INCOME TAXES
We determine the provision or benefit for income taxes using the asset and liability approach. Under this approach, deferred income taxes represent the expected future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. In assessing the need for a valuation allowance, we look to the future reversal of existing taxable temporary differences, taxable income in carryback years, the feasibility of tax planning strategies and estimated future taxable income. The valuation allowance can be affected by changes to tax laws, changes to statutory tax rates and changes to future taxable income estimates. For the year ended December 31, 2017, we released valuation allowances of $0.2 million on deferred tax assets that are expected to be realized in the foreseeable future.
The sources of pre-tax income and the components of income tax expense for the years ended December 31, 2017, 2016 and 2015, respectively, are as follows:
|
| | | | | | | | | | | | |
(in thousands) | | 2017 | | 2016 | | 2015 |
Income Components | | | | | | |
United States | | $ | 34,386 |
| | $ | 37,276 |
| | 33,274 |
|
Foreign | | 2,194 |
| | (89 | ) | | 157 |
|
Total pre-tax income from continuing operations | | $ | 36,580 |
| | $ | 37,187 |
| | $ | 33,431 |
|
Income tax expense components | | | | | | |
Current income tax provision | | | | | | |
United States-Federal | | $ | 11,952 |
| | $ | 15,106 |
| | $ | 10,549 |
|
United States-State and local | | 206 |
| | 311 |
| | 401 |
|
Foreign | | 758 |
| | 371 |
| | 910 |
|
Total current income tax provision | | 12,916 |
| | 15,788 |
| | 11,860 |
|
Deferred income tax provision (benefit) | | | | | | |
United States-Federal | | (35,486 | ) | | (1,733 | ) | | (9,350 | ) |
United States-State and local | | (260 | ) | | (278 | ) | | (42 | ) |
Foreign | | (87 | ) | | (245 | ) | | (10 | ) |
Total deferred income tax provision (benefit) | | (35,833 | ) | | (2,256 | ) | | (9,402 | ) |
Total income tax (benefit) expense | | $ | (22,917 | ) | | $ | 13,532 |
| | $ | 2,458 |
|
Effective income tax rate | | (62.6 | )% | | 36.4 | % | | 7.4 | % |
A reconciliation of the income tax provision at the U.S. statutory rate to the effective income tax rate as reported is as follows: |
| | | | | | | | | |
| | 2017 | | 2016 | | 2015 |
Tax provision at U.S. statutory rate | | 35.0 | % | | 35.0 | % | | 35.0 | % |
State and local income tax, net of federal benefit | | (0.1 | )% | | 0.1 | % | | 0.7 | % |
Foreign taxes | | (2.5 | )% | | — | % | | — | % |
Release of uncertain tax positions | | — | % | | — | % | | (29.9 | )% |
Prior year true-ups | | 0.3 | % | | — | % | | — | % |
Indemnity expense | | — | % | | — | % | | 3.3 | % |
Other | | 1.7 | % | | 1.3 | % | | (1.7 | )% |
Impact of federal rate change | | (97.0 | )% | | — | % | | — | % |
Effective income tax rate | | (62.6 | )% | | 36.4 | % | | 7.4 | % |
Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates in effect for the year in which we expect the differences will reverse. Deferred tax assets and liabilities include the following: |
| | | | | | | | |
(in thousands) |
| 2017 |
| 2016 |
Deferred Tax Assets |
|
|
|
|
Costs incurred in excess of billings |
| $ | 814 |
| | $ | 506 |
|
Compensation and benefits |
| 4,667 |
| | 10,816 |
|
Reserves |
| 2,473 |
| | 2,660 |
|
Other |
| 854 |
| | 3,116 |
|
Property, plant and equipment, net | | 774 |
| | (769 | ) |
Net operating losses | | 133 |
| | 168 |
|
Subtotal | | $ | 9,715 |
| | $ | 16,497 |
|
Valuation allowance | | — |
| | (157 | ) |
Total deferred tax assets | | $ | 9,715 |
| | $ | 16,340 |
|
Deferred Tax Liabilities |
| | | |
Goodwill |
| $ | (46,890 | ) | | $ | (77,171 | ) |
