Income Taxes
Income Taxes
Red Rock is taxed as a corporation and pays corporate federal, state and local taxes on income allocated to it by Station Holdco based upon Red Rock’s economic interest held in Station Holdco. As part of the IPO, Red Rock acquired the outstanding stock of the Merging Blockers which are taxed as corporations. As a result, Red Rock files as a consolidated group for federal income tax reporting purposes and in certain states as required or allowed. Station Holdco is treated as a pass-through partnership for income tax reporting purposes. Station Holdco’s members, including the Company, are liable for federal, state and local income taxes based on their share of Station Holdco’s pass-through taxable income.
The Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The Act reduces the U.S. federal corporate rate from 35% to 21%. At December 31, 2017, the Company has not completed its accounting for the tax effects of enactment of the Act; however, as described below, the Company has made a reasonable estimate of the effects on its existing deferred tax balances. The Company will continue to make and refine its calculations as additional analysis is completed. In addition, the Company’s estimates may also be affected as it gains a more thorough understanding of the tax law.
Provisional Amounts
The Company remeasured deferred tax assets and liabilities on the rates at which they are expected to reverse in the future, which is generally 21%. However, the Company is still analyzing certain aspects of the Act and refining its calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded related to the remeasurement of its deferred tax balance was $85.3 million.
Income Tax Expense
The components of income tax expense were as follows (amounts in thousands): |
| | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 |
Current income taxes | | | |
Federal | $ | (1,436 | ) | | $ | 1,233 |
|
State and local | 66 |
| | 17 |
|
Total current income taxes | (1,370 | ) | | 1,250 |
|
Deferred income taxes | | | |
Federal | 133,321 |
| | 6,614 |
|
State and local | 2,804 |
| | 348 |
|
Total deferred income taxes | 136,125 |
| | 6,962 |
|
Total income tax expense | $ | 134,755 |
| | $ | 8,212 |
|
The Company had no income tax expense for the year ended December 31, 2015.
A reconciliation of the statutory federal income tax rate to the Company’s effective income tax rate is as follows: |
| | | | | |
| Year Ended December 31, |
| 2017 | | 2016 |
Expected U.S. federal income taxes at statutory rate | 35.00 | % | | 35.00 | % |
Income attributable to noncontrolling interests | (4.93 | )% | | (27.20 | )% |
State and local income taxes, net of federal benefit | 0.24 | % | | 0.06 | % |
Non-deductible expenses | (0.69 | )% | | 0.14 | % |
Tax credits | (0.54 | )% | | (0.15 | )% |
Impact of tax rate change due to tax reform | 43.15 | % | | — | % |
Other | 0.39 | % | | 0.81 | % |
Valuation allowance | (4.49 | )% | | (3.65 | )% |
Income tax expense | 68.13 | % | | 5.01 | % |
The Company’s effective tax rate includes the net tax expense associated with remeasuring its deferred tax assets, deferred tax liabilities and related valuation allowances to reflect the enacted federal rate, and rate benefit attributable to the fact that Station Holdco operates as a limited liability company which is not subject to federal income tax. Accordingly, the Company is not liable for income taxes on the portion of Station Holdco’s earnings attributable to noncontrolling interests.
The components of deferred tax assets and liabilities are as follows (amounts in thousands): |
| | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 |
Deferred tax assets | | | |
Investment in partnership | $ | 159,272 |
| | $ | 256,983 |
|
Payable pursuant to tax receivable agreement | 30,296 |
| | 91,144 |
|
Total gross deferred tax assets | 189,568 |
| | 348,127 |
|
Valuation allowance | (57,348 | ) | | (103,661 | ) |
Total deferred tax assets, net of valuation allowance | $ | 132,220 |
| | $ | 244,466 |
|
The Company recorded a reduction to the net deferred tax asset resulting from the outside basis difference of its interest in Station Holdco. The Company also recorded a reduction to the deferred tax asset for its liability related to payments to be made pursuant to the TRA representing 85% of the tax savings the Company expects to receive from the amortization deductions associated with the step up in the basis of depreciable assets under Section 754 of the Internal Revenue Code. This deferred tax asset will be recovered as cash payments are made to the TRA participants. Both of these deferred tax assets were initially recorded through equity.
At December 31, 2017, the Company had a federal net operating loss carryforward of approximately $30.3 million. The federal net operating loss carryforward will begin to expire in 2037. The Company also had $1.7 million of additional tax attributes, including tax credits, at December 31, 2017.
