Taylor Morrison Home Corp

INCOME TAXES

The provision for income taxes for the years ended December 31, 2017, 2016 and 2015 consisted of the following:



	Year Ended December 31,
(Dollars in thousands)	2017			2016		2015
Domestic	$	173,541		$	98,125	$	84,880
Foreign	5,465			9,518		5,121
Total income tax provision	$	179,006		$	107,643	$	90,001
Current:
Federal	$	73,974		$	64,298	$	57,053
State	9,379			9,178		9,557
Foreign	7,169			7,213		5,545
Current tax provision	$	90,522		$	80,689	$	72,155
Deferred:
Federal	$	95,243		$	22,201	$	16,406
State	(5,055		)	2,448		1,864
Foreign	(1,704		)	2,305		(424		)
Deferred tax provision	$	88,484		$	26,954	$	17,846
Total income tax provision	$	179,006		$	107,643	$	90,001

The components of income before income taxes are as follows:



	Year Ended December 31,
(Dollars in thousands)	2017		2016		2015
Domestic	$	323,359	$	282,207	$	242,787
Foreign	32,297		31,999		18,200
Income before income taxes	$	355,656	$	314,206	$	260,987

A reconciliation of the provision for income taxes and the amount computed by applying the federal statutory income tax rate of 35% to income before provision for income taxes is as follows:



	Year Ended December 31,
	2017		2016		2015
Tax at federal statutory rate	35.0	%	35.0	%	35.0	%
State income taxes (net of federal benefit)	3.2		3.1		3.0
Foreign income taxed below U.S. Rate	(0.8	)	(0.9	)	(0.5	)
Valuation allowance	—		(0.6	)	(1.9	)
Built in loss limitation	—		0.3		1.6
Uncertain tax positions	1.1		—		—
Non-controlling interest	—		(0.1	)	(0.2	)
State net operating loss adjustment	(2.1	)	—		—
Deferred tax adjustments	(1.1	)	—		—
Disallowed compensation expense	0.2		0.1		0.2
Domestic Manufacturing Deduction	(2.1	)	(2.2	)	(3.1	)
Other	(0.2	)	(0.4	)	0.4
Tax reform legislation ⁽¹⁾	17.1		—		—
Effective Rate	50.3	%	34.3	%	34.5	%

⁽¹⁾ On December 22, 2017, new legislation commonly known as the "Tax Cuts and Jobs Act" ("Tax Act"), was enacted. The Tax Act made comprehensive reforms to the United States tax code, including a decrease to the corporate statutory tax rate from 35% to 21%, and a one-time mandatory deemed repatriation tax of foreign earnings at a reduced rate, that may be payable over eight years.

In response to the Tax Act, SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), which provides guidance on accounting for the impacts of the Tax Act. SAB 118 allows for the recording provisional amounts during a one year “measurement period” similar to that used when accounting for business combinations, if the Company has a reasonable estimate of the impact but the accounting is not yet complete. The measurement period is deemed to have ended in either one calendar year or when the Company has obtained, prepared and analyzed the information necessary to finalize its accounting for the impact of the Tax Act, whichever is earlier.

For the quarter ended December 31, 2017, we have recorded a discrete net tax expense of $61.0 million related to impacts related to the Tax Act. The net expense includes a provisional estimate of $57.4 million, a 16.1% increase to the effective rate, related to the write-down of our existing deferred tax assets to reflect the newly enacted U.S. federal tax rate, in accordance with SAB 118. The provisional expense is the Company’s best estimate of the deferred tax asset write-down at this time, however it is subject to change in the future. The estimate may be impacted by our calculation of additional adjustments made to federal temporary differences arising from a tax accounting method change filed with the IRS and the state tax effect of these additional adjustments.

The net expense related to tax reform recorded during the period ended December 31, 2017, also includes a provisional estimate of $3.6 million, a 1% increase to the effective rate, from the mandatory deemed repatriation of foreign earnings related to the sale of our Canadian business in 2015. The Tax Act imposes a mandatory deemed repatriation tax on post-1986 foreign earnings and profits (“E&P”) of certain foreign subsidiaries to their 10% U.S. shareholders (regardless of whether such E&P is distributed) at a rate of 15.5% for U.S. corporate shareholders to the extent E&P does not exceed the U.S. shareholder’s aggregate foreign cash position (as defined in the Tax Act) and 8% for E&P in excess of such cash position. The resulting tax may be payable over eight years. The mandatory tax is partially offset by foreign tax credits generated by cash taxes that our Canadian subsidiaries previously paid to Canada. To determine the amount of the Transition Tax, we must determine, in addition to other factors, the amount of foreign repatriation tax of our Canadian subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The provisional expense is the Company’s best estimate of the foreign repatriation tax at this time, however it is subject to change in the future as we are continuing to gather additional information to more precisely compute the amount of the tax.

We own more than a 50% interest in a Canadian corporation. As a result, the Canadian corporation is classified as a controlled foreign corporation (a “CFC”) for U.S. federal income tax purposes. In certain circumstances a U.S. shareholder of a CFC is required to include currently in its income its proportionate share of certain categories of the CFC’s current earnings and profits, regardless of whether any amounts are actually distributed by the CFC.

Certain transactions between us and our Canadian subsidiaries creates interest income in Canada and the passive nature also subjects that income to current U.S. tax through a deemed dividend under Subpart F. As TMHC’s ownership interest continues to increase, the deemed dividend also increases which will negatively impact the effective tax rate. The impact to the effective rate for 2017 as a result of Subpart F was approximately 1.1%.

