NOTE 9    INCOME TAXES

 

Income (loss) before income taxes, which is all domestic, was $(262) million, $201 million and $(5,476) million for the years ended December 31, 2017, 2016 and 2015, respectively.  The provision (benefit) for federal, state and local income taxes consisted of the following:

 

 

Total income tax expense (benefit) differs from the amounts computed by applying the U.S. federal income tax rate to pre-tax income (loss) as follows:

 

 

 

The Tax Cuts and Jobs Act (the Tax Act) was enacted on December 22, 2017. The Tax Act includes significant changes to U.S. income tax and related laws. In addition to the reduction in the top corporate tax rate, other provisions of the Tax Act include, but are not limited to, fully expensing the cost of acquired qualified property, subject to certain phase-out provisions, and limiting the interest expense deduction. We evaluated the provisions of the Tax Act, most of which are effective January 1, 2018, and determined that because of our tax-loss and valuation allowance position there will be no net current impact on our financial statements. Over the long term, the provisions are expected to be favorable to us when we begin to generate taxable income and should result in the deferral of cash tax payments from when they otherwise would have been due.

 

During 2017, our effective tax rate differed from the statutory tax rate of 35% due to (1) a 91% decrease related to a one-time adjustment of $240 million for the remeasurement of our net deferred tax asset as a result of the Tax Act, (2) a 19% increase related to enhanced oil recovery (EOR) tax credits, marginal well tax credits and other items and (3) a 6% increase related to state taxes.  All of these items resulted in a corresponding change to our valuation allowance increasing our effective tax rate by 33%, because it is not more-likely-than-not that our net deferred tax asset is realizable.

 

In the first quarter of 2016, we reduced our valuation allowance due to our evaluation of our assets and liabilities at the time of our 2015 debt exchange, which generated $1.4 billion of cancellation of debt income (CODI) for tax purposes.  Our evaluation indicated that our liabilities exceeded the value of our assets, both calculated in accordance with tax rules, enabling us to move the liability related to CODI to deferred tax liabilities.  The resulting increase of our deferred tax liabilities that could be offset against deferred tax assets caused an $82 million reduction in the valuation allowance and resulted in a benefit of $78 million, net of $4 million in state tax.  During the rest of 2016, we increased the valuation allowance by $480 million, which resulted in a net increase of the allowance by $398 million for the year.  The net change in the valuation allowance had the effect of increasing our provision by $384 million, after $14 million in state taxes, which increased our effective tax rate by 192%.  We concluded, on a more-likely-than-not basis, that we could not realize any of the deferred tax assets generated during 2016.

 

Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of existing deferred tax assets.  A significant piece of evidence evaluated is a history of operating losses.  Such evidence limits our ability to consider other evidence such as projections for growth.  As of December 31, 2017, we concluded that we could not realize, on a more-likely-than-not basis, any of our deferred tax assets and there is not sufficient evidence to support the reversal of all or any portion of this allowance.  Given our recent and anticipated future earnings trends, we do not believe any of the valuation allowance will be released within the next 12 months.  The amount of the deferred tax assets considered realizable could however be adjusted if estimates or amounts of deferred tax liabilities change.

 

Cancellation of debt income

 

As a result of our 2015, 2016 and 2017 debt transactions and amendments, we generated CODI of $1.4 billion, $1.3 billion and $13 million, respectively ($2.7 billion in the aggregate), for both U.S. federal and California state tax purposes.  These respective amounts were excluded from taxable income because we determined, in 2016, that our liabilities exceeded the value of our assets for tax purposes immediately prior to each of the deleveraging transactions.  In exchange for this exclusion, tax rules require us to reduce the tax basis of our assets.  Accordingly, we have reduced our net operating losses and the basis of property, plant and equipment by $1.2 billion for U.S. federal tax purposes and $1.9 billion for California tax purposes.  We were not required to make any further reductions in those assets because, beyond this point, our liabilities would have exceeded the tax basis of our assets.  Accordingly, any tax liability attributable to the remaining approximately $1.5 billion of federal and $800 million of California CODI was relieved without any future tax liability, which reduced our effective rate by 275%.

 

The tax effects of temporary differences resulting in deferred income taxes at December 31, 2017 and 2016 were as follows:

 

 

 

Prior to the Spin-off date, we were included in the Occidental income tax returns for all applicable years.  Under the tax sharing agreement, Occidental controls tax examinations for the periods in which we were included in a consolidated or combined income tax return filed by Occidental.  There were no amounts due to Occidental as of December 31, 2017 and 2016 under the tax sharing agreement.

 

Tax benefits are recognized only for tax positions that are more-likely-than-not to be sustained upon examination by tax authorities.  The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement.  A liability for unrecognized tax benefits is recorded for any tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards.  As of December 31, 2017 and 2016, we recorded a $25 million liability for tax positions taken in prior periods which has been classified as a deferred tax liability.  This amount of unrecognized tax benefit, if recognized, would affect the effective tax rate positively.  We believe there will not be significant increases or decreases to our unrecognized tax benefits within the next 12 months.

 

As of December 31, 2017, we had a U.S. federal net operating loss carryforward of $1.1 billion and $1.9 billion of net operating loss carryforwards in California.  The U.S. federal net operating loss carryforward expires in 2037.  The California net operating loss carryforwards began expiring in 2026.  A portion of the California net operating loss carryforwards resulted from acquisitions in prior years and is subject to an annual limitation.  Accordingly, no financial statement benefit has been recognized for $88 million of the California net operating loss carryforwards. The deduction and carryforward period for the U.S. federal net operating loss generated in 2017 are unchanged by the Tax Act.

 

During 2017, we generated $27 million of U.S federal credits primarily related to EOR projects and marginal well credits. We also generated an $8 million California credit related to EOR projects. The U.S. federal and California credits begin expiring in 2037.