Note 14—Income Taxes
We are subject to U.S. federal and state income taxes on our operations.
Tax Reform Act.
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (“TCJA”). Substantially all of the provisions of the TCJA are effective for taxable years beginning after December 31, 2017. The TCJA includes significant changes to the Internal Revenue Code of 1986, as amended (“the Code”), including amendments which significantly change the taxation of business entities. The more significant changes in the TCJA that impact Dynegy are:
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• | reductions in the corporate federal income tax rate from 35 percent to 21 percent, |
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• | repeal of the corporate Alternative Minimum Tax (“AMT”) providing for refunds of excess AMT credits, |
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• | limiting the utilization of Net Operating Losses (“NOLs”) arising after December 31, 2017 to 80 percent of taxable income with an indefinite carryforward (existing NOLs can continue to be utilized at 100 percent of taxable income with a 20-year carryforward), and |
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• | limiting the deduction of net business interest expense to 30 percent of adjusted taxable income as defined in the TCJA. |
As a result of the reduction in the U.S. federal corporate tax rate, Dynegy has recorded a $394 million reduction to our net deferred tax assets, including the federal benefit of state deferred taxes, which was fully offset by a decrease in our valuation allowance for the year ended December 31, 2017. Additionally, we have recorded a $223 million current tax benefit and long term tax receivable in 2017 related to the expected refund of our existing AMT credits.
In accordance with Staff Accounting Bulletin 118, the amounts recorded in the fourth quarter of 2017 related to the TCJA represent reasonable estimates based on our analysis to date and are considered to be provisional and subject to revision during 2018. Provisional amounts were recorded for the re-measurement of our 2017 U.S. deferred taxes and ancillary state tax effects. These amounts are considered to be provisional as we continue to assess available tax methods and elections and refine our computations. Additionally, further regulatory guidance related to the TCJA is expected to be issued in 2018 which may result in changes to our current estimates.
Our losses from continuing operations before income taxes were $538 million, $1.289 billion and $427 million for the years ended December 31, 2017, 2016 and 2015, respectively, which were solely from domestic sources.
Our components of income tax benefit related to losses from continuing operations were as follows:
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| | | | | | | | | | | | |
| | Year Ended December 31, |
(amounts in millions) | | 2017 | | 2016 | | 2015 |
Current tax benefit (expense) | | $ | 233 |
| | $ | 15 |
| | $ | (3 | ) |
Deferred tax benefit | | 377 |
| | 30 |
| | 477 |
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Income tax benefit | | $ | 610 |
| | $ | 45 |
| | $ | 474 |
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Our income tax benefit related to losses from continuing operations before income taxes for each of the years ended December 31, 2017, 2016 and 2015 were equivalent to effective rates of 113 percent, 3 percent, and 111 percent, respectively. Differences between taxes computed at the U.S. federal statutory rate and our reported income tax benefit were as follows:
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| | | | | | | | | | | | |
| | Year Ended December 31, |
(amounts in millions) | | 2017 | | 2016 | | 2015 |
Expected tax benefit at U.S. statutory rate (35%) | | $ | 189 |
| | $ | 451 |
| | $ | 149 |
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State taxes | | 35 |
| | 16 |
| | 68 |
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Permanent differences (1) | | (21 | ) | | (4 | ) | | 16 |
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Non-deductible goodwill | | (10 | ) | | — |
| | — |
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Valuation allowance (2)(3) | | 879 |
| | (404 | ) | | 271 |
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NOL adjustments from use limitations | | (13 | ) | | (17 | ) | | — |
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Adjustment to AMT credits | | (17 | ) | | — |
| | (26 | ) |
Change in federal tax rate as included in TCJA | | (429 | ) | | — |
| | — |
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Other | | (3 | ) | | 3 |
| | (4 | ) |
Income tax benefit | | $ | 610 |
| | $ | 45 |
| | $ | 474 |
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__________________________________________
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(1) | Permanent items for years ended December 31, 2017, 2016 and 2015 included a benefit of less than $1 million, a benefit of $2 million, and a benefit of $18 million, respectively, for the change in the fair value of warrants during the year that were not deductible for income taxes. Income tax benefit for the years ended December 31, 2017 and 2016 includes $8 million and $5 million, respectively, of income tax expense for non-deductible fees related to the Genco Plan. Please read Note 20—Genco Chapter 11 Bankruptcy for further discussion. Income tax benefit for the year ended December 31, 2017, includes $22 million for non-deductible legal fees related to the ENGIE Acquisition. |
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(2) | The EquiPower Acquisition on April 1, 2015 caused a change in the attributes and impacted our estimate of the realizability of our deferred tax assets. As a result, we recorded a $453 million reduction to our valuation allowance in 2015 and $3 million in 2016. |
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(3) | The ENGIE Acquisition on February 7, 2017 caused a change in the attributes and impacted our estimate of the realizability of our deferred tax assets. As a result, we recorded a $354 million reduction to our valuation allowance in 2017. We also recorded a benefit for the repeal of the corporate AMT in the amount of $223 million as included in the TCJA. |
