Income Taxes
On December 22, 2017, the President of the United States signed into law the Tax Act. The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act creates limitations on interest expense deductions (if certain conditions apply) and reduces the corporate federal tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. Since the Tax Act was enacted during calendar year 2017, the Company is required to value its deferred tax assets and liabilities applying the rates prescribed by the enacted law for the period in which such deferred tax assets and liabilities are expected to reverse. SEC Staff Accounting Bulletin (“SAB”) 118 allows us to provide a provisional estimate of the impacts of the Tax Act due to the complexities involved in accounting for the enactment of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the enactment of the Tax Act to complete the accounting under ASC 740, Income Taxes. Specific impacts of the Tax Act are discussed below.
The domestic and foreign components of Income (loss) before income taxes are as follows:
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| | | | | | | | | | | |
| For the years ended |
| December 31, 2017 | | December 31, 2016 | | December 31, 2015 |
(Amounts in thousands) | | |
Domestic | $ | 30,810 |
| | $ | (45,100 | ) | | $ | (143,446 | ) |
Foreign | 2,713 |
| | 2,245 |
| | 3,981 |
|
Income (loss) before income taxes | $ | 33,523 |
| | $ | (42,855 | ) | | $ | (139,465 | ) |
The (Provision) benefit for income taxes consists of the following:
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| | | | | | | | | | | |
| For the years ended |
| December 31, 2017 | | December 31, 2016 | | December 31, 2015 |
(Amounts in thousands) | | |
Current portion: | | | | | |
Federal | $ | — |
| | $ | — |
| | $ | — |
|
State | (870 | ) | | (775 | ) | | (550 | ) |
Foreign | (16,214 | ) | | (8,424 | ) | | (7,391 | ) |
| (17,084 | ) | | (9,199 | ) | | (7,941 | ) |
Deferred portion: | | | | | |
Federal | 15,063 |
| | 163 |
| | 16,024 |
|
State | 292 |
| | 37 |
| | 388 |
|
Foreign | 7 |
| | (1,139 | ) | | 201 |
|
| 15,362 |
| | (939 | ) | | 16,613 |
|
(Provision) benefit for income taxes | $ | (1,722 | ) | | $ | (10,138 | ) | | $ | 8,672 |
|
Temporary differences, which give rise to deferred tax assets and liabilities, were as follows:
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| | | | | | | |
| As of |
| December 31, 2017 | | December 31, 2016 |
(Amounts in thousands) | |
Deferred tax assets related to: | | | |
Workers' compensation accrual | $ | 2,276 |
| | $ | 5,007 |
|
Accrued vacation | 2,447 |
| | 3,780 |
|
Completion bonus allowance | 3,933 |
| | 6,260 |
|
Accrued severance | 109 |
| | 354 |
|
Accrued executive incentives | 5,475 |
| | 8,396 |
|
Legal reserve | 2,075 |
| | 1,645 |
|
Allowance for doubtful accounts | 3,223 |
| | 8,366 |
|
Accrued health costs | 2,398 |
| | 3,414 |
|
Contract loss reserve | 3,055 |
| | 5,083 |
|
Other accrued liabilities and reserves | 6,041 |
| | 6,619 |
|
Partnership / joint venture basis differences | 1,994 |
| | 3,629 |
|
Foreign tax credit carryforward | 45,426 |
| | 30,495 |
|
Net operating loss carryforward | 6,387 |
| | 4,222 |
|
Other carryforwards | 2,156 |
| | 1,393 |
|
Uncertain tax positions | 751 |
| | 943 |
|
Goodwill and other intangible assets | 14,451 |
| | 52,477 |
|
Valuation allowance | (66,618 | ) | | (88,806 | ) |
Total deferred tax assets | 35,579 |
| | 53,277 |
|
Deferred tax liabilities related to: | | | |
Prepaid insurance | (4,846 | ) | | (6,865 | ) |
Indefinite lived intangibles | — |
| | (15,473 | ) |
Unbilled receivables | (30,364 | ) | | (45,764 | ) |
Total deferred tax liabilities | (35,210 | ) | | (68,102 | ) |
| | | |
Total deferred tax assets (liabilities), net | $ | 369 |
| | $ | (14,825 | ) |
Non-current deferred tax assets, net, was $0.4 million and non-current deferred tax liabilities, net, was $14.8 million as of December 31, 2017 and December 31, 2016, respectively.