Unbilled receivables |
| (16,635 | ) | | (27,431 | ) |
Other liabilities | | (1,169 | ) | | (1,178 | ) |
Total deferred tax liabilities |
| $ | (64,694 | ) | | $ | (105,780 | ) |
Deferred taxes are classified in the Consolidated Balance Sheets as follows: |
| | | | | | | | |
(in thousands) |
| 2017 |
| 2016 |
Non-current assets | | $ | 350 |
| | $ | 227 |
|
Non-current liabilities |
| 55,329 |
| | 89,667 |
|
Net deferred tax liabilities |
| $ | 54,979 |
| | $ | 89,440 |
|
Uncertain Tax Position
A reconciliation of the beginning and ending amount of unrecognized tax benefits as of December 31, 2017, 2016 and 2015 is as follows: |
| | | | | | | | | | | | |
(in thousands) |
| 2017 |
| 2016 |
| 2015 |
Unrecognized tax benefits-January 1, |
| $ | 429 |
| | $ | — |
| | $ | 7,604 |
|
Additions for: |
| | | | | |
Current year tax positions |
| — |
| | 429 |
| | — |
|
Reductions for: |
| | | | | |
Settlements with tax authorities | | (429 | ) | | — |
| | — |
|
Prior year tax positions |
| — |
| | — |
| | (7,604 | ) |
Unrecognized tax benefits-December 31, |
| $ | — |
| | $ | 429 |
| | $ | — |
|
As of December 31, 2017, 2016 and 2015, unrecognized tax benefits from uncertain tax positions were $0.0 million, $0.4 million and $0.0 million, respectively. We effectively settled $0.4 million of unrecognized tax benefits during 2017 with the filing of our 2016 income tax returns. We effectively settled $6.9 million of unrecognized tax benefits during 2015 due to the resolution of examinations of tax returns of our Former Parent. The balance of $0.7 million was effectively settled with the filing of our 2014 income tax returns during 2015.
We classify interest relating to tax matters as a component of interest expense and tax penalties as a component of income tax expense in our Consolidated Statements of Income. During 2017, 2016 and 2015, we recognized interest expense related to tax matters of $0.0 million, $0.0 million and $0.1 million, respectively. As of December 31, 2017, 2016, and 2015, we had no interest accrued for tax matters.
The Company's earliest open tax year in the U.S. is 2014.
Tax Cut and Jobs Act
The Tax Cut and Jobs Act (the Tax Act), which was enacted on December 22, 2017 impacted our income tax expense for the year ended December 31, 2017. We would have had income tax expense of approximately $12.2 million under prior law, as compared to the tax benefit reflected of $(22.9) million reflected in the statements of income. The income tax benefit resulted primarily because; (i) the Tax Act requires the inclusion of the accumulated earnings and profits of foreign subsidiaries for which we have not provided U.S. federal income taxes of our controlled foreign corporations in the tax year ending December 31, 2017 and (ii) GAAP requires our deferred tax items to be revalued to reflect the lower 21% federal income tax rate. For the year ended December 31, 2017, these two items resulted in an increase in tax expense of $0.4 million and a tax benefit of $(35.5) million, respectively.
In addition, the Tax Act implements certain minimum taxes on excessive earnings of controlled foreign corporations and base erosion prevention requirements for tax years beginning after December 31, 2017. We are still evaluating the expected impact of these items on our income tax expense in future years and have recorded any estimated impact based on information available. The Tax Act also limits, or eliminates in full, certain tax deductions in future years and, as a result, is expected to impact the recognition of related deferred tax assets in future years under GAAP.
