Artisan Partners Asset Management Inc.

Note 10. Income Taxes and Related Payments

APAM is subject to U.S. federal, state and local income taxation on APAM’s allocable portion of Holdings’ income, as well as foreign income taxes payable by Holdings’ subsidiaries. Components of the provision for income taxes consist of the following:



	For the Years Ended December 31,
	2017			2016		2015
Current:
Federal	$	21,960		$	14,704	$	26,090
State and local	2,663			2,180		3,560
Foreign	469			639		600
Total	25,092			17,523		30,250
Deferred:
Federal	396,502			32,124		22,916
State and local	(1,086		)	1,836		(6,395		)
Total	395,416			33,960		16,521
Income tax expense	$	420,508		$	51,483	$	46,771

The provision for income taxes differs from the amount of income tax computed by applying the applicable U.S. statutory federal income tax rate to income before provision for income taxes as follows:



	Years Ended December 31,
	2017		2016		2015
U.S. federal statutory rate	35.0	%	35.0	%	35.0	%
Non-deductible share-based compensation	0.5		2.4		2.9
Rate benefit from the flow through entity	(6.2	)	(15.7	)	(17.7	)
Tax Reform - change in federal corporate tax rate	43.9		—		—
Change in deferred state tax rate	—		—		(3.0	)
Other	0.4		1.2		0.9
Effective tax rate	73.6	%	22.9	%	18.1	%

The effective tax rate includes a rate benefit attributable to the fact that, for the years ended December 31, 2017, 2016 and 2015, approximately 38%, 47% and 50%, respectively, of Artisan Partners Holdings’ taxable earnings were attributable to other partners and not subject to corporate-level taxes. The Tax Cuts and Jobs Act (“Tax Reform”) was enacted in December 2017. As a result of Tax Reform, existing deferred tax assets were remeasured to reflect the reduction in the enacted U.S. federal corporate tax rate. The tax rate used to measure deferred tax assets changed from 37.0% to 23.5%, which resulted in a reduction to our deferred tax assets of $352 million with a corresponding increase to the provision for income taxes for the year ended December 31, 2017. The actual impact of Tax Reform on effective tax rates and deferred tax assets may differ from these estimates due to changes in interpretations and assumptions made in determining these estimates, future guidance issued by the IRS, and the completion of the Company’s U.S. tax return.

In connection with the IPO, APAM entered into two tax receivable agreements (“TRAs”). The first TRA, generally provides for the payment by APAM to a private equity fund (the “Pre-H&F Corp Merger Shareholder”) of 85% of the applicable cash savings, if any, of U.S. federal, state and local income taxes that APAM actually realizes (or is deemed to realize in certain circumstances) as a result of (i) the tax attributes of the preferred units APAM acquired in the merger of a wholly-owned subsidiary of the Pre-H&F Corp Merger Shareholder into APAM in March 2013, (ii) net operating losses available as a result of the merger and (iii) tax benefits related to imputed interest.

The second TRA generally provides for the payment by APAM to current or former limited partners of Holdings of 85% of the applicable cash savings, if any, of U.S. federal, state and local income taxes that APAM actually realizes (or is deemed to realize in certain circumstances) as a result of (i) certain tax attributes of their partnership units sold to APAM or exchanged (for shares of Class A common stock, convertible preferred stock or other consideration) and that are created as a result of such sales or exchanges and payments under the TRAs and (ii) tax benefits related to imputed interest. Under both agreements, APAM generally will retain the benefit of the remaining 15% of the applicable tax savings.

For purposes of the TRAs, cash savings of income taxes are calculated by comparing APAM’s actual income tax liability to the amount it would have been required to pay had it not been able to utilize any of the tax benefits subject to the TRAs, unless certain assumptions apply. The TRAs will continue in effect until all such tax benefits have been utilized or expired, unless APAM exercises its right to terminate the agreements or payments under the agreements are accelerated in the event that APAM materially breaches any of its material obligations under the agreements.