As a result of the Tax Act, deferred tax assets, net, were reduced by $10.3 million with an equal and corresponding adjustment to the valuation allowance. Due to provisions within the Tax Act, the Company believes that it is more likely than not that the Company will create future offsetting indefinite lived deferred tax assets principally related to the carryover of non-deductible interest. Therefore, the Company has considered its indefinite lived deferred tax liability as a source of future taxable income, which resulted in the Company releasing $15.5 million of valuation allowance, of which $15.5 million adjusted the total provision for income taxes for the year ended December 31, 2017. The Company has assessed the valuation allowance implications of U.S. Tax Reform. Due to the uncertainties between the valuation allowance and future deferred tax assets and liabilities as of December 31, 2017, the Company included provisional estimates of the income tax effects of the Tax Act.
Management assesses both the available positive and negative evidence to determine whether it is more likely than not that there will be sufficient sources of future taxable income to recognize deferred tax assets. The Company must also assess whether its valuation allowance analyses are affected by the Tax Act. The following items impacted the valuation allowance due to the enacted Tax Act:
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• | A reduction in deductible interest expense for federal income tax purposes which will create an indefinite lived asset; |
| |
• | The prevention of deferring revenue with respect to unbilled receivables; and |
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• | The recognition of revenue it had previously deferred as unbilled receivables over a four-year period pursuant to Internal Revenue Code ("IRC") Section 481. |
While we anticipate that the Tax Act will result in the Company enhancing its ability to recognize existing deferred tax assets in the future, the Company also anticipates that the Tax Act will create new deferred tax assets that will be subject to future valuation allowance. As such, the Company will remain in a valuation allowance on most domestic deferred tax assets for the period ended December 31, 2017 but will assess the need for valuation allowance each period.
We adopted ASU 2015-17, Balance Sheet Classification of Deferred Taxes, during the year ended December 31, 2016 which eliminates the current requirement to present deferred tax liabilities and assets as current and noncurrent amounts in a classified statement of financial position and requires us to classify all deferred tax assets and liabilities as noncurrent in a statement of financial position. We applied ASU 2015-17 prospectively and prior periods were not retroactively adjusted.
As of December 31, 2017, we had $20.5 million of U.S. federal net operating losses available for use compared to $9.1 million U.S. federal net operating losses available for use as of December 31, 2016. Pursuant to the Tax Act, federal net operating losses created on or after January 1, 2018 have an infinite life (no carryover limit). The federal net operating losses discussed above were created prior to January 1, 2018 and have a 20-year carryforward limit. We anticipate using most, if not all of our federal net operating losses, in calendar year 2018. As of December 31, 2017 and December 31, 2016, we had state net operating losses of approximately $141.0 million and $131.0 million, respectively, most of which will begin to expire in 2020 or later. State net operating losses carryforward limits may change as a result of the Tax Act and the Company will stay alert to those changes. We had approximately $45.4 million and $30.5 million as of December 31, 2017 and December 31, 2016, respectively, in foreign tax credit carryforwards ("FTCs") which have begun to expire. Additionally, we made no estimated federal income tax payments nor have we received any federal income tax refunds for the year ended December 31, 2017. All income taxes paid or refunds received during the year ended December 31, 2017 related to state or foreign jurisdictions.
