15. Income Taxes
Tax Cuts and Jobs Act
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act, which significantly reforms the Code. The TCJA, among other things, contains significant changes to corporate taxation including (i) a permanent reduction of the corporate income tax rate from 35% to 21%, (ii) a partial limitation on the deductibility of business interest expense, (iii) a limitation of the deduction for certain net operating losses to 80% of current year taxable income, (iv) an indefinite net operating loss carryforward, (v) immediate deductions for certain new investments instead of deductions for depreciation expense over time, (vi) the cessation of like-kind exchange treatment for exchanges of tangible personal property and (vii) the modification or repeal of many business deductions and credits.
The SEC staff issued guidance on accounting for the tax effects of the TCJA that provides a measurement period for companies to complete its accounting for income taxes that should not extend beyond one year from the TCJA’s enactment date. As of December 31, 2017, we have not finalized our accounting for the tax effects of the TCJA; however, in accordance with the SEC staff guidance, because we were able to determine a reasonable estimate, we recorded a provisional estimate in our financial statements as described below.
In connection with our initial analysis of the TCJA, we remeasured our deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future. However, we are still analyzing certain aspects of the TCJA and refining our calculations, which could potentially affect the provisional measurement of these balances. We anticipate completion of our 2017 income tax returns by the third quarter of 2018. Future guidance and additional information and interpretations with respect to the TCJA could impact the provisional amounts we have recorded.
Based on our current estimates, the provisional amount recorded at December 31, 2017 resulted in a $53.4 million tax benefit to our provision for income taxes in our consolidated statement of operations. This amount consisted of a $57.7 million tax benefit due to reducing our continuing operations net deferred tax liability, a $4.6 million tax detriment due to reducing our discontinued operations deferred tax asset and a $0.3 million tax benefit due to reducing our other comprehensive income net deferred tax liability.
Current and Deferred Tax Provision
The provision for (benefit from) income taxes consisted of the following (in thousands):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 |
| 2016 |
| 2015 |
Current tax provision (benefit): | |
| | |
| | |
|
U.S. federal | $ | (1,495 | ) | | $ | — |
| | $ | 556 |
|
State | 172 |
| | 352 |
| | 1,415 |
|
Total current | $ | (1,323 | ) | | $ | 352 |
| | $ | 1,971 |
|
Deferred tax provision (benefit): | |
| | |
| | |
|
U.S. federal | $ | (67,443 | ) | | $ | (21,287 | ) | | $ | 48,450 |
|
State | 7,683 |
| | (3,669 | ) | | 2,768 |
|
Total deferred | (59,760 | ) | | (24,956 | ) | | 51,218 |
|
Provision for (benefit from) income taxes | $ | (61,083 | ) | | $ | (24,604 | ) | | $ | 53,189 |
|
The provision for (benefit from) income taxes for the years ended December 31, 2017, 2016 and 2015 resulted in effective tax rates on continuing operations of 143.3%, 27.5% and (50.1)%, respectively. The following table reconciles these effective tax rates to the U.S. statutory rate of 35%, the rate in effect during these years (in thousands):
|
| | | | | | | | | | | | |
| Year Ended December 31, | |
| 2017 |
| 2016 |
| 2015 | |
Income taxes at U.S. federal statutory rate of 35% | $ | (14,917 | ) | | $ | (31,297 | ) | | $ | (37,165 | ) | |
Net state income taxes | (4,693 | ) | (1) | 416 |
| | 2,383 |
| |
Tax Cuts and Jobs Act | (53,442 | ) | (2) | — |
| | — |
| |
Noncontrolling interest | (1,091 | ) | | 3,204 |
| | (2,904 | ) | |
Unrecognized tax benefits | 9,566 |
| (3) | (2,078 | ) | | 698 |
| |
Valuation allowances and write off of tax attributes | 247 |
| | 85 |
| | 88,088 |
| (4) |
Indemnification revenue / expense | 692 |
| | 3,006 |
| | 77 |
| |
Executive compensation limitation | 2,433 |
| | 856 |
| | 872 |
| |
Stock | (858 | ) | (5) | — |
| | — |
| |
Other | 980 |
| | 1,204 |
| | 1,140 |
| |
Provision for (benefit from) income taxes | $ | (61,083 | ) | | $ | (24,604 | ) | | $ | 53,189 |
| |
| |
(1) | Includes a deferred state release, net of federal benefit, of $3.7 million due to the remeasurement of our uncertain tax benefits. |
| |
(2) | See “Tax Cuts and Jobs Act” above for further details. |
| |
