Income Taxes
Our tax provision includes federal, state and foreign income taxes payable. The domestic and foreign components of income from continuing operations before income taxes were as follows:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (in millions) |
U.S. income before tax | $ | 791 |
| | $ | 934 |
| | $ | 262 |
|
Foreign income (loss) before tax | 139 |
| | (378 | ) | | 271 |
|
Income from continuing operations before income taxes | $ | 930 |
| | $ | 556 |
| | $ | 533 |
|
The components of our provision (benefit) for income taxes were as follows:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (in millions) |
Current: | | | | | |
Federal | $ | 239 |
| | $ | 441 |
| | $ | 164 |
|
State | 59 |
| | 143 |
| | 51 |
|
Foreign | 95 |
| | 70 |
| | 64 |
|
Total current | 393 |
| | 654 |
| | 279 |
|
Deferred: | | | | | |
Federal | (679 | ) | | (116 | ) | | (606 | ) |
State | (24 | ) | | 50 |
| | (86 | ) |
Foreign | (24 | ) | | (24 | ) | | 65 |
|
Total deferred | (727 | ) | | (90 | ) | | (627 | ) |
Total provision (benefit) for income taxes | $ | (334 | ) | | $ | 564 |
| | $ | (348 | ) |
Reconciliations of our tax provision at the U.S. statutory rate to the provision (benefit) for income taxes were as follows:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (in millions) |
Statutory U.S. federal income tax provision | $ | 326 |
| | $ | 194 |
| | $ | 187 |
|
State income taxes, net of U.S. federal tax benefit | 26 |
| | 23 |
| | 17 |
|
Impact of foreign operations | 1 |
| | 32 |
| | 3 |
|
Effects of the Tax Cuts and Jobs Act | (665 | ) | | — |
| | — |
|
Nontaxable liquidation of subsidiaries | — |
| | — |
| | (628 | ) |
Corporate restructuring | — |
| | 482 |
| | — |
|
Change in deferred tax asset valuation allowance | (48 | ) | | (22 | ) | | 24 |
|
Provision (benefit) for uncertain tax positions | 38 |
| | (139 | ) | | 18 |
|
Non-deductible share-based compensation | — |
| | — |
| | 23 |
|
Non-deductible goodwill | — |
| | — |
| | 13 |
|
Other, net | (12 | ) | | (6 | ) | | (5 | ) |
Provision (benefit) for income taxes | $ | (334 | ) | | $ | 564 |
| | $ | (348 | ) |
On December 22, 2017, the TCJ Act was signed into law, which permanently reduces the corporate income tax rate from a graduated 35 percent to a flat 21 percent rate and imposes a one-time transition tax on earnings of foreign subsidiaries that were previously deferred. As of December 31, 2017, we had not completed our accounting for the tax effects of enactment of the TCJ Act; however, where possible, as described below, we made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax. In other cases, we were not able to make a reasonable estimate and continued to account for those items based on the provisions of the tax laws that were in effect immediately prior to enactment. For the items for which we were able to determine a reasonable estimate, we recognized a provisional benefit of $665 million, of which $517 million was the result of the remeasurement of U.S. deferred tax assets and liabilities and other tax liabilities.
Provisional amounts
| |
• | Deferred tax assets and liabilities and other tax liabilities. We remeasured deferred tax assets and liabilities and other tax liabilities based on the rates at which they are expected to reverse in the future, which is generally 21 percent. The provisional amounts recorded related to the remeasurement of our deferred tax assets and liabilities, uncertain tax position reserves and other tax liabilities were income tax benefits of $517 million, $33 million and $84 million, respectively. However, this remeasurement is based on estimates as of the enactment date of the TCJ Act and our existing analysis of the numerous complex tax law changes in the TCJ Act. As we finalize our analysis of the tax law changes in the TCJ Act, including the impact on our current year tax return filing positions throughout the 2018 fiscal year, we will update our provisional amounts for this remeasurement. |
| |
• | Foreign taxation changes. A one-time transition tax is applied to foreign earnings previously not subjected to U.S. tax. The one-time transition tax is based on our total post-1986 earnings and profits ("E&P") that were previously deferred from U.S. income taxes, but is assessed at a lower tax rate than the federal corporate tax rate of 35 percent. We recorded a provisional amount for our one-time transition tax liability for our foreign subsidiaries based on estimates, as of the enactment date of the TCJ Act, for our controlled foreign subsidiaries and estimates of the total post-1986 E&P for noncontrolled foreign subsidiaries. Additionally, the language in the TCJ Act is not specific enough to address all aspects of the calculation of the transition tax and leaves certain components of the calculation open to interpretation. The U.S. Treasury department is expected to issue regulations to provide clarification. We will update our provisional amounts related to the transition tax for the E&P of our noncontrolled foreign subsidiaries as further guidance is provided by the U.S. Treasury department. We previously recorded a federal deferred tax liability for our deferred earnings at the statutory 35 percent rate. The application of the transition tax results in the deferred earnings previously recorded at 35 percent being subjected to a lower rate, resulting in a provisional income tax benefit of $15 million. We had not recorded certain deferred tax assets, related primarily to E&P deficits, for some foreign subsidiaries based upon an expectation that no tax benefit from such assets would be realized within the foreseeable future. The recognition of tax benefits from the deferred tax assets previously not recorded resulted in a provisional income tax benefit of $16 million. |
We have not made sufficient progress on our analysis of the TCJ Act’s impact on our recognition of deferred tax assets and liabilities for outside basis differences in our investments in foreign subsidiaries due to the complexity of these calculations on both our U.S. and foreign tax positions and uncertainty regarding the impact of new taxes on certain foreign earnings and, therefore, have not recorded provisional amounts. As of December 31, 2017, we have not recorded any deferred tax assets or liabilities for outside basis differences in our investments in foreign subsidiaries. We will further analyze the impact of these new taxes on foreign earnings and their impact on our tax positions throughout fiscal year 2018 to allow us to complete the required accounting for our outside basis differences in our investments in foreign subsidiaries. We continued to apply Accounting Standards Codification 740 based on the provisions of the tax laws that were in effect immediately prior to the TCJ Act being enacted.