As the result of the passage of the Tax Act, the Securities and Exchange Commission released Staff Accounting Bulletin SAB 118 (SAB 118) to provide guidance for companies that had not completed accounting for the income tax effects of the Tax Act prior to the release of their financial reports. SAB 118 provides guidance regarding disclosure on positions taken in the financial reports under three scenarios; (i) where the accounting for the income tax effects is complete, (ii) where the accounting for the income tax effects is incomplete but a reasonable estimate is available, (iii) where the accounting for the income tax effects is incomplete and a reasonable estimate is not available. SAB 118 provides guidance regarding disclosure requirements under these scenarios. The Tax Act has impacted and will impact a number of items in our tax accounting.
The Tax Act requires the acceleration of income tax recognition for various items as compared to prior tax guidance. As such, we will now be required to recognize income for tax purposes on certain government contracts in the same period as for financial reporting. The amount of this income, on a pretax basis, as of December 31, 2017 is $76.9 million, which will be taxed at the new lower statutory tax rate of 21% subsequent to 2017.
We believe we have reasonably estimated the inclusion of the accumulated earnings and profits of foreign subsidiaries for which we have not provided U.S. federal income taxes of our controlled foreign corporations for the tax year ended December 31, 2017. However, the jurisdictional income tax returns for a number of controlled foreign corporations have not been finalized. Once finalized, the results of those returns could impact the estimate as presented in our financial statements. We expect the returns to be finalized prior to December 31, 2018.
The Tax Act also added a new provision designed to tax global intangible low-taxed income (GILTI). Because of the complexity of the new GILTI tax rules, we are continuing to evaluate this provision of the Tax Act and the application of ASC 740. Under GAAP, we are allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). Our selection of an accounting policy with respect to the new GILTI tax rules will depend, in part, on analyzing our global income to determine whether we expect to have future U.S. inclusions in taxable income related to GILTI and, if so, what the impact is expected to be. Because whether we expect to have future U.S. inclusions in taxable income related to GILTI depends on not only our current structure and estimated future results of global operations but also our intent and ability to modify our structure and/or our business, we are not yet able to reasonably estimate the effect of this provision of the Tax Act. Therefore, we have not made any adjustments related to potential GILTI tax in our financial statements and have not made a policy decision regarding whether to record deferred taxes on GILTI.
We have executives who may receive compensation in excess of the amounts deductible under the Tax Act. We cannot determine with certainty whether these executives' compensation will exceed tax deductible limitations under our existing executive compensation plans or whether certain safe harbors will be available for this compensation. As such, we have not recorded certain deferred tax assets related to executive compensation and will refrain from doing so, until further guidance and interpretation is available regarding the matter. Currently, the amount is immaterial.
As the result of the Tax Act, certain book to tax differences, including both temporary and permanent items, that were allowable prior to the Tax Act are no longer allowable; as such, the calculation of our federal taxable income will change. In addition, we file tax returns in numerous states. Whether these states will adopt the federal tax changes under the Tax Act has yet to be determined. We cannot determine what impact the Tax Act will have on our state income tax liability in the future.
Tax Indemnifications
In connection with the Spin-off, pursuant to a Tax Matters Agreement with our Former Parent, our Former Parent agreed to indemnify us for up to $3.3 million of income tax return liabilities, which were settled with the filing of our Former Parent’s 2014 income tax return during the year ended December 31, 2015. As a result, as of December 31, 2015, we reduced the tax liabilities, which were included in “other long term liabilities” in the Consolidated Balance Sheets, from $3.2 million to zero, which provided an income tax benefit of $3.2 million. We had a corresponding indemnification receivable, including interest of $0.1 million, which was included in “other non-current assets” in the Consolidated Balance Sheets. We reduced the indemnification receivable from $3.3 million to zero, creating an expense of $3.3 million, which is included in "selling, general and administrative expenses" in the Consolidated Statements of Income for the year ended December 31, 2015. The net settlement of these tax liabilities and the indemnification receivable had no impact on our net income.