We will continue to have Subpart F deemed dividends in the future and a negative impact to our effective rate, unless we effectively unwind our Canadian subsidiaries from our structure, which could also cause the incurrence of certain Canadian withholding taxes in the period of unwind.

At December 31, 2017 and 2016, we had a valuation allowance of $0.8 million and $0.5 million, respectively, against net deferred tax assets, which include the tax benefit from Canadian, U.S. federal, and state net operating loss (“NOL”) carryforwards and capital loss carryforwards. Federal NOL carryforwards may be used to offset future taxable income for 20 years and begin to expire in 2027. State NOL carryforwards may be used to offset future taxable income for a period of 20 years, and begin to expire in 2026. For the years ended December 31, 2017 and December 31, 2016, we recorded a net valuation allowance increase of $0.3 million and decrease of $2.1 million, respectively. The increase in the valuation allowance primarily related to a capital loss carryforward which is not expected to be realized. Our future deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws. State deferred tax assets include approximately $15.9 million and $10.4 million at December 31, 2017 and 2016, respectively, of tax benefits related to state NOL carryovers. The increase in state NOL carryovers between the years ending December 31, 2017 and 2016 was primarily the result of additional NOLs generated upon receiving a favorable ruling from the jurisdiction. On an ongoing basis, we will continue to review all available evidence to determine if and when we expect to realize our deferred tax assets and federal and state NOL carryovers.

As a result of the 2011 acquisition by our Principal Equityholders, we had an “ownership change” as defined by Section 382 of the Internal Revenue Code of 1986 as amended (the “IRC”). Section 382 of the IRC imposes certain limitations on our ability to utilize certain tax attributes and net unrealized built-in losses that existed as of July 13, 2011. The gross deferred tax asset includes amounts that are considered to be net unrealized built-in losses. To the extent these net unrealized losses were realized during the five-year period between July 13, 2011 and July 13, 2016, they were not deductible for federal income tax reporting purposes to the extent they exceeded our overall IRC Section 382 limitation. On July 13, 2016, the limitation on net unrealized built-in losses expired. Therefore, the remaining valuation allowance related to built-in losses was released during the period ended December 31, 2016.

We have certain tax attributes available to offset the impact of future income taxes. The components of net deferred tax assets and liabilities at December 31, 2017 and 2016, consisted of timing differences related to real estate inventory impairment, expense accruals and reserves, provisions for liabilities, and NOL carryforwards. We have approximately $135.8 million in available federal NOL carryforwards. Our deferred tax assets and deferred tax liabilities for the year ending December 31, 2017 are presented net of the adjustments for the effects of tax legislation enacted during the year as discussed above. A summary of these components for the years ending December 31, 2017 and 2016 is as follows:



	Year Ended December 31,
(Dollars in thousands)	2017				2016
Deferred tax assets:
Real estate inventory	$	47,114			$	99,876
Accruals and reserves	12,872				27,519
Other	14,440				23,692
Net operating losses	44,446			⁽¹⁾	62,181
Total deferred tax assets	$	118,872			$	213,268
Deferred tax liabilities:
Real estate inventory, intangibles, other	(174		)		(2,621		)
Foreign exchange	200				(3,497		)
Valuation allowance	(760		)		(516		)
Total net deferred tax assets	$	118,138			$	206,634

⁽¹⁾ A portion of our net operating losses is limited by Section 382 of the IRC, stemming from the 2011 acquisition of the Company by our Principal Equityholders, as such acquisition was deemed a change in control as defined by Section 382.

We account for uncertain tax positions in accordance with ASC 740. ASC 740 requires a company to recognize the financial statement effect of a tax position when it is more likely than not based on the technical merits of the position that the position will be sustained upon examination. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to be recognized in the financial statements based upon the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Our inability to determine that a tax position meets the more-likely-than-not recognition threshold does not mean that the Internal Revenue Service (“IRS”) or any other taxing authority will disagree with the position that we have taken.

The following is a reconciliation of the total amounts of unrecognized tax benefits:



	Year Ending December 31,
(Dollars in thousands)	2017		2016		2015
Beginning of the period	$	7,773	$	7,016	$	2,353
Increases of current year items	—		18		5,217
Increases of prior year items	5,163		739		—
Decreased for tax positions of prior years	—		—		(554		)
End of the period	$	12,936	$	7,773	$	7,016

The unrecognized tax benefits increased for the year ending December 31, 2017 due to an increase in prior year reserves related to certain state potential utilization limits on our NOL's. If the unrecognized tax benefits as of December 31, 2017 were to be recognized, approximately $10.3 million would impact the effective tax rate. The amount impacting the Company’s effective rate is calculated by adding accrued interest and penalties to the gross unrecognized tax benefit and subtracting the tax benefit associated with state taxes and interest. These amounts are included in income taxes payable and as a reduction to deferred tax assets in the accompanying Consolidated Balance Sheets at December 31, 2017 and December 31, 2016.

We recognized potential penalties and interest expense on our uncertain tax positions of $1.0 million, $0.4 million, and $0.3 million for the years ended December 31, 2017, 2016, and 2015 respectively, which are included in income tax provision in the accompanying Consolidated Statements of Operations and income taxes payable in the accompanying Consolidated Balance Sheets.

We are currently under examination by certain taxing authorities and anticipate finalizing these examinations during the next twelve months. The outcome of these examinations is not currently determinable. The statute of limitations for our major taxing jurisdictions remains open for examination for tax years 2013 through 2017.