| Income Taxes | 20. Income Taxes Current and Deferred Tax Provision Our provision for (benefit from) income taxes consisted of the following (in thousands): Year Ended December 31, 2020 2019 2018 Current tax provision (benefit): U.S. federal $ (99) $ 75 $ — State 326 377 912 Total current 227 452 912 Deferred tax provision (benefit): U.S. federal (17,246) (35,597) 6,197 State (518) (4,000) (959) Total deferred (17,764) (39,597) 5,238 Provision for (benefit from) income taxes $ (17,537) $ (39,145) $ 6,150 The provision for (benefit from) income taxes for the years ended December 31, 2020, 2019 and 2018 resulted in effective tax rates on continuing operations of 20.4%, (67.0)% and 17.4%, respectively. The following table reconciles these effective tax rates to the U.S. statutory rate of 21%, the rate in effect during 2020, 2019 and 2018 (in thousands): Year Ended December 31, 2020 2019 2018 Income taxes at U.S. federal statutory rate $ (18,056) $ 12,276 $ 7,415 Net state income taxes (817) 1,634 1,570 Tax credits (1,256) (1,757) (244) Noncontrolling interest — — (1,793) Unrecognized tax benefits (1) 772 (1,958) (1,443) Valuation allowances and write off of tax attributes (2) 236 (50,219) (58) Executive compensation limitation 1,159 1,102 977 Stock 538 66 (455) Other (113) (289) 181 Provision for (benefit from) income taxes $ (17,537) $ (39,145) $ 6,150 (1) Reflects a decrease in our uncertain tax benefit, net of federal benefit, due to settlements of tax audits and expiration of statute of limitations in 2019 and 2018. (2) See “Tax Attributes and Valuation Allowances” below for further details. Deferred income tax balances are the direct effect of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities at the enacted tax rates expected to be in effect when the taxes are actually paid or recovered. The tax effects of temporary differences that gave rise to deferred tax assets and deferred tax liabilities were as follows (in thousands): December 31, 2020 2019 Deferred tax assets: Net operating loss carryforwards $ 158,916 $ 116,378 Accrued liabilities 3,133 3,486 Other 12,124 12,479 174,173 132,343 Valuation allowances (1) (1,027) (822) Total deferred tax assets 173,146 131,521 Deferred tax liabilities: Property, plant and equipment (6,066) (6,440) Basis difference in the Partnership (103,721) (81,645) Other (7,150) (8,083) Total deferred tax liabilities (116,937) (96,168) Net deferred tax asset (2) $ 56,209 $ 35,353 (1) See “Tax Attributes and Valuation Allowances” below for further details. (2) The 2020 and 2019 net deferred tax asset are reflected in our consolidated balance sheets as deferred tax assets of $56.9 million and $36.6 million, respectively, and deferred tax liabilities of $0.7 million and $1.3 million, respectively. Both the 2020 and 2019 balances are based on a U.S. federal tax rate of 21%. Tax Attributes and Valuation Allowances Pursuant to Sections 382 and 383 of the Code, utilization of loss and credit carryforwards are subject to annual limitations due to any ownership changes of 5% stockholders. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50% over a rolling three-year period. In 2018, the common stock we issued in the Merger caused a new ownership change to occur for Archrock. The limitations from this ownership change may cause us to pay U.S. federal income taxes earlier; however, we do not currently expect that any loss carryforwards or credit carryforwards will expire as a result of any 382 or 383 limitations. Our ability to utilize loss carryforwards and credit carryforwards against future U.S. federal taxable income and future U.S. federal income tax may be limited in the future if we have another 50% or more ownership change in our 5% stockholders. We record valuation allowances when it is more likely than not that some portion or all of our deferred tax assets will not be realized. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character and in the appropriate taxing jurisdictions in the future. If we do not meet our expectations with respect to taxable income, we may not realize the full benefit from our deferred tax assets, which would require us to record a valuation allowance in our tax provision in future years. As of each reporting date, we consider new evidence to evaluate the realizability of our net deferred tax asset position by assessing the available positive and negative evidence. Changes to the valuation allowance are reflected in the statement of operations. In 2018, the change in ownership and tax step up from the consideration given in the Merger caused us to record a $156.0 million deferred tax asset, which resulted in an overall $52.2 million net deferred tax asset, of which $46.6 million and $5.6 million related to continuing operations and discontinued operations, respectively. As of December 31, 2018, we had incurred a three-year cumulative book loss, which outweighed the positive evidence of projected future taxable income. Based on the weight of the evidence, we concluded that a $50.8 million valuation allowance was required, of which $45.2 million and $5.6 million were recorded to continuing operations and discontinued operations, respectively. The tax impact from the Merger was accounted for as an equity transaction; therefore, the valuation allowance was recorded as a decrease to additional paid-in capital. As of December 31, 2019, we achieved a three-year cumulative book income, and together with other positive and negative evidence, we concluded that there is sufficient positive evidence of projected future taxable income to release the $50.8 million valuation allowance previously required for our overall net deferred tax asset position. This release was offset by a $0.6 million increase in the valuation allowance on our state NOL deferred tax asset. The overall impact of the change in the valuation allowance was recorded as a $50.2 million benefit from income taxes in our consolidated statements of operations and a $50.2 million increase in deferred tax assets in our consolidated balance sheets, of which $44.6 million and $5.6 million were recorded to continuing operations and discontinued operations, respectively. The amount of our deferred tax assets