TWO Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Income Taxes

Income Taxes

12 Months Ended

Dec. 31, 2017

The TCJA significantly revises the U.S. corporate income tax by, among other things, lowering the federal income tax rate applicable to corporations from 35% to 21% and repealing the corporate alternative minimum tax. The Company has not completed its determination of the accounting implications of the TCJA on its tax accruals. However, the Company has reasonably estimated the effects of the TCJA and recorded provisional amounts in its financial statements as of December 31, 2017. The Company recognized a tax provision of $17.5 million, which is included as a component of income tax expense from continuing operations. This amount represents the remeasurement of federal net deferred tax assets resulting from the permanent reduction in the U.S. statutory corporate tax rate from 35% to 21%. The TCJA requires complex computations to be performed that were not previously required in U.S. tax law, significant judgments to be made in interpretation of the provisions of the TCJA and significant estimates in calculations, and the preparation and analysis of information not previously relevant or regularly produced. The U.S. Treasury, the IRS, and other standard-setting bodies could interpret or issue guidance on how provisions of the TCJA will be applied or otherwise administered that is different from the Company’s interpretation. As the Company completes its analysis of the TCJA, collects and prepares necessary data, and interprets any additional guidance, it may make adjustments to the provisional amounts. Those adjustments may materially impact the Company’s provision for income taxes in the period in which the adjustments are made.

For the years ended December 31, 2017, 2016 and 2015, the Company qualified to be taxed as a REIT under the Code for U.S. federal income tax purposes. As long as the Company qualifies as a REIT, the Company generally will not be subject to U.S. federal income taxes on its taxable income to the extent it annually distributes its net taxable income to stockholders, and does not engage in prohibited transactions. The Company intends to distribute 100% of its REIT taxable income and comply with all requirements to continue to qualify as a REIT. The majority of states also recognize the Company’s REIT status. The Company’s TRSs file separate tax returns and are fully taxed as standalone U.S. C-corporations. The tables below reflect the net taxes accrued at the TRS level and the tax attributes included in the consolidated financial statements. It is assumed that the Company will retain its REIT status and will incur no REIT level taxation as it intends to comply with the REIT regulations and annual distribution requirements.

Certain activities the Company performs may produce income that will not be qualifying income for REIT purposes. These activities include the designated portion of MSR treated as normal mortgage servicing, residential mortgage loans, certain derivative financial instruments and other risk-management instruments. The Company has designated its TRSs to engage in these activities.

The following table summarizes the tax (benefit) provision from continuing operations recorded at the taxable subsidiary level for the years ended December 31, 2017, 2016 and 2015:



	Year Ended
	December 31,
(in thousands)	2017			2016			2015
Current tax provision (benefit):
Federal	$	492		$	(1,616	)	$	(4,097	)
State	57			164			175
Total current tax provision (benefit)	549			(1,452		)	(3,922		)
Deferred tax (benefit) provision	(11,031		)	13,766			(12,638		)
Total (benefit from) provision for income taxes	$	(10,482	)	$	12,314		$	(16,560	)

During the year ended December 31, 2017, the Company’s TRSs recognized a benefit from income taxes of $10.5 million, which was primarily due to the remeasurement of federal net deferred tax assets resulting from the permanent reduction in the U.S. statutory corporate tax rate from 35% to 21%, realized losses on sales of AFS securities and net losses incurred on derivative instruments held in the Company’s TRSs. During the year ended December 31, 2016, the Company’s TRSs recognized a provision for income taxes of $12.3 million, which was primarily due to gains recognized on MSR and derivative instruments, offset by realized losses on sales of available-for-sale securities, held in the Company’s TRSs.

The Company’s taxable income before dividend distributions differs from its pre-tax net income for U.S. GAAP purposes primarily due to unrealized gains and losses, the recognition of credit losses for U.S. GAAP purposes but not tax purposes, differences in timing of income recognition due to market discount, and original issue discount and the calculations surrounding each. These book to tax differences in the REIT are not reflected in the consolidated financial statements as the Company intends to retain its REIT status.