(3) | Reflects an increase in our uncertain tax benefit, net of federal benefit, due to appellate court decisions in 2017 which required us to remeasure certain of our uncertain tax positions. |
| |
(4) | Reflects the tax impact of the unrealizability of tax attributes allocated to Exterran Corporation. At the time of the Spin-off we had $144.3 million in foreign tax credit deferred tax assets. These deferred tax assets related to foreign tax credits that can be used to reduce income taxes payable in future years. They will expire if they are not used within the 10-year carryforward period. As a result of the Spin-off it was projected that these foreign tax credits allocated to Exterran Corporation would expire unused because Exterran Corporation would not generate sufficient taxable income and foreign source taxable income after the Spin-off to utilize these credits. Consequently, in the fourth quarter of 2015, we wrote off foreign tax credits for the years 2005-2010 in the amount of $48.2 million and recorded a valuation allowance for the years 2011-2015 of $37.8 million for a total impact to our fourth quarter 2015 tax provision of $86.0 million. The credits and offsetting valuation allowance were allocated to Exterran Corporation for their use in future tax returns. |
| |
(5) | Reflects the impact of adopting the new share-based compensation accounting standard. See Note 2 (“Recent Accounting Developments”) for further details. |
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 gave rise to deferred tax assets and deferred tax liabilities were as follows (in thousands):
|
| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Deferred tax assets: | |
| | |
|
Net operating loss carryforwards | $ | 53,950 |
| | $ | 48,949 |
|
Alternative minimum tax credit carryforwards | — |
| | 1,496 |
|
Accrued liabilities | 6,407 |
| | 9,688 |
|
Other | 5,181 |
| | 5,005 |
|
| 65,538 |
| | 65,138 |
|
Valuation allowances | (300 | ) | | (633 | ) |
Total deferred tax assets | $ | 65,238 |
| | $ | 64,505 |
|
| | | |
Deferred tax liabilities: | |
| | |
|
Property, plant and equipment | $ | (17,999 | ) | | $ | (28,037 | ) |
Basis difference in the Partnership | (143,322 | ) | | (199,417 | ) |
Other | (1,860 | ) | | (4,165 | ) |
Total deferred tax liabilities | (163,181 | ) | | (231,619 | ) |
Net deferred tax liabilities | $ | (97,943 | ) | | $ | (167,114 | ) |
Tax balances are presented in the accompanying consolidated balance sheets as deferred income taxes. The 2016 balances are based on a U.S. federal tax rate of 35% as compared to a rate of 21% for the 2017 balances.
Tax Attributes and Valuation Allowances
Pursuant to Sections 382 and 383 of the Code, utilization of loss carryforwards and alternative minimum tax credits, are subject to annual limitations due to any ownership changes of 5% owners. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. The Hanover/Universal merger in 2007 resulted in such an ownership change but the Spin-off in 2015 did not result in such an ownership change for Archrock. Our ability to utilize loss carryforwards and credit carryforwards against future U.S. federal taxable income and future U.S. federal income tax may be limited in the future if we have another 50% or more ownership change in our 5% shareholders. The limitations may cause us to pay U.S. federal income taxes earlier; however, we do not currently expect that any loss carryforwards or credit carryforwards will expire as a result of any 382 or 383 limitations.
We record valuation allowances when it is more likely than not that some portion or all of our deferred tax assets will not be realized. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character and in the appropriate taxing jurisdictions in the future. If we do not meet our expectations with respect to taxable income, we may not realize the full benefit from our deferred tax assets which would require us to record a valuation allowance in our tax provision in future years.
At December 31, 2017, we had U.S. federal and state NOL carryforwards of $233.3 million and $97.7 million, respectively, included in our NOL deferred tax asset that are available to offset future taxable income. If not used, the federal and state carryforwards will begin to expire in 2025 and 2020, respectively. In connection with the state NOL deferred tax asset we recorded a valuation allowance of $0.3 million as of December 31, 2017.
Stock
Employee share-based compensation attributable to the exercise of stock options and vesting of restricted stock is deductible by us for tax purposes.
