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, 2018

For the years ended December 31, 2018, 2017 and 2016, 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, 2018, 2017 and 2016:



	Year Ended
	December 31,
(in thousands)	2018		2017			2016
Current tax (benefit) provision:
Federal	$	52	$	492		$	(1,616	)
State	1		57			164
Total current tax (benefit) provision	53		549			(1,452		)
Deferred tax (benefit) provision	41,770		(11,031		)	13,766
Total (benefit from) provision for income taxes	$	41,823	$	(10,482	)	$	12,314

During the year ended December 31, 2018, the Company’s TRSs recognized a provision for income taxes of $41.8 million, which was primarily due to realized gains on sales of AFS securities and gains recognized on MSR held in the TRSs as well as the write-down of net deferred tax assets resulting from the deemed liquidation of one of the Company’s TRSs due to its TRS election revocation, offset by net losses incurred on derivative instruments held in the TRS. 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.

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, 2018, 2017 and 2016:



	Year Ended
	December 31,
	2018					2017					2016
(dollars in thousands)	Amount			Percent		Amount			Percent		Amount			Percent
Computed income tax expense at federal rate	$	(518	)	21	%	$	104,215		35	%	$	127,957		35	%
State taxes, net of federal benefit, if applicable	1			—	%	37			—	%	106			—	%
Permanent differences in taxable income from GAAP net income ⁽¹⁾	28,414			(1,152	)%	1,208			—	%	401			—	%
Dividends paid deduction	13,926			(565	)%	(115,942		)	(39	)%	(116,150		)	(32	)%
(Benefit from) provision for income taxes/ Effective Tax Rate⁽²⁾	$	41,823		(1,696	)%	$	(10,482	)	(4	)%	$	12,314		3	%

____________________

(1)

For the year ended December 31, 2018, permanent differences include a provision of 17.8 million related to the write-down of the net deferred tax assets resulting from the deemed liquidation of three of the Company’s TRSs due to their election revocation, offset by the reversal of the valuation allowance upon TRS revocation. 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 (loss) income in the year ended December 31, 2018 was primarily due to the intercompany sale of RMBS between the Company’s TRS and the REIT, as well as the write-down of net deferred tax assets resulting from the deemed liquidation of three of the Company’s TRSs due to their TRS election revocation, offset by the reversal of the valuation allowance upon TRS revocation. Additionally, the Company’s recurring permanent differences in taxable income from GAAP net (loss) income in the years ended December 31, 2018, 2017 and 2016 were due to a difference in the dividends paid deduction for tax, compensation expense related to restricted stock dividends and, for the years ended December 31, 2017 and 2016, net losses incurred by consolidated securitization trusts that are not subject to federal taxes.

The Company’s consolidated balance sheets, as of December 31, 2018 and December 31, 2017 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, 2018			December 31, 2017
Income taxes receivable
Federal income taxes receivable	$	690		$	130
State and local income taxes receivable	—			—
Income taxes receivable, net	690			130
Deferred tax assets (liabilities)
Deferred tax asset	17,196			50,419
Deferred tax liability	(18,333		)	(24,463		)
Total net deferred tax (liabilities) assets	(1,137		)	25,956
Total tax assets (liabilities), net	$	(447	)	$	26,086

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 liabilities and assets as of December 31, 2018 and December 31, 2017 were as follows:



(in thousands)	December 31, 2018			December 31, 2017
Available-for-sale securities	$	19		$	(11,917	)
Mortgage servicing rights	(18,333		)	(9,054		)
Derivative assets and liabilities	33			4,870
Other assets	9			139
Other liabilities	652			545
Intangibles	101			108
Alternative minimum tax credit	—			2,386
Net operating loss carryforward	16,354			21,853
Capital loss carryforward	28			19,766
Total deferred tax (liabilities) assets	(1,137		)	28,696
Valuation allowance	—			(2,740		)
Total net deferred tax (liabilities) assets	$	(1,137	)	$	25,956

As of December 31, 2018, the Company has not recorded a valuation allowance for any portion of its deferred tax assets as it does not believe, at a more likely than not level, that any portion of its deferred tax assets will not be realized. At December 31, 2017, a $2.7 million valuation allowance was recorded because the Company determined that it was more likely than not that the associated deferred tax assets would not be realized. Of the TRS net operating loss deferred tax asset carryforward of $16.4 million, $2.4 million is scheduled to expire December 31, 2035, $12.3 million is scheduled to expire December 31, 2036, $1.7 million is scheduled to expire December 31, 2037.

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.