considered realizable could be adjusted if projections of future taxable income are reduced or objective negative evidence in the form of a three-year cumulative loss is present or both. Should we no longer have a level of sustained profitability, excluding nonrecurring charges, we will have to rely more on our future projections of taxable income to determine if we have an adequate source of taxable income for the realization of our deferred tax assets, namely NOL carryforwards and tax credit carryforwards. This may result in the need to record a valuation allowance against all or a portion of our deferred tax assets. At December 31, 2020, we had U.S. federal and state NOL carryforwards of $696.3 million and $257.6 million, respectively, included in our NOL deferred tax asset that are available to offset future taxable income. If not used, the federal and state NOL carryforwards will begin to expire in 2025 and 2021, respectively, though $457.3 million of the U.S. federal and $88.3 million of the state NOL carryforwards have no expiration date. In connection with the state NOL deferred tax asset, we recorded a valuation allowance of $1.0 million and $0.8 million as of December 31, 2020 and 2019, respectively. At December 31, 2020, we had U.S. federal and state tax credit carryforwards of $2.5 million and $0.2 million, respectively. If not used, the federal and state tax credit carryforwards will begin to expire in 2037 and 2040, respectively. Unrecognized Tax Benefits A reconciliation of the unrecognized tax benefit (including discontinued operations) activity is shown below (in thousands): Year Ended December 31, 2020 2019 2018 Beginning balance $ 18,453 $ 19,560 $ 21,400 Additions based on tax positions related to current year 2,397 2,227 1,893 Additions based on tax positions related to prior years — 2,047 450 Reductions based on settlement refunds from government authorities — (4,414) (3,461) Reductions based on tax positions related to prior years (73) (51) (20) Reductions based on lapse of statute of limitations (1,885) (916) (702) Ending balance $ 18,892 $ 18,453 $ 19,560 We had $18.9 million, $18.5 million and $19.6 million of unrecognized tax benefits at December 31, 2020, 2019 and 2018, respectively, of which $2.9 million, $3.2 million and $6.9 million, respectively, would affect the effective tax rate if recognized and $7.9 million, $8.3 million and $6.9 million, respectively, would be reflected in income from discontinued operations, net of tax if recognized. We recorded $2.1 million, $2.1 million and $2.2 million of potential interest expense and penalties related to unrecognized tax benefits associated with uncertain tax positions (including discontinued operations) in our consolidated balance sheets as of the years ended December 31, 2020, 2019 and 2018, respectively. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as reductions in income tax expense. During each of the years ended December 31, 2020 and 2019, we recorded releases of potential interest expense and penalties of $0.1 million and in the year ended December 31, 2018, we recorded $0.7 million of potential interest expense and penalties in our consolidated statements of operations. Subject to the provisions of our tax matters agreement with Exterran Corporation, both parties agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. As of December 31, 2020 and 2019, we recorded an indemnification asset (including penalties and interest) of $7.9 million and $8.5 million, respectively, related to unrecognized tax benefits in our consolidated balance sheets. We and our subsidiaries file consolidated and separate income tax returns in the U.S. federal jurisdiction and in numerous state jurisdictions. U.S. federal income tax returns are generally subject to examination for up to three years after filing the returns. Due to our NOL carryforwards, our U.S. federal income tax returns can be examined back to the inception of our NOL carryforwards; therefore, expanding our examination period beyond 20 years. In 2020, the IRS completed their examination of our 2014 and 2015 tax years. Due to this audit being related to tax periods that commenced prior to the Spin-off, Exterran Corporation was also involved in the audit. The tax adjustments recorded from this audit did not have a material impact on our consolidated financial position or results of operations. State income tax returns are generally subject to examination for a period of three to five years after filing the returns. However, the state impact of any U.S. federal audit adjustments and amendments remains subject to examination by various states for up to one year after formal notification to the states. We are currently involved in two state audits. During the years ended December 31, 2019 and 2018, we settled certain state audits, which resulted in refunds of $2.4 million and $1.7 million, respectively, and reductions in previously-accrued uncertain tax benefits of $4.4 million and $3.5 million, respectively. As of December 31, 2020, we did not have any state audits underway that we believe would have a material impact on our consolidated financial statements. As of December 31, 2020, we believe it is reasonably possible that $2.7 million of our unrecognized tax benefits, including penalties, interest and discontinued operations, will be reduced prior to December 31, 2021 due to the settlement of audits or the expiration of statutes of limitations or both. However, due to the uncertain and complex application of the tax regulations, it is possible that the ultimate resolution of these matters may result in liabilities that could materially differ from this estimate. CARES Act On March 27, 2020, President Trump signed into law the CARES Act, which includes, among other things, refundable payroll tax credits, deferment of employer-side social security payments, NOL carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The CARES Act provisions did not have a material impact on our consolidated financial statements. Future regulatory guidance under the CARES Act or additional legislation enacted by Congress in connection with the COVID-19 pandemic could impact our tax provision in future periods. |
