Income Tax
We are the sole managing member of HPIH. HPIH is treated as a partnership for U.S. federal, and most applicable state and local income tax purposes. As a partnership, HPIH is not subject to entity-level federal or state income taxation. Any taxable income or loss generated by HPIH 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, state and local income taxes on our allocable share of net taxable income or loss of HPIH, as well as any stand-alone income or loss generated by HIIQ. HIIQ’s subsidiary HP is subject to U.S. federal, state and local income taxes separately from HIIQ due to the ownership structure.
The provision for income tax for the years ended December 31, 2017 and 2016, consisted of the following components ($ in thousands):
|
| | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 |
Current: | |
| | |
|
Federal | $ | 2,473 |
| | $ | 3,295 |
|
State | 385 |
| | 493 |
|
Total current taxes | 2,858 |
| | 3,788 |
|
Deferred: | |
| | |
|
Federal | 13,264 |
| | (7,736 | ) |
State | 696 |
| | (803 | ) |
Total deferred taxes | 13,960 |
| | (8,539 | ) |
Income taxes | $ | 16,818 |
| | $ | (4,751 | ) |
For the year ended December 31, 2017 the provision for income taxes was $16.8 million. For the year ended December 31, 2016 the benefit for income taxes was $4.8 million. Deferred taxes on our investment in HPIH are measured on the difference between the carrying amount of our investment in HPIH and the corresponding tax basis of this investment. We do not measure deferred taxes on differences within HPIH, as those differences inherently comprise our deferred taxes on our external investment in HPIH.
The items accounting for differences between the federal statutory income tax rate and our effective tax rate for the years ended December 31, 2017 and 2016, are as follows:
|
| | | | | |
| 2017 | | 2016 |
U.S. federal income tax rate | 35.0 | % | | 35.0 | % |
State income taxes, net of federal tax benefits | 3.1 | % | | (0.1 | )% |
Tax Act | 18.7 | % | | — | % |
Valuation allowance | (10.6 | )% | | (51.6 | )% |
Operations of nontaxable subsidiary | (8.0 | )% | | (40.9 | )% |
Stock-based compensation contribution | — | % | | (1.2 | )% |
Non-deductible or non-taxable items | 0.1 | % | | 2.0 | % |
Other | 0.5 | % | | — | % |
Total | 38.8 | % | | (56.8 | )% |
The effective tax rate for the year ended December 31, 2017 was 38.8% and the effective tax rate for the year ended December 31, 2016 was (56.8)%. The difference was mainly driven by the Tax Act, the change in the valuation allowance on the investment in HPIH that is deemed permanent in nature, and the non-controlling interest income. HP’s 2017 book loss generates a deferred tax benefit which is offset by a valuation allowance. On a standalone basis, the effective tax rate for the year ended December 31, 2017 for HIIQ and HP was 33.4% and 0.0%, respectively.
The deferred income tax assets consisted of the following as of December 31, 2017 and 2016 ($ in thousands):
|
| | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 |
Deferred tax assets: | |
| | |
|
Investment in subsidiary | $ | 17,980 |
| | $ | 16,715 |
|
Tax receivable agreement | 3,991 |
| | 3,789 |
|
Stock compensation | 694 |
| | 694 |
|
Net operating loss carryforwards | 3,165 |
| | 2,230 |
|
Allowance for doubtful accounts | 5 |
| | 4 |
|
Other | 2 |
| | 165 |
|
Total deferred tax assets | 25,837 |
| | 23,597 |
|
Less valuation allowances | (9,250 | ) | | (12,799 | ) |
Deferred tax assets, net of valuation allowance | 16,587 |
| | 10,798 |
|
Deferred tax liabilities: | |
| | |
|
Identifiable intangible assets | (1,197 | ) | | (2,383 | ) |
Stock compensation | (423 | ) | | (225 | ) |
Other | (7 | ) | | (9 | ) |
Deferred tax assets, net | $ | 14,960 |
| | $ | 8,181 |
|
As of December 31, 2017, the Company had net deferred tax assets totaling approximately $15.0 million. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
At December 31, 2017 and 2016, HIIQ had no federal or state net operating loss carryforwards. Additionally, at December 31, 2017 and 2016, HP had approximately $14.0 million and $5.7 million, respectively, of federal and state net operating loss carryforwards. These carryforwards are generally available through 2037 and start expiring in 2033.
As of December 31, 2017, the Company determined that a valuation allowance of $9.3 million was necessary to reduce the HPIH outside basis deferred tax asset that is permanent in nature by $7.0 million and HP’s deferred tax assets by $2.3 million. We evaluate quarterly the positive and negative evidence regarding the expected realization of net deferred tax assets. The carrying value of our net deferred tax assets is based on our assessment as to whether it is more likely than not that we will generate sufficient future taxable income to realize these deferred tax assets. We had recorded a valuation allowance against all of the deferred tax assets of HIIQ and maintained a full valuation allowance on all of these deferred tax assets until December 31, 2016. When we determined that we would be able to realize our remaining deferred income tax assets in the foreseeable future, a release of the related valuation allowance resulted in the recognition of $8.1 million of deferred tax assets at December 31, 2016. Significant management judgment is required in determining the period in which the reversal of a valuation allowance should occur.
The Tax Act
On December 22, 2017, prior to the end of the Company’s fiscal year, the President of the United States signed into law H.R. 1, referred to as the “Tax Act.” The Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 118 (“SAB 118”) on December 22, 2017. SAB 118 provides up to a one-year measurement period from a registrant’s reporting period that includes the Tax Act’s enactment date to allow the registrant sufficient time to obtain, prepare and analyze information to complete the accounting required under ASC 740.
The reduction of the U.S. federal tax rate from 35% to 21% resulted in tax expense of $12.6 million due to the re-measurement of our deferred tax assets. The reduction of the federal tax rate also resulted in a one-time increase to income of $11.8 million due to the reduction of the TRA liability. The overall net impact of these amounts reduced earnings by $775,000. The reduction in the tax rate will also impact the company’s tax expense in future periods beginning in 2018.
The Company is evaluating the other provisions of the Act and does not believe that the other provisions will have a material impact on the consolidated financial statements, if any.
Uncertain Tax Positions
We account for uncertainty in income taxes using a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon audit, including resolution of related appeals or litigation processes, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Such amounts are subjective, as a determination must be made on the probability of various possible outcomes. We reevaluate uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Such a change in recognition and measurement could result in recognition of a tax benefit or an additional tax provision.
As of December 31, 2017 and 2016, respectively, we did not have a balance of gross unrecognized tax benefits, and as such, no amount would favorably affect the effective income tax rate in any future periods. The Company accounts for interest and penalties associated with uncertain tax positions as a component of tax expense, and none were included in the Company’s financial statements as there are no uncertain tax positions outstanding as of December 31, 2017 and 2016, respectively. The Company’s 2013 through 2016 tax years remain subject to examination by tax authorities.