During the year ended December 31, 2016, we effected two corporate structuring transactions that included: (i) the organization of Hilton's assets and subsidiaries in preparation for the spin-offs; and (ii) a restructuring of Hilton's international assets and subsidiaries (the "international restructuring"). The international restructuring involved a transfer of certain assets, including intellectual property used in the international business, from U.S. subsidiaries to foreign subsidiaries, and became effective in December 2016. The transfer of the intellectual property resulted in the recognition of tax expense representing the estimated U.S. tax expected to be paid in future years on income generated from the intellectual property transferred to foreign subsidiaries. Further, our deferred effective tax rate is determined based upon the composition of applicable federal and state tax rates. Due to the changes in the footprint of the Company and the expected applicable tax rates at which our domestic deferred tax assets and liabilities will reverse in future periods as a result of the described structuring activities, our estimated deferred effective tax rate increased for the year ended December 31, 2016. In total, these structuring transactions, which became effective in December 2016, resulted in additional income tax expense of $482 million in the period.
Deferred income taxes represent the tax effect of the differences between the book and tax bases of assets and liabilities plus carryforward items. The tax effects of the temporary differences and carryforwards that give rise to our net deferred tax asset (liability) were as follows: |
| | | | | | | |
| December 31, |
| 2017 | | 2016 |
| (in millions) |
Deferred tax assets: | | | |
Net operating loss carryforwards | $ | 395 |
| | $ | 394 |
|
Compensation | 123 |
| | 214 |
|
Other reserves | 12 |
| | 15 |
|
Capital lease obligations | 78 |
| | 84 |
|
Insurance reserves | 27 |
| | 36 |
|
Program surplus | 17 |
| | 84 |
|
Property and equipment | 32 |
| | 26 |
|
Investments | 16 |
| | 12 |
|
Other | 57 |
| | 66 |
|
Total gross deferred tax assets | 757 |
| | 931 |
|
Less: valuation allowance | (408 | ) | | (507 | ) |
Deferred tax assets | 349 |
| | 424 |
|
Deferred tax liabilities: | | | |
Brands | (1,121 | ) | | (1,626 | ) |
Amortizing intangible assets | (178 | ) | | (305 | ) |
Investment in foreign subsidiaries | — |
| | (39 | ) |
Deferred income | — |
| | (150 | ) |
Deferred tax liabilities | (1,299 | ) | | (2,120 | ) |
Net deferred taxes | $ | (950 | ) | | $ | (1,696 | ) |
As of December 31, 2017, we had foreign net operating loss carryforwards of $1.6 billion, which resulted in deferred tax assets of $395 million for foreign jurisdictions. Approximately $6 million of our deferred tax assets as of December 31, 2017 related to net operating loss carryforwards that will expire between 2018 and 2037 with less than $1 million of that amount expiring in 2018. Approximately $389 million of our deferred tax assets as of December 31, 2017 resulted from net operating loss carryforwards that are not subject to expiration. We believe that it is more likely than not that the benefit from certain foreign net operating loss carryforwards will not be realized. In recognition of this assessment, we provided a valuation allowance of $384 million as of December 31, 2017 on the deferred tax assets relating to the foreign net operating loss carryforwards. Our total valuation allowance relating to these net operating loss carryforwards and other deferred tax assets decreased $99 million during the year ended December 31, 2017. Based on our consideration of all available positive and negative evidence, we determined that it was more likely than not that we would be able to realize the benefit of certain foreign deferred tax assets and released valuation allowances of $48 million against our foreign deferred tax assets through continuing operations. Additionally, other factors that did not have any impact on income tax expense, including revaluations of certain foreign deferred tax assets and their associated valuation allowances, resulted in the reduction of total valuation allowances of $51 million.
