Income Taxes
The Company elected to be taxed as, and has operated in a manner that management believes will allow the Company to continue to qualify as, a REIT under the Code for federal income tax purposes. So long as the Company qualifies as a REIT, it generally will not be subject to U.S. federal corporate income tax on the net taxable income that is currently distributed to its stockholders. A REIT is subject to a number of organizational and operational requirements, including a requirement that it currently distributes at least 90% of its REIT taxable income (subject to certain adjustments) to its stockholders. If the Company fails to qualify as a REIT in any taxable year, without the benefit of certain relief provisions, the Company will be subject to federal, state and local income tax on its taxable income at regular corporate tax rates and will not be eligible to re-elect REIT status for the four years following the failure. Even if the Company continues to qualify for taxation as a REIT, the Company also may be subject to certain federal, state, and local taxes on its income and assets, including, (1) taxes on any undistributed income, (2) taxes related to its TRS, (3) certain state or local income taxes, (4) franchise taxes, (5) property taxes, (6) transfer taxes and (7) corporate alternative minimum tax (for tax years ending prior to January 1, 2018).
The Company has elected to treat certain of its consolidated subsidiaries, and may in the future elect to treat newly formed subsidiaries, as TRSs pursuant to the Code. TRSs may participate in non-real estate related activities and/or perform non-customary services for tenants and are subject to federal and state income tax at regular corporate tax rates. The Company’s hotels are leased, through its Operating Partnership, to certain subsidiaries of the Company’s TRS. Lease revenue at the Operating Partnership and lease expense from the TRS subsidiaries are eliminated in consolidation for financial statement purposes.
In December 2017, the Tax Cuts and Jobs Act ("TCJA") was signed into law and introduced significant changes to the U.S. federal income tax code. The TCJA reduced the corporate tax rate from 35% to 21%, which will lower our future corporate tax rate and related income tax expense for tax years beginning after December 31, 2017. Accordingly, the Company reflected this rate decrease in the calculation of deferred tax assets, liabilities and the valuation allowance for the year ended December 31, 2017. As a result, the Company recorded a one-time adjustment to our net deferred tax asset resulting in the recognition of $0.6 million in deferred income tax expense for the year ended December 31, 2017.
For the year ended December 31, 2017 the Company recognized income tax expense of $7.8 million, including the one-time deferred income tax expense of $0.6 million, using an estimated federal and state statutory combined rate of 37.28%.
During the year ended December 31, 2016, the Company recognized income tax expense of $5.1 million using an estimated federal and state statutory combined rate of 36.26%.
During the year ended December 31, 2015, the Company recognized income tax expense of $6.3 million, of which $1.9 million of the expense related to taxes on a gain on the transfer of a hotel resulting in a more optimal structure in connection with the Company’s intention to elect to be taxed as a REIT. The Company's effective tax rate differed from the federal statutory rate predominately due to the dividends paid deduction, state income taxes, and changes to valuation allowances.
The provision for income taxes related to continuing operations consisted of the following:
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| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Current: | | | | | |
Federal | $ | (5,685 | ) | | $ | (3,139 | ) | | $ | (4,028 | ) |
State | (1,748 | ) | | (1,196 | ) | | (2,178 | ) |
Total current | $ | (7,433 | ) | | $ | (4,335 | ) | | $ | (6,206 | ) |
Deferred: | | | | | |
Federal | $ | (411 | ) | | $ | (71 | ) | | $ | (471 | ) |
State | 11 |
| | (671 | ) | | 382 |
|
Total deferred | $ | (400 | ) | | $ | (742 | ) | | $ | (89 | ) |
Total tax provision | $ | (7,833 | ) | | $ | (5,077 | ) | | $ | (6,295 | ) |
Below is a reconciliation between the provision for income taxes and the amount computed by applying the federal statutory income tax rate to the income or loss for continuing operations before income taxes:
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| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Provision for income taxes at statutory rate | $ | (38,027 | ) | | $ | (32,024 | ) | | $ | (33,393 | ) |
Tax benefit related to REIT operations | 31,551 |
| | 28,351 |
| | 27,783 |
|
Income for which no federal tax benefit was recognized | (2 | ) | | (7 | ) | | (1,930 | ) |
Valuation allowances | — |
| | (20 | ) | | 2,752 |
|
Impact of rate change on deferred tax balances | (529 | ) | | (666 | ) | | — |
|
State tax provision, net of federal | (1,109 | ) | | (986 | ) | | (1,706 | ) |
Other | 283 |
| | 275 |
| | 199 |
|
Total tax provision | $ | (7,833 | ) |
| $ | (5,077 | ) | | $ | (6,295 | ) |
Deferred tax assets and liabilities are included within deferred costs and other assets and other liabilities in the consolidated balance sheets, respectively, and are attributed to the activity of the Company's TRS. The components of the deferred tax assets and liabilities at December 31, 2017 and 2016 were as follows:
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| | | | | | | |
| December 31, 2017 | | December 31, 2016 |
Net operating loss | $ | 3,049 |
| | $ | 4,501 |
|
Deferred income | 1,007 |
| | 1,414 |
|
Miscellaneous | 108 |
| | 89 |
|
Total deferred tax assets | $ | 4,164 |
| | $ | 6,004 |
|
Less: Valuation allowance | (3,001 | ) | | (4,442 | ) |
Net deferred tax assets | $ | 1,163 |
| | $ | 1,562 |
|
The Company's remaining U.S. federal net operating loss carryforwards were $11.2 million as of December 31, 2017 and 2016, and are all subject to limitation. As such, the Company has established a valuation allowance against such amounts. The Company had state net operating loss carryfowards of $25.2 million and $26.1 million as of December 31, 2017 and 2016, respectively, certain of which are subject to limitation. As such, the Company established a $23.4 million valuation allowance as of December 31, 2017 and 2016 against these amounts.
Deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including future reversal of existing taxable temporary differences, future projected taxable income, and tax-planning strategies. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets 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 become deductible. The Company has considered various factors, including future reversals of existing taxable temporary differences, projected future taxable income, and tax-planning strategies in making this assessment.
Based upon tax-planning strategies and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance of $3.0 million, at December 31, 2017. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
During the year ended December 31, 2017 and 2016, the Company decreased the valuation allowance associated with certain deferred tax assets by $1.4 million and increased $20 thousand, respectively. All of the decrease during the year ended December 31, 2017 was made in connection with the change in the corporate income tax rate used to measure the deferred tax assets. The $20 thousand increase for the year December 31, 2016 was generated by net operating losses.
Uncertain Tax Positions
The Company had no unrecognized tax benefits as of or during the three-year period ended December 31, 2017. The Company expects no significant increases or decreases in unrecognized tax benefits due to changes in tax positions within one year of December 31, 2017. The Company has no material interest or penalties relating to income taxes recognized in the combined consolidated statements of operations and comprehensive income for the years ended December 31, 2017, 2016, and 2015 or in the consolidated balance sheets as of December 31, 2017 and 2016. As of December 31, 2017, the Company’s 2017, 2016, and 2015 tax years remain subject to examination by U.S. and various state tax jurisdictions.