Prior to the adoption of Update 2016-09
For post-2005 tax years, to the extent the tax stock deductions exceeded the previously accrued deferred tax benefit for these items the additional tax benefit was not recognized until the deduction reduced current taxes payable. For pre-2006 tax years, the additional tax benefit was included in our NOL deferred tax asset with a corresponding valuation allowance negating the benefit. At December 31, 2016, the post-2005 tax benefit not included in our NOL deferred tax asset was $0.6 million and the pre-2006 tax benefit included in our NOL deferred tax asset with an offsetting valuation allowance was $0.6 million.
Subsequent to the adoption of Update 2016-09
The additional tax benefit associated with tax stock deductions that exceeds the previously accrued deferred tax benefit is recognized discretely in the period it occurs regardless of its impact on current taxes payable. Upon the adoption of Update 2016-09, we recognized the $0.6 million post-2005 tax benefit in our NOL deferred tax asset and released the valuation allowance on our pre-2006 tax benefit. The tax impact of both adjustments, as well as the forfeiture modifications, was reported as a $1.2 million cumulative effect adjustment to retained earnings. See Note 2 (“Recent Accounting Developments) for further details.
Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of unrecognized tax benefits (including discontinued operations) is shown below (in thousands):\
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Beginning balance | $ | 9,665 |
| | $ | 11,998 |
| | $ | 14,595 |
|
Additions based on tax positions related to current year | 2,002 |
| | 271 |
| | 845 |
|
Additions based on tax positions related to prior years | 9,887 |
| | 862 |
| | 3,648 |
|
Reductions based on settlement with government authority | (154 | ) | | (3,466 | ) | | — |
|
Reductions based on tax positions related to prior years | — |
| | — |
| | (592 | ) |
Reductions based on tax positions transferred to Exterran Corporation | — |
| | — |
| | (6,498 | ) |
Ending balance | $ | 21,400 |
| | $ | 9,665 |
| | $ | 11,998 |
|
Appellate court decisions during the year ended December 31, 2017 required us to remeasure certain of our uncertain tax positions and increase our unrecognized tax benefit for these positions. We had $21.4 million, $9.7 million and $12.0 million of unrecognized tax benefits at December 31, 2017, 2016 and 2015, respectively, of which $16.1 million, $9.7 million and $12.0 million, respectively, would affect the effective tax rate if recognized (except for amounts that would be reflected in income from discontinued operations, net of tax). Our income tax provision also reflects a federal benefit on the state portion of our unrecognized tax benefits of $1.8 million, $1.1 million and $0.3 million as of December 31, 2017, 2016 and 2015, respectively. The 2017 federal benefit includes a $1.7 million cumulative reduction due to the change in the corporate tax rate from the TCJA.
We recorded $1.6 million, $0.2 million and $0.2 million of potential interest expense and penalties related to unrecognized tax benefits associated with uncertain tax positions (including discontinued operations) in our consolidated balance sheets as of December 31, 2017, 2016 and 2015, respectively. 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 2015, we recorded $1.4 million and $0.1 million of potential interest expense and penalties in our consolidated statements of operations. We recorded an immaterial amount of potential interest expense and penalties related to unrecognized tax benefits associated with uncertain tax positions in our consolidated statement of operation during the year ended December 31, 2016.
Subject to the provisions of the tax matters agreement between Exterran Corporation and us, both parties agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. As of December 31, 2017 and 2016, we recorded a $6.4 million and $6.6 million indemnification asset (including penalties and interest), respectively, related to unrecognized tax benefits.
We and our subsidiaries file consolidated and separate income tax returns in the U.S. federal jurisdiction and in numerous state jurisdictions. Due to our NOL carryforwards, we are subject to U.S. federal income tax examinations for tax years beginning from 1997 onward. During the second quarter of 2017, the IRS commenced an examination of our U.S. federal income tax return for the 2014 tax year. Due to this audit being related to a tax period prior to the Spin-off, Exterran Corporation is also involved in this audit. We do not expect any tax adjustments from this audit to have a material impact on our consolidated financial position or consolidated results of operations.
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 remains 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 $5.6 million and a reduction of $3.5 million of previously accrued uncertain tax benefits. As of December 31, 2017, we did not have any state audits underway that we believe would have a material impact on our consolidated financial position or consolidated results of operations.
We do not believe any of our unrecognized tax benefits will be reduced before the year ended December 31, 2018 due to the settlement of audits and the expiration of statutes of limitations. However, due to the uncertain and complex application of tax regulations, it is possible that the ultimate resolution of these matters may result in liabilities which could materially differ from these estimates.