We classify reserves for tax uncertainties within current income taxes payable and other long-term liabilities in our consolidated balance sheets. Reconciliations of the beginning and ending amounts of unrecognized tax benefits were as follows:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (in millions) |
Balance at beginning of year | $ | 174 |
| | $ | 315 |
| | $ | 296 |
|
Additions for tax positions related to the prior year | 3 |
| | 77 |
| | 25 |
|
Additions for tax positions related to the current year | 126 |
| | 9 |
| | 8 |
|
Reductions for tax positions related to prior years | (10 | ) | | (204 | ) | | (4 | ) |
Settlements | (9 | ) | | (21 | ) | | (4 | ) |
Lapse of statute of limitations | (2 | ) | | (2 | ) | | (2 | ) |
Currency translation adjustment | 1 |
| | — |
| | (4 | ) |
Balance at end of year | $ | 283 |
| | $ | 174 |
| | $ | 315 |
|
The changes to our unrecognized tax benefits during the year ended December 31, 2017 were primarily related to uncertainty regarding the valuation of certain tax assets in the U.S. and the United Kingdom. The changes to our unrecognized tax benefits during the years ended December 31, 2016 and 2015 were primarily the result of items identified, resolved and settled as part of our ongoing U.S. federal audit. We recognize interest and penalties accrued related to uncertain tax positions in income tax expense. During the years ended December 31, 2017, 2016 and 2015, we accrued $3 million, $4 million and $5 million, respectively, of interest and penalties and as of December 31, 2017 and 2016, we had accrued balances of $33 million and $30 million, respectively, for the related payments. Included in the balance of uncertain tax positions as of December 31, 2017 and 2016 were $285 million and $176 million, respectively, associated with positions that if favorably resolved would provide a benefit to our effective tax rate.
In April 2014, we received 30-day Letters from the Internal Revenue Service ("IRS") and the Revenue Agents Report ("RAR") for the 2006 and October 2007 tax years. We disagreed with several of the proposed adjustments in the RAR, filed a formal appeals protest with the IRS and did not make any tax payments related to this audit. The issues being protested in appeals relate to assertions by the IRS that: (i) certain foreign currency denominated intercompany loans from our foreign subsidiaries to certain U.S. subsidiaries should be recharacterized as equity for U.S. federal income tax purposes and constitute deemed dividends from such foreign subsidiaries to our U.S. subsidiaries; (ii) in calculating the amount of U.S. taxable income resulting from our Hilton Honors guest loyalty program, we should not reduce gross income by the estimated costs of future redemptions, but rather such costs would be deductible at the time the points are redeemed; and (iii) certain foreign currency denominated loans issued by one of our Luxembourg subsidiaries whose functional currency is USD, should instead be treated as issued by one of our Belgian subsidiaries whose functional currency is the euro, and thus foreign currency gains and losses with respect to such loans should have been measured in euros, instead of USD. Additionally, in January 2016, we received a 30-day Letter from the IRS and the RAR for the December 2007 through 2010 tax years. The RAR includes the proposed adjustments for tax years December 2007 through 2010, which reflect the carryover effect of the three protested issues from 2006 through October 2007. These proposed adjustments will also be protested in appeals, and formal appeals protests have been submitted. In total, the proposed adjustments sought by the IRS would result in additional U.S. federal tax owed of approximately $874 million, excluding interest and penalties and potential state income taxes. The portion of this amount related to Hilton Honors would result in a decrease to our future tax liability when the points are redeemed. We disagree with the IRS's position on each of these assertions and intend to vigorously contest them. However, based on continuing appeals process discussions with the IRS, we believe that it is more likely than not that we will not recognize the full benefit related to certain of the issues being appealed. Accordingly, we have recorded $45 million of unrecognized tax benefits related to these issues.
We file income tax returns, including returns for our subsidiaries, with federal, state, local and foreign tax jurisdictions. We are under regular and recurring audit by the IRS and other taxing authorities on open tax positions. The timing of the resolution of tax audits is highly uncertain, as are the amounts, if any, that may ultimately be paid upon such resolution. Changes may result from the conclusion of ongoing audits, appeals or litigation in federal, state, local and foreign tax jurisdictions or from the resolution of various proceedings between the U.S. and foreign tax authorities. We are no longer subject to U.S. federal income tax examination for years through 2004. As of December 31, 2017, we remain subject to federal examinations from 2005 through 2016, state examinations from 2005 through 2016 and foreign examinations of our income tax returns for the years 1996 through 2016.
State income tax returns are generally subject to examination for a period of three to five years after filing the respective return; however, the state effect of any federal tax return changes remains subject to examination by various states for a period generally of up to one year after formal notification to the states. The statute of limitations for the foreign jurisdictions generally ranges from three to ten years after filing the respective tax return.