A reconciliation of the statutory federal income tax rate to our effective rate is provided below:
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| | | | | | | | |
| For the years ended |
| December 31, 2017 | | December 31, 2016 | | December 31, 2015 |
| | |
Statutory rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State income tax, less effect of federal deduction | 1.7 | % | | (1.7 | )% | | (0.1 | )% |
Noncontrolling interests | (1.3 | )% | | 0.9 | % | | 0.5 | % |
Goodwill impairment (1) | — | % | | — | % | | (11.6 | )% |
Nondeductible meals and entertainment | 2.4 | % | | (2.2 | )% | | (0.7 | )% |
Nondeductible expenses | 2.9 | % | | (2.7 | )% | | (0.2 | )% |
Impact of Tax Act | 30.7 | % | | — | % | | — | % |
Valuation allowance | (68.1 | )% | | (52.9 | )% | | (16.7 | )% |
Other | 1.8 | % | | (0.1 | )% | | — | % |
Effective tax rate | 5.1 | % | | (23.7 | )% | | 6.2 | % |
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(1) | Includes non-cash impairment charges to goodwill for the year ended December 31, 2015. |
Due to the nature of our business, as a provider of professional and technical government services to the U.S. government, foreign earnings are generally exempt from foreign tax due to various bi-lateral agreements often referred to as Status of Forces Agreements ("SOFA") and Status of Mission Agreements ("SOMA") or their equivalents. We repatriate and provide U.S. income taxes on virtually all income we earn outside of the United States.
We file income tax returns in U.S. federal and state jurisdictions and in various foreign jurisdictions which are subject to examinations by the IRS and other taxing authorities. These audits can result in adjustments of taxes due. Our estimate of the potential outcome of any uncertain tax issue prior to audit is subject to management's assessment of relevant risks, facts, and circumstances existing at that time. An unfavorable result under audit may reduce the amount of state net operating losses we have available for carryforward to offset future taxable income, or may increase the amount of tax due for the period under audit, resulting in an increase to the effective rate in the year of resolution. The statute of limitations is open for U.S. federal income tax returns for our fiscal year 2014 forward. The statute of limitations for state income tax returns is open for our fiscal year 2014 forward, with few exceptions, and the statute of limitations for foreign income tax examinations is open for calendar year 2012 forward, with few exceptions.
Uncertain Tax Positions
We account for uncertain tax positions in accordance with ASC 740 - Income Taxes, which prescribes the more likely than not threshold for recognition of a tax position in the financial statements. The amount of unrecognized tax benefits at December 31, 2017 and December 31, 2016 was $2.8 million and $2.6 million, respectively, of which $2.7 million and $2.3 million, respectively, would impact our effective tax rate if recognized. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
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| | | |
(Amounts in thousands) | Unrecognized Tax Benefits |
Balance at December 31, 2015 | $ | 2,634 |
|
Additions for tax positions related to prior years | — |
|
Reductions for tax positions of prior years | — |
|
Settlements | — |
|
Remeasurements | — |
|
Net releases | — |
|
Lapse of statute of limitations | — |
|
Balance at December 31, 2016 | $ | 2,634 |
|
Additions for tax positions related to prior years | 158 |
|
Reductions for tax positions of prior years | — |
|
Settlements | — |
|
Remeasurements | — |
|
Net releases | — |
|
Lapse of statute of limitations | — |
|
Balance at December 31, 2017 | $ | 2,792 |
|
We recognize interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included on the related tax liability line in the consolidated balance sheet. For the years ended December 31, 2017 and December 31, 2016, there was no accrued interest related to unrecognized tax benefits in interest expense and no penalties recognized in the provision for income taxes within our consolidated statements of operations. We do not expect the unrecognized tax benefit of $3.5 million, inclusive of penalties, as of December 31, 2017 to be settled within the next 12 months. In addition to the above, the Company established a reserve during the year ended December 31, 2017 related to uncertain tax positions in the deferred tax accounts, offsetting the FTC, by $0.8 million.