INCOME TAXES
We are the sole managing member of SSE Holdings, and as a result, consolidate the financial results of SSE Holdings. SSE Holdings is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, SSE Holdings is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by SSE Holdings is passed through to and included in the taxable income or loss of its members, including us, on a pro rata basis. We are subject to U.S. federal income taxes, in addition to state and local income taxes with respect to our allocable share of any taxable income or loss of SSE Holdings, as well as any stand-alone income or loss generated by Shake Shack Inc. We are also subject to withholding taxes in foreign jurisdictions.
In December 2017, the Tax Cuts and Jobs Act of 2017 (the "TCJA") was enacted into law. The TCJA provides for significant changes to the U.S. Internal Revenue Code of 1986, as amended, including the reduction of the U.S. federal corporate income tax rate from 35% to 21%, among other provisions. We have calculated our best estimate of the impact of the TCJA based on current interpretations and understanding of the TCJA and recognized an additional $138,636 of income tax expense as a provisional amount, in accordance with Staff Accounting Bulletin No. 118 ("SAB 118"), relating to the remeasurement of our deferred tax assets. Any subsequent adjustment to these provisional amounts as a result of obtaining, preparing, or analyzing additional information about facts and circumstances that existed as of the enactment date will be recognized as income tax expense in fiscal 2018.
Income Tax Expense
The components of income before income taxes are follows:
|
| | | | | | | | | | | |
| 2017 |
| | 2016 |
| | 2015 |
|
Domestic | $ | 152,204 |
| | $ | 20,623 |
| | $ | 244 |
|
Foreign | 8,089 |
| | 7,873 |
| | 6,184 |
|
Income before income taxes | $ | 160,293 |
| | $ | 28,496 |
| | $ | 6,428 |
|
The components of income tax expense are as follows:
|
| | | | | | | | | | | | | |
| | | 2017 |
| | 2016 |
| | 2015 |
|
Current income taxes: | | | | | |
| Federal | $ | 518 |
| | $ | 3,767 |
| | $ | 2,474 |
|
| State and local | 3,615 |
| | 2,439 |
| | 1,131 |
|
| Foreign | 942 |
| | 667 |
| | 433 |
|
| Total current income taxes | 5,075 |
| | 6,873 |
| | 4,038 |
|
Deferred income taxes: | | | | | |
| Federal | 145,139 |
| | (48 | ) | | (267 | ) |
| State and local | 1,195 |
| | (475 | ) | | (467 | ) |
| Total deferred income taxes | 146,334 |
| | (523 | ) | | (734 | ) |
Income tax expense | $ | 151,409 |
| | $ | 6,350 |
| | $ | 3,304 |
|
Reconciliations of income tax expense computed at the U.S. federal statutory income tax rate to the recognized income tax expense and the U.S. statutory income tax rate to our effective tax rates are as follows:
|
| | | | | | | | | | | | | | | | | | |
| | 2017 | | | 2016 | | | 2015 | |
Expected U.S. federal income taxes at statutory rate | $ | 56,103 |
| 35.0 | % | | $ | 9,689 |
| 34.0 | % | | $ | 2,186 |
| 34.0 | % |
State and local income taxes, net of federal benefit | 2,590 |
| 1.6 | % | | 1,461 |
| 5.1 | % | | 663 |
| 10.3 | % |
Foreign withholding taxes | 942 |
| 0.6 | % | | 667 |
| 2.3 | % | | 433 |
| 6.7 | % |
Non-deductible expenses | 223 |
| 0.1 | % | | 25 |
| 0.1 | % | | 653 |
| 10.2 | % |
Tax credits | (1,230 | ) | (0.8 | )% | | (779 | ) | (2.7 | )% | | (141 | ) | (2.2 | )% |
Non-controlling interest | (3,273 | ) | (2.0 | )% | | (3,765 | ) | (13.2 | )% | | (490 | ) | (7.6 | )% |
Remeasurement of deferred tax assets in connection with the enactment of the TCJA | 138,636 |
| 86.5 | % | | — |
| — | % | | — |
| — | % |
Remeasurement of deferred tax assets in connection with other tax rate changes | 1,657 |