The following is a reconciliation of the statutory federal and state rates to the effective rates, for the years ended December 31, 2017, 2016 and 2015:



	Year Ended
	December 31,
	2017					2016					2015
(dollars in thousands)	Amount			Percent		Amount			Percent		Amount			Percent
Computed income tax expense at federal rate	$	104,215		35	%	$	127,957		35	%	$	166,432		35	%
State taxes, net of federal benefit, if applicable	37			—	%	106			—	%	114			—	%
Permanent differences in taxable income from GAAP net income ⁽¹⁾	1,208			—	%	401			—	%	4,203			1	%
Dividends paid deduction	(115,942		)	(39	)%	(116,150		)	(32	)%	(187,309		)	(39	)%
(Benefit from) provision for income taxes/ Effective Tax Rate⁽²⁾	$	(10,482	)	(4	)%	$	12,314		3	%	$	(16,560	)	(3	)%

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(1)	For the year ended December 31, 2017, permanent differences include a provision of $17.5 million related to the effect of the federal tax reform statutory rate change from 35% to 21%.


(2)	The provision for (benefit from) income taxes is recorded at the taxable subsidiary level.

The Company’s permanent differences in taxable income from GAAP net income in the years ended December 31, 2017, 2016 and 2015 were primarily due to net losses incurred by consolidated securitization trusts that are not subject to federal taxes and a recurring difference in compensation expense related to restricted stock dividends.

The Company’s consolidated balance sheets, as of December 31, 2017 and December 31, 2016 contain the following current and deferred tax liabilities and assets, which are included in other assets, and are recorded at the taxable subsidiary level:



(in thousands)	December 31, 2017			December 31, 2016
Income taxes receivable
Federal income taxes receivable	$	130		$	1,527
State and local income taxes receivable	—			—
Income taxes receivable, net	130			1,527
Deferred tax assets (liabilities)
Deferred tax asset	50,419			111,636
Deferred tax liability	(24,463		)	(54,275		)
Total net deferred tax assets	25,956			57,361
Total tax assets, net	$	26,086		$	58,888

Deferred Tax Assets and Liabilities

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting and tax purposes at the TRS level. Components of the Company’s deferred tax assets as of December 31, 2017 and December 31, 2016 were as follows:



(in thousands)	December 31, 2017			December 31, 2016
Available-for-sale securities	$	(11,917	)	$	17,942
Mortgage servicing rights	(9,054		)	(9,492		)
Derivative assets and liabilities	4,870			(42,666		)
Other assets	139			24
Other liabilities	545			2,713
Intangibles	108			235
Alternative minimum tax credit	2,386			1,904
Net operating loss carryforward	21,853			42,039
Capital loss carryforward	19,766			44,662
Total deferred tax assets	28,696			57,361
Valuation allowance	(2,740		)	—
Total net deferred tax assets	$	25,956		$	57,361

As of December 31, 2017, a $2.7 million valuation allowance was recorded because the Company determined that it is more likely than not that the associated deferred tax asset will not be realized. At December 31, 2016, the Company had not recorded a valuation allowance for any portion of its deferred tax assets as it did not believe, at a more likely than not level, that any portion of its deferred tax assets would not be realized. Of the TRS net operating loss carryforward of $21.9 million, $0.6 million is scheduled to expire December 31, 2033, $1.5 million is scheduled to expire December 31, 2034, $2.6 million is scheduled to expire December 31, 2035, $15.4 million is scheduled to expire December 31, 2036 and $1.7 million is scheduled to expire December 31, 2037. Of the TRS net capital loss carryforward of $19.8 million, $5.1 million is scheduled to expire December 31, 2019, $12.7 million is scheduled to expire December 31, 2020 and $2.0 million is scheduled to expire December 31, 2021.

Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s consolidated financial statements of a contingent tax liability for uncertain tax positions. Additionally, there were no amounts accrued for penalties or interest as of or during the periods presented in these consolidated financial statements.