Income Taxes
In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted. The 2017 Tax Act includes a number of changes to existing U.S. tax laws that impact the company, most notably a reduction of the U.S. corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017. The 2017 Tax Act also provides for the acceleration of depreciation for certain assets placed into service after September 27, 2017 as well as prospective changes beginning in 2018, including additional limitations on executive compensation and limitations on the deductibility of interest.
The company recognized the income tax effects of the 2017 Tax Act in its 2017 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, "Income Taxes", in the reporting period in which the 2017 Tax Act was signed into law. As such, the company’s financial results reflect the income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is complete and provisional amounts for those specific income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined. The company included provisional estimates of income tax effects of the 2017 Tax Act as the interaction between valuation allowance and future deferred tax assets and liabilities is uncertain as of December 25, 2017.
The changes to existing U.S. tax laws as a result of the 2017 Tax Act, which we believe have the most significant impact on the company’s federal income taxes are as follows:
Reduction of the U.S. Corporate Income Tax Rate
The company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 35 percent to 21 percent, resulting in a $2.2 million decrease in income tax expense for the year ended December 25, 2017 and a corresponding $2.2 million decrease in net deferred tax liabilities as of December 25, 2017.
Our income tax provision (benefit) for the years ended December 25, 2017, December 26, 2016 and December 28, 2015 consists of the following (in thousands):
|
| | | | | | | | | | | | |
| | 2017 | | 2016 | | 2015 |
Current | | | | |
| | |
|
State | | 125 |
| | 128 |
| | 97 |
|
Subtotal Current | | 125 |
| | 128 |
| | 97 |
|
Deferred | | | | |
| | |
|
Federal | | (1,538 | ) | | 665 |
| | 660 |
|
State | | 83 |
| | 68 |
| | 82 |
|
Subtotal Deferred | | (1,455 | ) | | 733 |
| | 742 |
|
Total income tax provision (benefit) | | $ | (1,330 | ) | | $ | 861 |
| | $ | 839 |
|
Total income tax expense differed from the amount which would have been provided by applying the statutory federal income tax rate of 35% to earnings before taxes as follows (in thousands):
|
| | | | | | | | | | | | |
| | 2017 | | 2016 | | 2015 |
Income tax expense (benefit) at federal statutory rate | | $ | (1,162 | ) | | $ | 932 |
| | $ | 687 |
|
State income taxes | | 27 |
| | 138 |
| | 129 |
|
Increase (decrease) in valuation allowance | | 1,962 |
| | (370 | ) | | (68 | ) |
Deferred taxes | | (23 | ) | | 83 |
| | 30 |
|
Meals and entertainment | | 66 |
| | 78 |
| | 61 |
|
Equity Based Compensation | | (2 | ) | | — |
| | — |
|
Impacts related to 2017 Tax Act | | $ | (2,198 | ) | | $ | — |
| | $ | — |
|
Total income tax provision (benefit) | | $ | (1,330 | ) | | $ | 861 |
| | $ | 839 |
|
Significant components of our deferred tax assets and liabilities at December 25, 2017 and December 26, 2016 are as follows:
|
| | | | | | | | |
| | 2017 | | 2016 |
Non-current: | | | | |
|
Deferred tax assets: | | | | |
|
Net operating loss | | $ | 5,838 |
| | $ | 6,045 |
|
Landlord contributions | | 6,910 |
| | 8,644 |
|
Deferred rent | | 3,244 |
| | 3,474 |
|
Stock compensation | | 1,509 |
| | 1,391 |
|
Deemed landlord financing | | 6,629 |
| | 9,522 |
|
Charitable contributions | | 80 |
| | 94 |
|
Deferred revenue | | 424 |
| | 455 |
|
Depreciation | | 417 |
| | 236 |
|
Other | | 268 |
| | 223 |
|
Valuation allowance | | (7,764 | ) | | (8,831 | ) |
Deferred tax liabilities: | | | | |
|
Goodwill | | 4,022 |
| | 5,476 |
|
Property and equipment | | 17,555 |
| | 21,253 |
|
Net deferred tax liabilities, non-current | | 4,022 |
| | 5,476 |
|
Total net deferred tax liabilities | | $ | 4,022 |
| | $ | 5,476 |
|
Due to our early adoption of ASU 2015-17 on a prospective basis all deferred taxes are presented as non-current as of December 25, 2017 and December 26, 2016. ASC 740 requires that we reduce our deferred income tax assets by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that all or a portion of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences are deductible. We have established a valuation allowance of $7.8 million and $8.8 million as of December 25, 2017 and December 26, 2016, respectively, against our net deferred tax assets due to the fact that it is not more likely than not that there will be sufficient taxable income in the future when the temporary differences are deductible.
A rollforward of activity in the valuation allowances follows: |
| | | | |
Balance at December 29, 2014 | | $ | 9,270 |
|
Addition to valuation allowance | | — |
|
Deductions | | (69 | ) |
Balance at December 28, 2015 | | 9,201 |
|
Addition to valuation allowance | | — |
|
Deductions | | (370 | ) |
Balance at December 26, 2016 | | 8,831 |
|
Addition to valuation allowance | | — |
|
Deductions | | (1,067 | ) |
Balance at December 25, 2017 | | $ | 7,764 |
|
We have recorded a full valuation allowance for the net amount of the deferred tax assets which are in excess of the indefinite-lived intangible asset deferred tax liabilities. The indefinite-lived intangible asset deferred tax liability in the amount of $4.0 million and $5.5 million as of December 25, 2017 and December 26, 2016, respectively, related to the book-tax basis difference in goodwill has not been netted against the deferred tax assets due to the uncertainty inherent in the reversal of this deferred tax liability.
At December 25, 2017, we have unused federal and state net operating loss carryforwards of $24.9 million and $12.3 million, respectively. Such losses expire in various amounts at varying times beginning in 2027 through 2037. Certain tax attributes are subject to annual limitations under Internal Revenue Code Section 382 as a result of changes in ownership. A valuation allowance is recorded against the net deferred tax assets, exclusive of indefinite-lived intangibles discussed above, including these carryforwards. We file income tax returns, which can be periodically audited by various federal and state jurisdictions. We are generally no longer subject to federal or state income examinations for years prior to fiscal year 2013.
The company currently believes that it is more likely than not that it will not be subject to the new interest expense limitations as a result of the 2017 Tax Act. When interest is limited under the 2017 Act, a company may carry forward the unused interest limitation indefinitely. Additionally, as a result of the 2017 Act, net operating losses generated after 2017 may be carried forward indefinitely. Indefinite carry forwards give rise to indefinite lived deferred tax assets. When such indefinite carry forwards are generated, our indefinite lived deferred tax liability could be considered as a source of future taxable income which may be netted with the indefinite lived deferred tax assets. Generation of future indefinite lived deferred tax assets could potentially result in a future reduction in our valuation allowance.
We continue to monitor and evaluate the rationale for recording a valuation allowance against our deferred tax assets including the interaction with indefinite lived deferred tax assets as a result of the 2017 Tax Act. As the Company increases earnings and utilizes deferred tax assets, it is possible the valuation allowance could be reduced or eliminated.