| 1.0 | % | | (1,353 | ) | (4.7 | )% | | — |
| — | % |
Remeasurement of liabilities under tax receivable agreement in connection with the enactment of the TCJA | (44,051 | ) | (27.4 | )% | | — |
| — | % | | — |
| — | % |
Other | (188 | ) | (0.1 | )% | | 405 |
| 1.4 | % | | — |
| — | % |
Income tax expense | $ | 151,409 |
| 94.5 | % | | $ | 6,350 |
| 22.3 | % | | $ | 3,304 |
| 51.4 | % |
Our effective income tax rates for fiscal 2017, 2016 and 2015 were 94.5%, 22.3% and 51.4%, respectively. The increase in our effective income tax rate from fiscal 2016 to fiscal 2017 is primarily due to the remeasurement of deferred tax assets resulting from the enactment of the TCJA. The decrease in our effective income tax rate from fiscal 2015 to fiscal 2016 is due to the IPO and Organizational Transactions that occurred in fiscal 2015. As the non-recurring compensation expenses and other IPO-related expenses recognized during fiscal 2015 were incurred in the period prior to the Organizational Transactions, and prior to our becoming a member of SSE Holdings, we were not entitled to any tax benefits related to those losses. We recognized tax expense in fiscal 2015 based on our allocable share of the taxable income generated in the period subsequent to our becoming a member of SSE Holdings, which resulted in a very high effective tax rate in fiscal 2015 when compared to our consolidated pre-tax income. Additionally, in fiscal 2016, the effective tax rate was positively impacted by a tax benefit of $1,353 we recognized due to the impact from a tax rate change on our deferred tax assets, as well as other rate changes.
Deferred Tax Assets and Liabilities
The components of deferred tax assets and liabilities are as follows:
|
| | | | | | | | | |
| | | December 27
2017 |
| | December 28
2016 |
|
Deferred tax assets: | | | |
| Investment in partnership | $ | 137,449 |
| | $ | 209,648 |
|
| Tax Receivable Agreement | 43,464 |
| | 110,022 |
|
| Deferred rent | 571 |
| | 561 |
|
| Deferred revenue | 59 |
| | 53 |
|
| Stock-based compensation | 322 |
| | 331 |
|
| Net operating loss carryforwards | 12,332 |
| | 7,338 |
|
| Tax credits | 2,328 |
| | 1,084 |
|
| Other assets | 176 |
| | 108 |
|
| Total gross deferred tax assets | 196,701 |
| | 329,145 |
|
Valuation allowance | (10,114 | ) | | (15,568 | ) |
Total deferred tax assets, net of valuation allowance | 186,587 |
| | 313,577 |
|
Deferred tax liabilities: | | | |
| Property and equipment | (673 | ) | | (370 | ) |
| Total gross deferred tax liabilities | (673 | ) | | (370 | ) |
Net deferred tax assets | $ | 185,914 |
| | $ | 313,207 |
|
As of December 27, 2017, our federal and state net operating loss carryforwards for income tax purposes were $51,668 and $19,166. If not utilized, our federal and state net operating loss carryforwards will begin to expire in 2035.
As described in Note 11, we acquired an aggregate of 1,376,093 LLC Interests during fiscal 2017 through redemptions of LLC Interests and the exercise of employee stock options. We recognized a deferred tax asset in the amount of $14,370 associated with the basis difference in our investment in SSE Holdings upon acquiring these LLC Interests. These were partially offset by reductions in basis due to the utilization of $14,339 of amortization. However, a portion of the total basis difference will only reverse upon the eventual sale of our interest in SSE Holdings, which we expect would result in a capital loss. As of December 27, 2017, we established a valuation allowance in the amount of $10,114 against the deferred tax asset to which this portion relates.
