Income Taxes

12 Months Ended

Dec. 31, 2018

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including, but not limited to, the following that impact us: (1) reducing the U.S. federal corporate income tax rate from 35 percent to 21 percent; (2) eliminating the corporate alternative minimum tax; (3) creating a new limitation on deductible interest expense; (4) repealing the domestic production activities deduction; (5) limiting the deductibility of certain executive compensation; and (6) limiting certain other deductions.

The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides for a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting relating to the Tax Act under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in its financial statements. If a company cannot

determine a provisional estimate to be included in its financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

As the result of our initial analysis of the impact of the Tax Act, we recorded a provisional amount of net tax expense of $172.1 million in 2017 related to the remeasurement of our deferred tax balances and other effects. We completed our accounting for the income tax effects of the Tax Act in 2018, and no material adjustments were required to the provisional amounts initially recorded.

Components of current and deferred income tax expense (benefit) are as follows ($000’s omitted):



	2018			2017			2016
Current expense (benefit)
Federal	$	(44,462	)	$	81,101		$	9,464
State and other	7,202			(11,801		)	(13,104		)
	$	(37,260	)	$	69,300		$	(3,640	)
Deferred expense (benefit)
Federal	$	271,544		$	444,695		$	312,288
State and other	91,233			(22,388		)	22,499
	$	362,777		$	422,307		$	334,787
Income tax expense (benefit)	$	325,517		$	491,607		$	331,147

The following table reconciles the statutory federal income tax rate to the effective income tax rate:



	2018		2017		2016
Income taxes at federal statutory rate	21.0	%	35.0	%	35.0	%
State and local income taxes, net of federal tax	4.0		3.1		3.3
Tax accounting method change	(2.5	)	—		—
Changes in tax laws, including the Tax Act	1.0		18.3		0.5
Deferred tax asset valuation allowance	0.9		(1.1	)	(2.2	)
Tax contingencies	0.1		(1.0	)	(1.3	)
Other	(0.3	)	(1.9	)	0.2
Effective rate	24.2	%	52.4	%	35.5	%

The 2018 effective tax rate differs from the federal statutory rate primarily due to state income tax expense on current year earnings, tax benefits due to Internal Revenue Service (IRS) acceptance of a tax accounting method change applicable to the 2017 tax year, valuation allowances relating to projected utilization of certain state net operating loss carryforwards, and state tax law changes. The acceptance of the tax accounting method change provided a deferral of profit and acceleration of certain costs associated with home sales, which resulted in a favorable adjustment in 2018 due to the tax rate reduction in the Tax Act. The 2017 effective tax rate differs from the federal statutory rate primarily due to the impacts of the Tax Act, state income tax expense on current year earnings, the favorable resolution of certain state income tax matters, the domestic production activities deduction, and state tax law changes. The 2016 effective tax rate differs from the federal statutory rate primarily due to state income taxes, the reversal of a portion of our valuation allowance related to a legal entity restructuring, the favorable resolution of certain state income tax matters, the impact on our net deferred tax assets due to changes in business operations and state tax laws, and recognition of energy efficient home credits.

As a result of the adoption of ASU No. 2016-09, excess tax benefits related to equity compensation are recorded as a component of income tax expense, pursuant to which we recorded a cumulative-effect adjustment to increase retained earnings and deferred tax assets as of January 1, 2017 by $18.6 million for previously unrecognized excess tax benefits.

Deferred tax assets and liabilities reflect temporary differences arising from the different treatment of items for tax and accounting purposes. Components of our net deferred tax asset are as follows ($000’s omitted):



	At December 31,
	2018			2017
Deferred tax assets:
Accrued insurance	$	117,682		$	117,133
Inventory valuation reserves	132,495			202,791
Other reserves	60,585			78,271
NOL carryforwards:
Federal	27,122			41,282
State	228,959			248,224
Alternative minimum tax credit carryforwards	2,546			54,965
Energy and other credit carryforwards	5,146			41,763
	574,535			784,429
Deferred tax liabilities:
Capitalized items, including real estate basis differences, deducted for tax, net	(1,038		)	(17,895		)
Deferral of profit on home sales	(188,628		)	(34,769		)
Intangibles	(16,701		)	(17,860		)
	(206,367		)	(70,524		)
Valuation allowance	(92,589		)	(68,610		)
Net deferred tax asset	$	275,579		$	645,295

Our federal NOL carryforward deferred tax asset of $27.1 million expires, if unused, between 2031 and 2032. We also have state NOLs in various jurisdictions which may generally be carried forward up to 20 years, depending on the jurisdiction. Our NOL carryforward deferred tax assets will expire if unused at various dates as follows: $32.6 million from 2019 to 2023 and $196.4 million from 2024 and thereafter.

We evaluate our deferred tax assets each period to determine if a valuation allowance is required based on whether it is "more likely than not" that some portion of the deferred tax assets would not be realized. The ultimate realization of these deferred tax assets is dependent upon the generation of sufficient taxable income during future periods. We conduct our evaluation by considering all available positive and negative evidence. This evaluation considers, among other factors, historical operating results, forecasts of future profitability, the duration of statutory carryforward periods, and the outlooks for the U.S. housing industry and broader economy.

Our ability to use certain of Centex’s federal losses and credits is limited by Section 382 of the Internal Revenue Code. We do not believe that this limitation will prevent us from utilizing these Centex losses and credits. We do believe that full utilization of certain state NOL carryforwards will be limited due to Section 382.

The accounting for deferred taxes is based upon estimates of future results. Differences between estimated and actual results could result in changes in the valuation of our deferred tax assets that could have a material impact on our consolidated results of operations or financial position. Changes in existing tax laws could also affect actual tax results and the realization of deferred tax assets over time.

Unrecognized tax benefits represent the difference between tax positions taken or expected to be taken in a tax return and the benefits recognized for financial statement purposes. We had $30.6 million and $48.6 million of gross unrecognized tax benefits at December 31, 2018 and 2017, respectively. If recognized, $19.7 million and $23.4 million, respectively, of these amounts would impact our effective tax rate. Additionally, we had accrued interest and penalties of $5.8 million and $4.9 million at December 31, 2018 and 2017, respectively.

It is reasonably possible within the next twelve months that our gross unrecognized tax benefits may decrease by up to $16.6 million, excluding interest and penalties, primarily due to potential settlements. A reconciliation of the change in the unrecognized tax benefits is as follows ($000’s omitted):



	2018			2017			2016
Unrecognized tax benefits, beginning of period	$	48,604		$	21,502		$	38,992
Increases related to tax positions taken during a prior period	5,389			20,555			224
Decreases related to tax positions taken during a prior period	(31,850		)	(9,665		)	(13,218		)
Increases related to tax positions taken during the current period	8,411			18,895			114
Decreases related to settlements with taxing authorities	—			—			(707		)
Reductions as a result of a lapse of the applicable statute of limitations	—			(2,683		)	(3,903		)
Unrecognized tax benefits, end of period	$	30,554		$	48,604		$	21,502

We continue to participate in the Compliance Assurance Process (“CAP”) with the IRS as an alternative to the traditional IRS examination process. As a result of our participation in CAP, federal tax years 2016 and prior are closed. Tax year 2017 is expected to close by the second quarter of 2019. We are also currently under examination by various state taxing jurisdictions and anticipate finalizing certain of the examinations within the next twelve months. The outcome of these examinations is not yet determinable. The statute of limitations for our major tax jurisdictions remains open for examination for tax years 2005 to 2018.