| Income Taxes | 12. Income Taxes
Income tax expense includes current and deferred taxes as follows
(dollars in thousands):
Current Deferred Total
Three months ended March 31, 2016:
Federal $ 639 $ 7,651 $ 8,290
State 169 710 879
$ 808 $ 8,361 $ 9,169
Current Deferred Total
Three Months Ended March 31, 2015:
Federal $ 979 $ 5,054 $ 6,033
State 579 1,836 2,415
$ 1,558 $ 6,890 $ 8,448
The reconciliation between the income tax computed by applying the
U.S. federal statutory rate and the effective tax rate on net
income is as follows for the three months ended March 31, 2016
and 2015 (dollars in thousands):
March 31,
2016 2015
Income tax expense / (benefit) Rate Rate
Taxes computed at federal rate $ 8,065 35.0 % $ 6,250 35.0 %
State and local taxes, net of federal tax benefit 882 3.8 % 790 4.4 %
Effect of deferred tax rate change
— 0.0 % 1,284 7.2 %
Change in income tax benefit payable to stockholder
— 0.0 % (57 ) (0.3 )%
Meals and entertainment 218 1.0 % 180 1.0 %
Other 4 0.0 % 1 0.0 %
Income tax expense $ 9,169 39.8 % $ 8,448 47.3 %
Deferred income tax assets and liabilities consist of the following
at March 31, 2016 and December 31, 2015 (dollars in
thousands):
March 31, 2016 December 31, 2015
Deferred income tax assets:
Section 754 election tax basis step-up $ 126,935 $ 129,862
Tenant improvements 3,225 3118
Restricted stock units 4,971 6,229
Compensation
— 4,267
Intangible asset 415 425
Other 531 465
Deferred income tax asset 136,077 144,366
Deferred income tax liabilities:
Goodwill (1,263 ) (1,262 )
Compensation (273 )
—
Servicing rights (11,496 ) (10,827 )
Deferred rent (1,730 ) (1,822 )
Investment in partnership (578 ) (578 )
Deferred income tax liability (15,340 ) (14,489 )
Net deferred income tax asset $ 120,737 $ 129,877
The primary deferred tax asset represents a tax basis step-up
election under Section 754 of the Internal Revenue Code
(“Section 754”) made by the Company relating to the
initial purchase of units of the Operating Partnerships in
connection with the Reorganization Transactions and a tax basis
step-up on subsequent exchanges of Operating Partnership units for
shares of the Company’s Class A common stock since the
date of the Reorganization Transactions. As a result of the step-up
in basis from these transactions, the Company is entitled to annual
future tax benefits in the form of amortization for income tax
purposes. The annual pre-tax benefit on the Section 754
step-up and past payments under the tax receivable agreement was
approximately $126.9 million at March 31, 2016. To the extent
that the Company does not have sufficient taxable income in a year
to fully utilize this annual deduction, the unused benefit is
recharacterized as a net operating loss and can then be carried
back two years or carried forward for twenty years. The Company
measured the deferred tax asset based on the estimated income tax
effects of the increase in the tax basis of the assets owned by the
Operating Partnerships utilizing the enacted tax rates at the date
of the transaction. All subsequent changes in the measurement of
the deferred tax assets due to changes in the enacted tax rates or
changes in the valuation allowance, if any, are recorded as a
component of income tax expense.
In evaluating the realizability of the deferred tax assets,
management makes estimates and judgments regarding the level and
timing of future taxable income, including projecting future
revenue growth and changes to the cost structure. In order to
realize the anticipated 2016 pre-tax benefit of approximately
$34.6 million, the Company needs to generate approximately
$305 million in revenue during 2016, assuming a constant cost
structure. In the event that the Company cannot realize the
anticipated 2016 pre-tax benefit of $34.6 million, the
shortfall becomes a net operating loss that can be carried back
two years to offset prior years’ taxable income or
carried forward twenty years to offset future taxable income.
Based on this analysis and other quantitative and qualitative
factors, management believes that it is currently more likely than
not that the Company will be able to generate sufficient taxable
income to realize the net deferred tax assets resulting from the
basis step up transactions (initial sale of units in the Operating
Partnerships and subsequent exchanges of Operating Partnership
units since the date of the Reorganization Transactions). The
Company has no federal or state net operating losses at
March 31, 2016.
The Company has analyzed the need for a reserve for unrecognized
tax benefits under ASC 740-10 and has determined that any such tax
benefits do not have a material impact on the financial statements.