During fiscal 2017, we also recognized $7,661 of deferred tax assets related to additional tax basis increases generated from expected future payments under the Tax Receivable Agreement and related deductions for imputed interest on such payments. See "—Tax Receivable Agreement" for more information.
We evaluate the realizability of our deferred tax assets on a quarterly basis and establish valuation allowances when it is more likely than not that all or a portion of a deferred tax asset may not be realized. As of December 27, 2017, we concluded, based on the weight of all available positive and negative evidence, that all of our deferred tax assets (except for those deferred tax assets described above relating to basis differences that are expected to result in a capital loss upon the eventual sale of our interest in SSE Holdings) are more likely than not to be realized. As such, no additional valuation allowance was recognized. The net change in valuation allowance for fiscal 2017 was a decrease of $5,454.
Uncertain Tax Positions
There were no reserves for uncertain tax positions as of December 27, 2017 and December 28, 2016. Shake Shack Inc. was formed in September 2014 and did not engage in any operations prior to the IPO and Organizational Transactions. Shake Shack Inc. first filed tax returns for tax year 2014, which is the first tax year subject to examination by taxing authorities for U.S. federal and state income tax purposes. Additionally, although SSE Holdings is treated as a partnership for U.S. federal and state income taxes purposes, it is still required to file an annual U.S. Return of Partnership Income, which is subject to examination by the Internal Revenue Service ("IRS"). The statute of limitations has expired for tax years through 2013 for SSE Holdings.
Tax Receivable Agreement
Pursuant to our election under Section 754 of the Internal Revenue Code (the "Code"), we expect to obtain an increase in our share of the tax basis in the net assets of SSE Holdings when LLC Interests are redeemed or exchanged by the non-controlling interest holders and other qualifying transactions. We plan to make an election under Section 754 of Code for each taxable year in which a redemption or exchange of LLC Interest occurs. We intend to treat any redemptions and exchanges of LLC Interests by the non-controlling interest holders as direct purchases of LLC Interests for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that we would otherwise pay in the future to various tax authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.
On February 4, 2015, we entered into a tax receivable agreement with the then-existing non-controlling interest holders (the "Tax Receivable Agreement") that provides for the payment by us to the non-controlling interest holders of 85% of the amount of any tax benefits that we actually realize, or in some cases are deemed to realize, as a result of (i) increases in our share of the tax basis in the net assets of SSE Holdings resulting from any redemptions or exchanges of LLC Interests, (ii) tax basis increases attributable to payments made under the Tax Receivable Agreement, and (iii) deductions attributable to imputed interest pursuant to the Tax Receivable Agreement (the "TRA Payments"). We expect to benefit from the remaining 15% of any tax benefits that we may actually realize. The TRA Payments are not conditioned upon any continued ownership interest in SSE Holdings or us. The rights of each non-controlling interest holder under the Tax Receivable Agreement are assignable to transferees of its LLC Interests.
During fiscal 2017, we acquired an aggregate of 1,003,585 LLC Interests in connection with the redemption of LLC Interests, which resulted in an increase in the tax basis of our investment in SSE Holdings subject to the provisions of the Tax Receivable Agreement. We recognized an additional liability in the amount of $18,973 for the TRA Payments due to the redeeming members, representing 85% of the aggregate tax benefits we expect to realize from the tax basis increases related to the redemption of LLC Interests, after concluding it was probable that such TRA Payments would be paid based on our estimates of future taxable income. Also, we recognized $125,859 benefit in other income related to the reduction in liabilities under its Tax Receivable Agreement related to the enactment of the TCJA. During fiscal 2017 payments of $4,910, inclusive of interest, were made to members of SSE Holdings pursuant to the Tax Receivable Agreement. As of December 27, 2017, the total amount of TRA Payments due under the Tax Receivable Agreement was $159,373, of which $937 was included in other current liabilities on the Consolidated Balance Sheet. See Note 17 for more information relating to our liabilities under the Tax Receivable Agreement.