Each reporting period, the Company analyzes the likelihood that its deferred tax assets will be realized. A valuation allowance is recorded if, based on the weight of all available positive and negative evidence, it is more likely than not (a likelihood of more than 50%) that some portion, or all, of a deferred tax asset will not be realized. On an annual basis, the Company performs a comprehensive analysis of all forms of positive and negative evidence based on year end results. During each interim period, the Company updates its annual analysis for significant changes in the positive and negative evidence. As a result of this analysis, the Company determined that the deferred tax asset related to acquiring its interest in Station Holdco through the newly issued LLC Units is not expected to be realized unless the Company disposes of its investment in Station Holdco. Accordingly, as part of the Reorganization Transactions in May 2016, the Company established a valuation allowance of $109.4 million against this portion of its deferred tax asset, which was also recorded through equity. The Company recognizes subsequent changes to the valuation allowance through the provision for income tax or other comprehensive (loss) income, as applicable, and at December 31, 2017 and 2016, the valuation allowance was $57.3 million and $103.7 million, respectively.
Uncertain Tax Positions
The Company records uncertain tax positions on the basis of a two-step process in which (1) the Company determines whether it is more likely than not the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions meeting the more likely than not recognition threshold, the Company recognizes the largest amount of tax benefit that is more than 50% likely to be realized upon ultimate settlement with the related tax authority.
The Company determined that no liability for unrecognized tax benefits for uncertain tax positions was required at December 31, 2017. In addition, the Company does not believe that it has any tax positions for which it is reasonably possible that it will be required to record a significant liability for unrecognized tax benefits within the next twelve months.
The first tax year subject to examination by taxing authorities for U.S. federal and state income tax purposes is 2015, though the Company reported no activity during that period. Additionally, although Station Holdco is treated as a partnership for U.S. federal and state income tax purposes, it is 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 Station Holdco.
Tax Receivable Agreement
Pursuant to the election under Section 754 of the Internal Revenue Code, the Company continues to expect to obtain an increase in its share of the tax basis in the net assets of Station Holdco when LLC Units are exchanged by Station Holdco’s noncontrolling interest holders and other qualifying transactions. These increases in tax basis may reduce the amounts that the Company 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.
In connection with the IPO, the Company entered into the TRA with certain pre-IPO owners of Station Holdco. In the event that such parties exchange any or all of their LLC Units for Class A common stock, the TRA requires the Company to make payments to such holders for 85% of the tax benefits realized by the Company by such exchange. The Company expects to realize these tax benefits based on current projections of taxable income. The annual tax benefits are computed by calculating the income taxes due, including such tax benefits, and the income taxes due without such benefits. In connection with the new U.S. federal corporate rate enacted, the Company expects to realize fewer tax benefits at the time of each exchange of LLC Units, and as a result, the Company’s liability under the TRA was reduced by $135.1 million. For the years ended December 31, 2017 and 2016, exchanges of LLC Units and Class B common shares resulted in increases of $22.8 million and $213.2 million, respectively, in amounts payable under the TRA liability and net increases of $24.6 million and $223.0 million, respectively, in deferred tax assets, all of which were recorded through equity. At December 31, 2017 and 2016, the Company’s liability under the TRA was $141.9 million and $258.5 million, respectively, of which $17,000 and $1.0 million, respectively, are presented within current liabilities. In January 2018, the Company paid $5.0 million to a pre-IPO owner of Station Holdco in exchange for which the owner assigned to the Company all of its rights under the TRA and released the Company from all obligations thereunder. As a result, $21.9 million of the Company’s liability under the TRA was effectively extinguished.
The timing and amount of aggregate payments due under the TRA may vary based on a number of factors, including the amount and timing of the taxable income the Company generates each year and the tax rate then applicable. The payment obligations under the TRA are Red Rock’s obligations and are not obligations of Station Holdco or Station LLC. Payments are generally due within a specified period of time following the filing of the Company’s annual tax return and interest on such payments will accrue from the original due date (without extensions) of the income tax return until the date paid. Payments not made within the required period after the filing of the income tax return generally accrue interest at a rate of LIBOR plus 5.00%.
The TRA will remain in effect until all such tax benefits have been utilized or expired unless the Company exercises its right to terminate the TRA. The TRA will also terminate if the Company breaches its obligations under the TRA or upon certain mergers, asset sales or other forms of business combinations, or other changes of control. If the Company exercises its right to terminate the TRA, or if the TRA is terminated early in accordance with its terms, Red Rock’s payment obligations would be accelerated based upon certain assumptions, including the assumption that the Company would have sufficient future taxable income to utilize such tax benefits.
Tax Distributions
Station Holdco is treated as a pass-through partnership for income tax reporting purposes. Federal, state and local taxes resulting from the pass-through taxable income of Station Holdco are obligations of its members. Net profits and losses are generally allocated to the members of Station Holdco (including the Company) in accordance with the number of LLC Units held by each member for tax reporting. The amended and restated operating agreement of Station Holdco provides for cash distributions to assist members (including the Company) in paying their income tax liabilities. Station Holdco paid tax distributions to noncontrolling interest holders of $26.5 million for the year ended December 31, 2017 and $30.4 million for the period from May 2, 2016 through December 31, 2016.