Income Taxes
On December 22, 2017 (the "Enactment Date"), the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act makes broad and complex changes to the U.S. tax code and key provisions applicable to the Company, or certain of Tinuum Group's existing or potential customers, for 2018 include the following: (1) reduction of the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) elimination of the corporate alternative minimum tax (AMT); (3) a new limitation on deductible interest expense; (4) limitations on the deductibility of certain executive compensation; (5) limitations on the use of federal tax credits ("FTCs") to reduce the U.S. income tax liability; (6) limitations on net operating losses (“NOL’s”) generated after December 31, 2017, to 80 percent of taxable income; and the introduction of the Base Erosion Anti-Abuse Tax (“BEAT”) for tax years beginning after December 31, 2017.
Concurrent with the enactment of the Tax Act, in December 2017, the SEC staff issued Staff Accounting Bulletin 118 ("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 Enactment Date for companies to complete the accounting under Accounting Standards Codification 740 - Income Taxes ("ASC 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 740 is complete. To the extent that an entity'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 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
The Company's accounting for the income tax effects of the Tax Act affecting its consolidated financial statements as of December 31, 2017 is generally complete, subject to continued evaluation under SAB 118, and as such, the Company recorded an adjustment to its recorded deferred tax assets and deferred tax liabilities as of the Enactment Date from 35 percent to 21 percent. Accordingly, the Company has recorded a reduction of $5.8 million to its net deferred tax asset as of December 22, 2017 with a corresponding entry to deferred tax expense for the year ended December 31, 2017 for those temporary differences expected to reverse after the Enactment Date. The Company does not anticipate any other accounting impacts of the Tax Act during the period within one year from the Enactment Date however, it will continue to assess any potential impact from the Tax Act through this period.
The provision for income taxes consists of the following: |
| | | | | | | | | | | | |
| | Years Ended December 31, |
(in thousands, except for rate) | | 2017 | | 2016 | | 2015 |
Current portion of income tax expense: | | | | | | |
Federal | | $ | 519 |
| | $ | — |
| | $ | — |
|
State | | 894 |
| | 458 |
| | 20 |
|
| | 1,413 |
| | 458 |
| | 20 |
|
Deferred portion of income tax (benefit) expense: | | | | | | |
Federal | | 23,003 |
| | (61,396 | ) | | — |
|
State | | (264 | ) | | — |
| | — |
|
| | 22,739 |
| | (61,396 | ) | | — |
|
Total income tax (benefit) expense | | $ | 24,152 |
| | $ | (60,938 | ) | | $ | 20 |
|
Effective tax rate | | 46 | % | | (166 | )% | | — | % |
A reconciliation of expected federal income taxes on income from operations at statutory rates with the expense (benefit) for income taxes is as follows: |
| | | | | | | | | | | | |
| | Years Ended December 31, |
(in thousands) | | 2017 | | 2016 | | 2015 |
Federal statutory rate | | $ | 18,209 |
| | $ | 12,859 |
| | $ | (10,542 | ) |
State income taxes, net of federal benefit | | 1,721 |
| | 987 |
| | (781 | ) |
Permanent differences | | 777 |
| | 84 |
| | 35 |
|
Tax credits | | (1,949 | ) | | (2,419 | ) | | (38,998 | ) |
Valuation allowances | | (474 | ) | | (72,359 | ) | | 50,066 |
|
Changes in tax rates | | 5,818 |
| | (125 | ) | | (243 | ) |
Stock-based compensation | | 303 |
| | 36 |
| | 487 |
|
Other | | (253 | ) | | (1 | ) | | (4 | ) |
Expense (benefit) for the provision for income taxes | | $ | 24,152 |
| | $ | (60,938 | ) | | $ | 20 |
|
Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the accompanying Consolidated Balance Sheets. These temporary differences result in taxable or deductible amounts in future years. Details of the Company’s deferred tax assets and liabilities are summarized as follows:
|
| | | | | | | | |
| | As of December 31, |
(in thousands) | | 2017 | | 2016 |
Deferred tax assets | | | | |
Tax credits | | $ | 100,367 |
| | $ | 99,903 |
|
Deferred revenues and loss contract provisions | | 906 |
| | 268 |
|
Employee related liabilities | | 393 |
| | 3,796 |
|
Intangible assets | | 914 |
| | 1,518 |
|
Equity method investments | | 8,457 |
| | 12,326 |
|
Net operating loss carryforwards | | 2,004 |
| | 13,341 |
|
Settlement and Royalty Indemnification | | — |
| | 4,264 |
|
Other investments | | 563 |
| | 680 |
|
Other | | 648 |
| | 1,429 |
|
Total deferred tax assets | | 114,252 |
| | 137,525 |
|
Less valuation allowance | | (75,436 | ) | | (75,910 | ) |
Deferred tax assets | | 38,816 |
| | 61,615 |
|
Less: Deferred tax liabilities | | | | |
Property and equipment and other | | (155 | ) | | (219 | ) |
Total deferred tax liabilities | | (155 | ) | | (219 | ) |
Net deferred tax assets | | $ | 38,661 |
| | $ | 61,396 |
|
For 2017, the Company recorded an income tax expense of $24.2 million compared to an income tax benefit of $60.9 million for 2016. The income tax expense for the year ended December 31, 2017 was primarily related to federal and state taxes of $19.9 million, plus the aforementioned adjustment related to the Tax Act, which increased the Company's income tax expense by $5.8 million. The income tax benefit for the year ended December 31, 2016 was primarily due to reversals of the valuation allowance of the Company’s net deferred tax assets of $61.4 million.