The actual increase in tax basis, as well as the amount and timing of any payments under these agreements, will vary depending upon a number of factors, including the timing of sales or exchanges by the holders of limited partnership units, the price of the Class A common stock at the time of such sales or exchanges, whether such sales or exchanges are taxable, the amount and timing of the taxable income APAM generates in the future and the tax rate then applicable and the portion of APAM’s payments under the TRAs constituting imputed interest or depreciable basis or amortizable basis.

Payments under the TRAs, if any, will be made pro rata among all TRA counterparties entitled to payments on an annual basis to the extent APAM has sufficient taxable income to utilize the increased depreciation and amortization charges and imputed interest deductions. Artisan expects to make one or more payments under the TRAs, to the extent they are required, prior to or within 125 days after APAM’s U.S. federal income tax return is filed for each fiscal year. Interest on the TRA payments will accrue at a rate equal to one-year LIBOR plus 100 basis points from the due date (without extension) of such tax return until such payments are made.

The reduction in deferred tax assets described above (including the results of Tax Reform) resulted in a decrease in the amounts payable under the TRAs, reflecting the reduced estimate of APAM’s tax savings that will be paid to the TRA counterparties. Amounts payable under tax receivable agreements are estimates which may be impacted by factors, including but not limited to, expected tax rates, projected taxable income, and projected ownership levels and are subject to change. Changes in the estimates of amounts payable under tax receivable agreements are recorded as non-operating income (loss) in the Consolidated Statements of Operations.

The change in the Company’s deferred tax assets related to the tax benefits described above and the change in corresponding amounts payable under the TRAs for the years ended December 31, 2017 and 2016 is summarized as follows:



	Deferred Tax Asset - Amortizable Basis			Amounts Payable Under Tax Receivable Agreements
December 31, 2015	$	660,254		$	589,101
2016 Holdings Common Unit Exchanges	29,977			25,480
Amortization	(35,953		)	—
Payments under TRAs⁽¹⁾	—			(27,685		)
Change in estimate	(336		)	(650		)
December 31, 2016	$	653,942		$	586,246
2017 Follow-On Offering	113,419			96,406
2017 Holdings Common Unit Exchanges	28,134			23,914
Amortization	(42,891		)	—
Payments under TRAs⁽¹⁾	—			(30,234		)
Tax Reform - change in federal corporate tax rate	(341,669		)	(290,418		)
Change in estimate	(245		)	(501		)
December 31, 2017	$	410,690		$	385,413
⁽¹⁾ Interest payments of $85 thousand and $127 thousand were paid in addition to these TRA payments for the years ended December 31, 2017 and 2016, respectively.

Net deferred tax assets comprise the following:



	As of December 31, 2017		As of December 31, 2016
Deferred tax assets:
Amortizable basis ⁽¹⁾	$	410,690	$	653,942
Other ⁽²⁾	18,522		24,576
Total deferred tax assets	429,212		678,518
Less: valuation allowance ⁽³⁾	—		—
Net deferred tax assets	$	429,212	$	678,518
⁽¹⁾ Represents the unamortized step-up of tax basis and other tax attributes from the merger and partnership unit sales and exchanges described above. These future tax benefits are subject to the TRA agreements.
⁽²⁾ Represents the net deferred tax assets associated with the merger described above and other miscellaneous deferred tax assets.
⁽³⁾ Artisan assessed whether the deferred tax assets would be realizable and determined based on its history of taxable income that the benefits would more likely than not be realized. Accordingly, no valuation allowance is required.

Accounting standards establish a minimum threshold for recognizing, and a system for measuring, the benefits of income tax return positions in financial statements. There were no uncertain tax positions recorded as of December 31, 2017 and December 31, 2016.

In the normal course of business, Artisan is subject to examination by federal and certain state, local and foreign tax regulators. As of December 31, 2017, U.S. federal income tax returns for the years 2014 through 2016 are open and therefore subject to examination. State and local tax returns are generally subject to examination from 2013 to 2016. Foreign tax returns are generally subject to examination from 2013 to 2016.