Deferred Tax Liabilities and Assets. Our significant components of deferred tax assets and liabilities were as follows:
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| | | | | | | | |
| | Year Ended December 31, |
(amounts in millions) | | 2017 | | 2016 |
Non-current deferred tax assets: | | | | |
NOL carryforwards | | $ | 1,195 |
| | $ | 1,629 |
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AMT, state, and other tax credit carryforwards | | 25 |
| | 241 |
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Reserves (legal, environmental and other) | | 4 |
| | 7 |
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Pension and other post-employment benefits | | 11 |
| | 18 |
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Asset retirement obligations | | 68 |
| | 85 |
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Deferred financing costs and intangible/other contracts | | 22 |
| | 48 |
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Derivative contracts | | 69 |
| | 57 |
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Other | | 29 |
| | 46 |
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Subtotal | | 1,423 |
| | 2,131 |
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Less: valuation allowance | | (852 | ) | | (1,704 | ) |
Total non-current deferred tax assets | | $ | 571 |
| | $ | 427 |
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Non-current deferred tax liabilities: | | | | |
Depreciation and other property differences | | $ | (560 | ) | | $ | (371 | ) |
Derivative contracts | | (7 | ) | | (44 | ) |
Other | | (11 | ) | | (17 | ) |
Total non-current deferred tax liabilities | | $ | (578 | ) | | $ | (432 | ) |
Net non-current deferred tax liabilities | | $ | (7 | ) | | $ | (5 | ) |
NOL Carryforwards. As of December 31, 2017, we had approximately $4.6 billion of NOLs and $3.6 billion of state NOLs that can be used to offset future taxable income. The federal NOLs expire beginning in 2024 through 2037. Similarly, the state NOLs will expire at various dates (based on the company’s review of the application of apportionment factors and other state tax limitations). Under federal income tax law, our NOLs can be utilized to reduce future taxable income subject to certain limitations, including if we were to undergo an ownership change as defined by Internal Revenue Code (“IRC”) Section 382. If an ownership change were to occur as a result of future transactions in our stock, our ability to utilize the NOLs may be significantly limited.
Alternative Minimum Tax Credit Carryforwards. For the years ended December 31, 2017 and 2016, the Company elected to accelerate the minimum tax credit in lieu of claiming the bonus depreciation allowance, resulting in a current Income tax benefit of $18 million and $16 million, respectively. Dynegy has recorded a $223 million tax benefit in 2017 related to the expected refund of its existing AMT Credits as provided for in the TCJA.
Change in Valuation Allowance. Realization of our deferred tax assets is dependent upon, among other things, our ability to generate taxable income of the appropriate character in the future. At December 31, 2017 and 2016, we have a valuation allowance against our net deferred assets including federal and state NOLs and AMT credit carryforwards. Additionally, at December 31, 2017 and 2016, our temporary differences were in a net deferred tax asset position. We do not believe we will produce sufficient future taxable income, nor are there tax planning strategies available, to realize the tax benefits of our net deferred tax asset associated with temporary differences. Accordingly, we have recorded a full valuation allowance against the net asset temporary differences related to federal income tax and the net asset temporary differences related to most state income tax as appropriate.
The changes in the valuation allowance were as follows:
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| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Beginning of period | | $ | 1,704 |
| | $ | 1,276 |
| | $ | 1,535 |
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Changes in valuation allowance—continuing operations: | | | | | | |
Charged to costs and expenses | | (854 | ) | | 428 |
| | (259 | ) |
Charged to other accounts | | 2 |
| | — |
| | — |
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End of period | | $ | 852 |
| | $ | 1,704 |
| | $ | 1,276 |
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Unrecognized Tax Benefits. We are complete with federal income tax audits by the Internal Revenue Service (“IRS”) through 2015 as a result of our participation in the IRS’ Compliance Assurance Process. However, any NOLs we claim in future years to reduce taxable income could be subject to additional IRS examination regardless of when the NOLs occurred. We are generally not subject to examinations for state and local taxes for tax years 2013 or earlier with few exceptions.
A reconciliation of our beginning and ending amounts of unrecognized tax benefits were as follows:
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| | | | | | | | | | | | |
| | Year Ended December 31, |
amounts in millions | | 2017 | | 2016 | | 2015 |
Unrecognized tax benefits, beginning of period | | $ | 3 |
| | $ | 3 |
| | $ | 4 |
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Increase due to ENGIE acquisition | | 63 |
| | — |
| | — |
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Decrease due to rate changes | | (26 | ) | | — |
| | — |
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Decrease due to settlements and payments | | — |
| | — |
| | (1 | ) |
Unrecognized tax benefits, end of period | | $ | 40 |
| | $ | 3 |
| | $ | 3 |
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As of December 31, 2017, approximately $3 million of unrecognized tax benefits would impact our effective tax rate if recognized.