Accounting for income taxes requires that companies assess whether a valuation allowance should be recorded against their deferred tax asset based on an assessment of the amount of the deferred tax asset that is “more likely than not” to be realized. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized.
The Company assesses the valuation allowance recorded against deferred tax assets at each reporting date. The determination of whether a valuation allowance for deferred tax assets is appropriate requires the evaluation of positive and negative evidence that can be objectively verified. Consideration must be given to all sources of taxable income available to realize the deferred tax asset, including, as applicable, the future reversal of existing temporary differences, future taxable income forecasts exclusive of the reversal of temporary differences and carryforwards, taxable income in carryback years and tax planning strategies. In estimating taxes, the Company assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial, and regulatory guidance.
As of December 31, 2017, the Company concluded it is more likely than not the Company will generate sufficient taxable income within the applicable NOL and tax credit carry-forward periods to realize $38.7 million of its net deferred tax assets, and therefore, reversed $0.5 million of the valuation allowance. In reaching this conclusion, the Company most significantly considered: (1) forecasts of continued future taxable income, (2) changes to the current DTA balances related to the effects of the Tax Act, (3) changes to forecasts of future utilization of DTA's related to the effects of the Tax Act, and (4) impacts of additional RC invested facilities during 2017.
Prior to 2016, the Company had recorded a valuation allowance for all of its deferred tax assets, primarily due to its historical three-year cumulative loss position. However, as of December 31, 2016, the Company concluded it was more likely than not the Company would generate sufficient taxable income within the applicable NOL and tax credit carry-forward periods to realize $61.4 million of its net deferred tax assets, and therefore, reversed $61.4 million of the valuation allowance, after utilizing $11.0 million during 2016. This conclusion was reached after weighing all of the evidence and determining that the positive evidence outweighed the negative evidence. The positive evidence considered by management in arriving at its conclusion to partially reverse the valuation allowance includes factors such as: (1) emergence from the previous three-year cumulative loss position during the fourth quarter of 2016, (2) completion of four consecutive quarters of profitability and (3) forecasts of continued future profitability.
The following table presents the approximate amount of state net operating loss carryforwards and federal tax credit carryforwards available to reduce future taxable income, along with the respective range of years that the net operating loss and tax credit carryforwards would expire if not utilized: |
| | | | | | | | |
| | As of December 31, |
(in thousands) | | 2017 | | Beginning expiration year | | Ending expiration year |
State net operating loss carryforwards | | $ | 41,071 |
| | 2021 | | 2037 |
Federal tax credit carryforwards | | $ | 100,367 |
| | 2031 | | 2037 |
The following table sets forth a reconciliation of the beginning and ending unrecognized tax benefits on a gross basis for the years ended December 31, 2017, 2016 and 2015:
|
| | | | | | | | | | | | |
| | Years Ended December 31, |
(in thousands) | | 2017 | | 2016 | | 2015 |
Balance as of January 1 | | $ | 54 |
| | $ | — |
| | $ | — |
|
Increases for tax positions of current year | | — |
| | 54 |
| | — |
|
Balance as of December 31 | | $ | 54 |
| | $ | 54 |
| | $ | — |
|
The Company did not record any adjustments or recognize interest expense for uncertain tax positions for the years ended December 31, 2017, 2016 and 2015. Interest and penalties related to uncertain tax positions are accrued and included in the Interest expense line item in the Consolidated Statements of Operations. Additionally, the Company recognizes interest expense related to tax treatment of RC facilities at Tinuum Group in the Interest expense line item in the Consolidated Statements of Operations. Additional information related to these interest amounts is included in Note 10.
The Company files income tax returns in the U.S. and in various states. The Company is no longer subject to U.S. federal examinations by tax authorities for years before 2014. The Company is generally no longer subject to state examinations by tax authorities for years before 2013