INCOME TAXES

Income Tax Expense

The components of the Company’s income tax expense are as follows:



	Year Ended September 30,
	2018		2017		2016
	(In millions)
Current tax expense:
Federal	$	373.2	$	425.6	$	376.0
State	53.6		27.3		15.9
	426.8		452.9		391.9
Deferred tax expense:
Federal	158.7		87.9		47.6
State	12.2		22.9		27.7
	170.9		110.8		75.3
Total income tax expense	$	597.7	$	563.7	$	467.2

The Company’s effective tax rate was 29.0%, 35.2% and 34.5% in fiscal 2018, 2017 and 2016, respectively. The effective tax rate for fiscal 2018 reflects the impact of the Tax Cuts and Jobs Act (Tax Act), which was enacted into law on December 22, 2017, an excess tax benefit related to stock-based compensation, the release of a valuation allowance against deferred tax assets related to Forestar, and the enactment of the Bipartisan Budget Act of 2018, which retroactively extended the expiration date of the federal energy efficient home credit from December 31, 2016 until December 31, 2017. The effective tax rates for all years include an expense for state income taxes, reduced by tax benefits for the domestic production activities deduction.

The Tax Act reduced the corporate tax rate from 35% to 21% for all corporations effective January 1, 2018. For fiscal year companies, the change in law requires the application of a blended tax rate in the year of change, which for the Company was 24.5% for the fiscal year ended September 30, 2018. Thereafter, the applicable statutory tax rate is 21%. ASC 740 requires all companies to reflect the effects of the new law in the period in which the law was enacted. Accordingly, the Company reduced the statutory tax rate that applied to its year-to-date earnings from 35% to 24.5%. In addition, the Company remeasured its deferred tax assets and liabilities for the tax law change, which resulted in additional income tax expense of $108.7 million recognized during the three months ended December 31, 2017. No other tax law changes as a result of the Tax Act had a significant impact on the Company’s financial statements.

On October 5, 2017, the Company acquired 75% of the outstanding shares of Forestar. The Company recorded goodwill of $29.2 million, which is not deductible for income tax purposes. At the acquisition date, a valuation allowance of $20.1 million was recorded against Forestar’s $20.4 million of deferred tax assets due to Forestar’s cumulative losses in recent years. During the fourth quarter of fiscal 2018, Forestar emerged from the cumulative loss position. The Company evaluated all positive and negative evidence and determined the emergence from the cumulative loss position and other positive evidence outweighed the negative evidence, and reduced the valuation allowance which resulted in a corresponding reduction in income tax expense. As of September 30, 2018, the Company has retained a valuation allowance of $3.5 million related to Forestar’s state deferred tax assets for net operating loss (NOL) carryforwards that are more likely than not to expire before being realized.

Reconciliation of Expected Income Tax Expense

Differences between income tax expense and tax computed by applying the federal statutory rate of 24.5% in fiscal 2018 and 35% in fiscal 2017 and 2016 to income before income taxes during each year is due to the following:



	Year Ended September 30,
	2018			2017			2016
	(In millions)
Income taxes at federal statutory rate	$	505.0		$	560.7		$	473.7
Increase (decrease) in tax resulting from:
State income taxes, net of federal benefit	59.4			42.3			38.6
Domestic production activities deduction	(36.7		)	(39.8		)	(36.3		)
Valuation allowance	(7.3		)	0.8			0.2
Tax credits	(19.0		)	(3.5		)	(15.9		)
Excess tax benefit from equity compensation	(21.2		)	—			—
Tax law change from enactment of Tax Act	108.7			—			—
Other	8.8			3.2			6.9
Total income tax expense	$	597.7		$	563.7		$	467.2

Deferred Income Taxes

Deferred tax assets and liabilities reflect the tax consequences of temporary differences between the financial statement bases of assets and liabilities and their tax bases, tax losses and credit carryforwards. Components of deferred income taxes, including Forestar’s deferred tax assets and liabilities as of September 30, 2018, are summarized as follows:



	September 30,
	2018			2017
	(In millions)
Deferred tax assets:
Inventory costs	$	40.9		$	42.6
Inventory impairments	31.8			83.9
Warranty and construction defect costs	121.8			163.7
Net operating loss carryforwards	38.1			26.2
Tax credit carryforwards	4.3			2.5
Incentive compensation plans	55.2			92.6
Deferred income	1.3			1.7
Other	5.8			13.9
Total deferred tax assets	299.2			427.1
Valuation allowance	(17.7		)	(11.2		)
Total deferred tax assets, net of valuation allowance	281.5			415.9
Deferred tax liabilities:
Deferral of profit on home sales	64.9			41.6
Other	22.6			9.3
Total deferred tax liabilities	$	87.5		$	50.9
Deferred income taxes, net	$	194.0		$	365.0

D.R. Horton has $19.3 million of tax benefits for state NOL carryforwards that expire at various times depending on the tax jurisdiction. Of the total amount, $5.4 million of the tax benefits expire over the next ten years and the remaining $13.9 million expires from fiscal years 2029 to 2038.

Forestar has $14.8 million of tax benefits for federal NOL carryforwards, after consideration of intra-entity profit eliminations, which have no expiration date. Additionally, Forestar has $4.0 million of tax benefits for state NOL carryforwards that expire at various times depending on the tax jurisdiction.

The accounting for deferred taxes is based upon estimates of future results. Differences between the anticipated and actual outcomes of these future results could have a material impact on the Company’s consolidated results of operations or financial position. Also, changes in existing federal and state tax laws and tax rates could affect future tax results and the valuation of the Company’s deferred tax assets.

Valuation Allowance

In addition to the $3.5 million valuation allowance related to Forestar’s state deferred tax assets, the Company has a valuation allowance of $14.2 million related to D.R. Horton’s state deferred tax assets for NOL carryforwards because it is more likely than not that a portion of the state NOL carryforwards will expire before being realized. In total, the Company’s valuation allowance was $17.7 million at September 30, 2018 and $11.2 million at September 30, 2017. The Company will continue to evaluate both the positive and negative evidence in determining the need for a valuation allowance with respect to the remaining state NOL carryforwards. Any reversal of the valuation allowance in future periods will impact the Company’s effective tax rate.

Regulations and Legislation

D.R. Horton is subject to federal income tax and to income tax in multiple states. The statute of limitations for D.R. Horton’s major tax jurisdictions remains open for examination for fiscal years 2015 through 2018. D.R. Horton is currently being audited by various states; however, to date, management is not aware of any significant findings identified by the taxing authorities.

Forestar is subject to federal income tax and to income tax in multiple states. All federal statutes of limitations for tax years prior to 2016 are effectively closed. The statute of limitations in major state jurisdictions for tax years prior to 2014 is closed. Forestar is currently under audit by the IRS for the 2016 tax year. At this time, Forestar is not aware of any significant findings identified by the IRS. Forestar is not currently being audited by any state jurisdictions.