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, 2019

For the years ended December 31, 2019, 2018 and 2017, 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. 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, 2019, 2018 and 2017:



	Year Ended
	December 31,
(in thousands)	2019			2018		2017
Current tax provision:
Federal	$	8,684		$	52	$	492
State	2,668			1		57
Total current tax provision	11,352			53		549
Deferred tax (benefit) provision	(24,912		)	41,770		(11,031		)
Total (benefit from) provision for income taxes	$	(13,560	)	$	41,823	$	(10,482	)

During the year ended December 31, 2019, the Company’s TRSs recognized a benefit from income taxes of $13.6 million, which was primarily due to losses recognized on MSR, offset by net gains recognized on derivative instruments held in the Company’s TRSs. 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 TRSs. 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, 2019, 2018 and 2017:



	Year Ended
	December 31,
	2019					2018					2017
(dollars in thousands)	Amount			Percent		Amount			Percent		Amount			Percent
Computed income tax expense at federal rate	$	65,184		21	%	$	(518	)	21	%	$	104,215		35	%
State taxes, net of federal benefit, if applicable	2,108			1	%	1			—	%	37			—	%
Permanent differences in taxable income from GAAP net income	702			—	%	28,414			(1,152	)%	1,208			—	%
Dividends paid deduction	(81,554		)	(26	)%	13,926			(565	)%	(115,942		)	(39	)%
(Benefit from) provision for income taxes/ Effective Tax Rate⁽¹⁾	$	(13,560	)	(4	)%	$	41,823		(1,696	)%	$	(10,482	)	(4	)%

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

The Company’s permanent differences in taxable income from GAAP net income (loss) in the year ended December 31, 2019 were primarily due to dividends paid from the Company’s TRSs to the REIT, offset by permanent differences related to the intercompany sale of securities between the Company’s TRSs and the REIT. The Company’s permanent differences in taxable income from GAAP net income (loss) in the year ended December 31, 2018 were primarily due to the intercompany sales of securities between the Company’s TRSs 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. The Company’s permanent differences in taxable income from GAAP net income (loss) in the year ended December 31, 2017 were primarily due to a provision of $17.5 million related to the effect of the federal tax reform statutory rate change from 35% to 21%, offset by net losses incurred by consolidated securitization trusts that were not subject to federal taxes and permanent differences related to discontinued operations. Additionally, the Company’s recurring permanent differences in taxable income from GAAP net income (loss) in the years ended December 31, 2019, 2018 and 2017 were due to a difference in the dividends paid deduction for tax and compensation expense related to restricted stock dividends.

The Company’s consolidated balance sheets, as of December 31, 2019 and December 31, 2018 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, 2019			December 31, 2018
Income taxes receivable
Federal income taxes receivable	$	17,539		$	690
State and local income taxes receivable	—			—
Income taxes receivable, net	17,539			690
Deferred tax assets (liabilities)
Deferred tax asset	23,756			17,196
Deferred tax liability	(19		)	(18,333		)
Total net deferred tax assets (liabilities)	23,737			(1,137		)
Total tax assets (liabilities), net	$	41,276		$	(447	)

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, 2019 and December 31, 2018 were as follows:



(in thousands)	December 31, 2019			December 31, 2018
Available-for-sale securities	$	(19	)	$	19
Mortgage servicing rights	23,110			(18,333		)
Derivative assets and liabilities	67			33
Other assets	12			9
Other liabilities	463			652
Intangibles	90			101
Net operating loss carryforward	7			16,354
Capital loss carryforward	7			28
Total deferred tax assets (liabilities)	23,737			(1,137		)
Valuation allowance	—			—
Total net deferred tax assets (liabilities)	$	23,737		$	(1,137	)

As of December 31, 2019 and December 31, 2018, 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.

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.