and during the year ended December 31, 2015.
We and our subsidiaries file income tax returns in the U.S. federal jurisdiction and in numerous state jurisdictions. State income tax returns are generally subject to examination for a period of three to five years after filing the returns. However, the state impact of any U.S. federal audit adjustments and amendments remain subject to examination by various states for up to one year after formal notification to the states. We are currently involved in several state audits. During 2016, we settled certain years of a state audit, which resulted in a refund of $1.2 million and a reduction of $0.2 million of previously accrued uncertain tax benefits. As of December 31, 2017, we did not have any federal or state audits underway that would have a material impact on our financial position or results of operations.
U.S. Federal Tax Considerations
Exterran Holdings, Inc. completed an internal restructuring on November 3, 2015 in connection with the Spin-off which we believe, when combined with the sale or exchange of Partnership units during the 12 months prior to the Spin-off, resulted in a technical termination of the Partnership for U.S. federal income tax purposes on the date of the Spin-off. The 2015 Technical Termination did not affect our consolidated financial statements nor did it affect our classification as a partnership or otherwise affect the nature or extent of our “qualifying income” for U.S. federal income tax purposes. Our taxable year for all unitholders ended on November 3, 2015 and resulted in a deferral of depreciation deductions that were otherwise allowable in computing the taxable income of our unitholders. This deferral of depreciation deductions may have resulted in increased taxable income (or reduced taxable loss) to certain of our unitholders in 2015.
The following table reconciles net loss to our U.S. federal partnership taxable income (loss) (in thousands):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Net loss | $ | (421 | ) | | $ | (10,757 | ) | | $ | (84,025 | ) |
Book/tax depreciation and amortization adjustment | (179,330 | ) | (1) | (289,694 | ) | (1) | 17,468 |
|
Book/tax goodwill impairment | — |
| | — |
| | 127,757 |
|
Book/tax long-lived asset impairment | 19,107 |
| | 46,258 |
| | 38,987 |
|
Book/tax adjustment for unit-based compensation expense | 835 |
| | 978 |
| | 754 |
|
Book/tax adjustment for interest rate swap terminations | 2,410 |
| | 364 |
| | 1,233 |
|
Other temporary differences | (13,781 | ) | | (5,390 | ) | | (15,907 | ) |
Other permanent differences | 3,422 |
| | 1,796 |
| | (155 | ) |
U.S. federal partnership taxable income (loss) | $ | (167,758 | ) | | $ | (256,445 | ) | | $ | 86,112 |
|
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| |
(1) | Represents the excess of tax depreciation and amortization over book depreciation and amortization, which increased in connection with the 2015 Technical Termination. |
The following allocations and adjustments (which are not reflected in the reconciliation because they do not affect our total taxable income) may affect the amount of taxable income or loss allocated to a unitholder:
| |
• | IRC Section 704(c) Allocations: We make special allocations under IRC Section 704(c) to eliminate the disparity between a unitholder’s U.S. GAAP capital account (credited with the fair market value of contributed property or the investment) and tax capital account (credited with the investor’s tax basis). The effect of such allocations will be to either increase or decrease a unitholder’s share of depreciation, amortization and/or gain or loss on the sale of assets. |
| |
• | IRC Section 743(b) Basis Adjustments: Because we have made the election provided by IRC Section 754, we adjust each unitholder’s basis in our assets (inside basis) pursuant to IRC Section 743(b) to reflect their purchase price (outside basis). The Section 743(b) adjustment belongs to a particular unitholder and not to other unitholders. Basis adjustments such as this give rise to income and deductions by reference to the portion of each transferee unitholder’s purchase price attributable to each of our assets. The effect of such adjustments will be to either increase or decrease a unitholder’s share of depreciation, amortization and/or gain or loss on sale of assets. |
| |
• | Gross Income and Loss Allocations: To maintain the uniformity of the economic and tax characteristics of our units, we will sometimes make a special allocation of income or loss to a unitholder. Any such allocations of income or loss will decrease or increase, respectively, our distributive taxable income. |
The net tax basis in our assets and liabilities is less than the reported amounts on the financial statements by approximately $700 million as of December 31, 2017.