Note 8. Income Taxes

Arlington Asset is subject to taxation as a corporation under Subchapter C of the Internal Revenue Code of 1986, as amended (the “Code”). As of September 30, 2018, the Company had estimated net operating loss (“NOL”) carryforwards of $27,988 that can be used to offset future taxable ordinary income. The Company’s NOL carryforwards begin to expire in 2027. As of September 30, 2018, the Company had estimated net capital loss (“NCL”) carryforwards of $390,923 that can be used to offset future net capital gains. The scheduled expirations of the Company’s NCL carryforwards are $136,840 in 2019, $102,927 in 2020, $70,319 in 2021, $3,763 in 2022 and $77,074 in 2023.

Income taxes are provided for using the asset and liability method. Deferred tax assets and liabilities reflect the impact of temporary differences between the carrying amount of assets and liabilities pursuant to the application of GAAP and their respective tax bases and are stated at tax rates expected to be in effect when the taxes are actually paid or recovered. Deferred tax assets are also recognized for NOL carryforwards and NCL carryforwards.

On December 22, 2017, the President signed the Tax Cuts and Jobs Act, which provides for substantial changes to the federal taxation of individuals and corporations with an effective date of January 1, 2018. For corporate taxpayers, the federal income tax rate was lowered from 35.0% to 21.0%. The effects of changes in tax laws and rates on deferred tax assets and liabilities are required to be recognized in the period in which the legislation is enacted as a discrete item within the income tax provision. Accordingly, the Company recorded the effect of the decrease in the federal tax rate on the Company’s deferred tax assets and liabilities as of December 31, 2017.

Through December 31, 2017, the Company was subject to federal alternative minimum tax (“AMT”) on its taxable income and gains that are not offset by its NOL and NCL carryforwards with any AMT credit carryforwards available to offset future regular tax liabilities. As part of the Tax Cuts and Jobs Act, the corporate AMT is repealed for tax years beginning after December 31, 2017 with any AMT credit carryforward after that date continuing to be available to offset a taxpayer’s future regular tax liability. In addition, for tax years beginning in 2018, 2019 and 2020, to the extent that AMT credit carryforwards exceed the regular tax liability, 50% of the excess AMT credit carryforwards would be refundable in that year with any remaining AMT credit carryforwards fully refundable in 2021. As a result, the realizability of the Company’s AMT credit carryforward is now certain and will now be realized as either a cash refund or as an offset to future regular tax liabilities or a combination of both. Accordingly, the Company reclassified its AMT credit carryforward from net deferred tax assets to a receivable as of December 31, 2017. As of September 30, 2018 and December 31, 2017, the Company had AMT credit carryforwards of $9,132 and $9,133, respectively, included in other assets on the accompanying consolidated balance sheets.

A valuation allowance is provided against the deferred tax asset if, based upon the Company’s evaluation, it is more-likely-than-not that some or all of the deferred tax assets will not be realized. All available evidence, both positive and negative, is incorporated into the determination of whether a valuation allowance for deferred tax assets is appropriate. Items considered in the valuation allowance determination include expectations of future earnings of the appropriate tax character, recent historical financial results, tax planning strategies, the length of statutory carry-forward periods and the expected timing of the reversal of temporary differences.

As of September 30, 2018 and December 31, 2017, the Company determined that it should record a full valuation allowance against its deferred tax assets that are capital in nature, which consists of its NCL carryforwards and temporary GAAP to tax differences that are expected to result in capital losses in future periods. As of September 30, 2018 and December 31, 2017, the Company determined that it should not record any valuation allowance against its deferred tax assets that are ordinary in nature, which consists of its NOL carryforwards and temporary GAAP to tax differences that are expected to result in deductions from ordinary income in future periods. For the three and nine months ended September 30, 2018, the Company recorded an increase to its valuation allowance of $8,503 and $40,833, respectively.

Deferred tax assets and liabilities consisted of the following as of the dates indicated:

	September 30, 2018			December 31, 2017
Ordinary deferred tax assets:
NOL carryforward	$	7,204		$	15,619
Deferred net loss on designated hedges		—			4,381
Stock-based compensation		1,726			1,999
Other, net		86			19
Total ordinary deferred tax assets		9,016			22,018
Ordinary deferred tax liabilities:
Deferred net gain on designated hedges		(4,443	)		—
Net unrealized gain on designated hedges		(38,212	)		(21,218	)
Total ordinary deferred tax liabilities		(42,655	)		(21,218	)
Ordinary deferred tax (liabilities) assets, net		(33,639	)		800

Capital deferred tax assets:
NCL carryforward		100,624			80,895
Net unrealized loss on investments		44,535			23,431
Valuation allowance		(145,159	)		(104,326	)
Total capital deferred tax assets, net		—			—
Total deferred tax (liabilities) assets, net	$	(33,639	)	$	800

The Company expects to fully utilize its net operating loss carryforward during 2019, although changes to the composition and size of the portfolio and actual higher or lower than expected future taxable income could change that estimate. As a result, the Company is currently evaluating possible long-term tax structures, including potentially electing to be taxed as a real estate investment trust (“REIT”) as early as January 1, 2019. However, there is no certainty as to the timing of a REIT election or whether the Company will make a REIT election at all. If the Company were to elect to be taxed as a REIT, it would require, among other things, approval from its board of directors and certain changes to its organization documents. The Company does not anticipate that significant modifications to its investment portfolio or operations would be required to qualify as a REIT. If or when the Company determines that it is prepared to qualify as a REIT in all material respects and it commits itself to a REIT election, the Company expects that its deferred tax assets and liabilities would be derecognized from its consolidated balance sheets with a corresponding impact to its consolidated statements of comprehensive income.

On May 30, 2018, the Company received an assessment of $9,380 from Arlington County, Virginia for a business, professional and occupation license (“BPOL”) tax for calendar year 2017. The BPOL tax is a local privilege tax on a business’ gross receipts for conducting business activities subject to licensure within Arlington County. The Company has not been assessed or paid any such BPOL tax prior to calendar year 2017. The Company does not believe it is subject to the BPOL tax. During the second quarter of 2018, the Company filed an administrative appeal with Arlington County. During the third quarter of 2018, Arlington County denied the Company’s administrative appeal and, subsequently, the Company filed an administrative appeal with the Tax Commissioner of Virginia. The Company intends to fully contest the assessment. As of September 30, 2018, the Company does not believe that it is probable that is has incurred a BPOL tax liability.