It is not expected that there will be a significant increase or
decrease in the amount of unrecognized tax benefits within the next
12 months. With few exceptions, the Company is no longer subject to
US federal or state and local tax examination by tax authorities
before 2011.
The Company will recognize interest and penalties related to
unrecognized tax benefits in interest and other income, net in the
consolidated statements of income. There were no interest or
penalties recorded in the three month periods ending March 31,
2016 2015.
Tax Receivable Agreement
In connection with the Reorganization Transactions, HFF LP and HFF
Securities made an election under Section 754 for 2007 and
kept that election in effect for each taxable year in which an
exchange of Operating Partnership units for shares of the
Company’s Class A common stock occurred. The initial
sale as a result of the Offering and subsequent exchanges of
Operating Partnership units for shares of Class A common stock
produced increases in the tax basis of the assets owned by HFF LP
and HFF Securities to their fair market value. This increase in tax
basis allows the Company to reduce the amount of tax payments to
the extent that the Company has taxable income. As a result of the
increase in tax basis, the Company is entitled to future tax
benefits of $126.9 million and has recorded this amount as a
deferred tax asset on its consolidated balance sheet. The Company
has updated its estimate of these future tax benefits based on the
changes to the estimated annual effective tax rate for 2016. The
Company is obligated, however, pursuant to its tax receivable
agreement with HFF Holdings, to pay to HFF Holdings 85% of the
amount of cash savings in U.S. federal, state and local income tax
that the Company actually realizes as a result of these increases
in tax basis and as a result of certain other tax benefits arising
from the Company entering into the tax receivable agreement and
making payments under that agreement. For purposes of the tax
receivable agreement, actual cash savings in income tax is computed
by comparing the Company’s actual income tax liability to the
amount of such taxes that it would have been required to pay had
there been no increase to the tax basis of the assets of HFF LP and
HFF Securities as a result of the initial sale and later exchanges
had the Company not entered into the tax receivable agreement.
The Company accounted for the income tax effects and corresponding
tax receivable agreement effects as a result of the initial
purchase and the sale of units of the Operating Partnerships in
connection with the Reorganization Transactions and subsequent
exchanges of Operating Partnership units for the Company’s
Class A shares, by recognizing a deferred tax asset for the
estimated income tax effects of the increase in the tax basis of
the assets owned by the Operating Partnerships, based on enacted
tax rates at the date of the transaction, less any tax valuation
allowance the Company believes is required. Subsequent changes in
enacted tax rates or any valuation allowance are recorded as a
component of income tax expense.
The Company believes it is more likely than not that it will
realize the benefit represented by the deferred tax asset, and,
therefore, the Company recorded 85% of this estimated amount of the
increase in deferred tax assets as a liability to HFF Holdings
under the tax receivable agreement and the remaining 15% of the
increase in deferred tax assets directly in additional paid-in
capital in stockholders’ equity at the time of each exchange
of Operating Partnership partnership units for shares of the
Company’s Class A common stock. As of August 31,
2012, all of the Operating Partnership partnership units have been
exchanged.
While the actual amount and timing of payments under the tax
receivable agreement depend upon a number of factors, including the
amount and timing of taxable income generated in the future,
changes in future tax rates, the value of individual assets, the
portion of the Company’s payments under the tax receivable
agreement constituting imputed interest and increases in the tax
basis of the Company’s assets resulting in payments to HFF
Holdings, the Company has estimated that the future payments that
will be made to HFF Holdings will be $121.2 million, and has
recorded this obligation to HFF Holdings as a liability on the
consolidated balance sheet. To the extent the Company does not
realize all of the tax benefits in future years, this liability to
HFF Holdings may be reduced.
In conjunction with the filing of the Company’s 2014 federal
and state tax returns, the benefit for 2014 relating to the
Section 754 basis step-up was finalized, resulting in $12.6
million of tax benefits being realized by the Company. As discussed
above, the Company is obligated to remit to HFF Holdings 85% of any
such cash savings in federal and state tax. As such, during the
third quarter of 2015, the Company paid $10.8 million to HFF
Holdings under the tax receivable agreement. As of March 31,
2016, the Company has made payments to HFF Holdings pursuant to the
terms of the tax receivable agreement in an aggregate amount of
approximately $63.4 million and the Company anticipates making a
payment of $10.8 million to HFF Holdings in 2016. |
