Income Taxes
On December 22, President Trump signed into law the Tax Act that significantly reforms the U.S. tax code. The provisions of the Tax Act that impact us include, but are not limited to: (i) a permanent reduction of the corporate income tax rate from 35% to 21%, (ii) a limitation of the deduction for certain net operating losses to 80% of the current year taxable income, (iii) an elimination of net operating loss carryback coupled with an indefinite net operating loss carryforward, (iv) a partial limitation on the deductibility of business interest expense, and (v) immediate deductions for certain new investments.
In response to the Tax Act, the SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC Topic 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC Topic 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC Topic 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
Our accounting for the following elements of the Tax Act is incomplete. However, we were able to make reasonable estimates of certain effects and, therefore, recorded provisional adjustments as follows:
Reduction of US Federal Corporate Tax Rate: The Tax Act reduces the corporate tax rate to 21%, effective January 1, 2018. In connection with the re-measurement of deferred taxes to the 21% tax rate, we have recorded a provisional increase of $19.8 million to deferred tax expense for the year ended December 31, 2017. There was no earnings impact for the revaluation of our domestic deferred tax assets, which include our net operating losses, as they continue to be fully reserved. While we are able to make a reasonable estimate of the impact of the reduction in corporate rate, it may be affected by other analyses related to the Tax Act, including, but not limited to, changes to our cost recovery assumptions and the state tax effect of adjustments to federal temporary differences.
Net Operating Loss Utilization: With respect to net operating losses generated after 2017, the Tax Act eliminated carrybacks, provided an indefinite carryforward period, and lowered the maximum deduction to 80% of corporate taxable income. On a provisional basis we have determined that there is no impact to the valuation allowance for changes to the net operating loss standards under the Tax Act
Immediate Expensing of Certain Investments: The Tax Act provides accelerated expensing of certain assets placed in service after September 27, 2017. For the first five years (through 2022), the provision allows for 100% immediate expensing of qualified property. Thereafter, accelerated depreciation will be reduced over each of the next four years (through 2026). We have not yet completely inventoried and analyzed our 2017 capital expenditures that qualify for bonus expensing. We have recorded a provisional tax depreciation expense of $14.0 million which does not include full expensing of all qualifying capital expenditures.
Prior to July 31, 2017, the Predecessor was a limited liability corporation treated as a partnership for federal and state income tax purposes, in which the taxable income tax or loss of the Predecessor were passed through to its unitholders. Limited liability companies are subject to Texas margin tax. In addition, certain of the Predecessor’s subsidiaries were C corporations subject to federal and state income taxes. Therefore, with the exception of the state of Texas and certain subsidiaries, the Predecessor did not directly pay federal and state income taxes and recognition was not given to federal and state income taxes for the operations of the Predecessor. Tax benefits of $0.5 million, $1.3 million, and $0.3 million are included in our Consolidated Statements of Operations for the seven months ended July 31, 2017 (Predecessor) and the years ended December 31, 2016, and 2015 (Predecessor), respectively, as a component of Selling, general and administrative expenses.
The deferred tax effects of the Company’s transition to a C corporation are included in the period ended July 31, 2017. Since the Company’s net deferred tax asset as of July 31, 2017 was fully reserved, there was no impact to the consolidated financial statements.
A reconciliation of the federal statutory tax rate to the effective tax rate is as follows:
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| | |
| Successor |
| Five Months Ended December 31, 2017 |
Federal statutory rate | 35.0 | % |
Permanent items | (2.0 | )% |
Federal statutory rate change | (17.8 | )% |
State, net of federal tax benefit | 3.0 | % |
Valuation allowance adjustments | (18.2 | )% |
Effective rate | — | % |
Deferred income tax balances representing the tax effect of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities are as follows:
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| | | |
| Successor |
| December 31, 2017 |
Deferred tax assets: | |
Net operating loss carryforwards | $ | 2,957 |
|
Asset retirement obligation | 39,084 |
|
Derivative instruments | 7,655 |
|
Accrued Liabilities | 6,681 |
|
Bad debts | 1,489 |
|
Investment in subsidiaries | 4,827 |
|
Other | 31 |
|
Valuation allowance | (35,447 | ) |
Total deferred tax assets | 27,277 |
|
Deferred tax liabilities: | |
Oil & natural gas property | (27,277 | ) |
Total deferred tax liabilities | (27,277 | ) |
Net deferred tax assets (liabilities) | $ | — |
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At December 31, 2017, the Company has U.S. domestic net operating loss carry forwards of approximately $6.6 million which will begin to expire in varying amounts beginning in 2035 and state net operating loss carry forwards of approximately $6.6 million which will expire in varying amounts beginning in 2023.
In assessing the realizability of net 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 deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2017, based upon the projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is not more likely than not that the Company will realize the benefits of these deductible differences.
In accordance with the applicable accounting standards, the Company recognizes only the impact of income tax positions that, based on their merits, are more likely than not to be sustained upon audit by a taxing authority. To evaluate its current tax positions in order to identify any material uncertain tax positions, the Company developed a policy of identifying and evaluating uncertain tax positions that considers support for each tax position, industry standards, tax return disclosures and schedules and the significance of each position. It is the Company’s policy to recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense. The Company had no material uncertain tax positions at December 31, 2017. The tax year 2017 remains open to examination for federal and state income tax purposes.