INCOME TAXES

12 Months Ended

Dec. 31, 2019

NOTE 14. INCOME TAXES

In 2019, the Company recorded an income tax benefit of $11.0 million, including a $11.8 million decrease in the deferred tax asset valuation allowance as a result of management’s reassessment, as of December 31, 2019, of the Company’s ability to utilize tax net operating losses (“NOLs”) to offset future taxable income. During 2019, Orchid raised capital, which is expected to result in an increase in future management fee revenue. Because of this increase in cash flows, and projections for future growth, management has revised its estimated utilization of NOL carryforwards in future periods, resulting in a decrease in the deferred tax valuation asset allowance at December 31, 2019.

In 2018, the Company recorded an income tax provision of $21.1 million, including a $22.5 million increase in the deferred tax asset valuation allowance as a result of management’s reassessment, as of December 31, 2018, of the Company’s ability to utilize NOLs to offset future taxable income. During 2018, Orchid’s book value and monthly dividend decreased, which caused decreases in management fee revenue and dividend income on Orchid stock. Because of this decrease in cash flows in 2018, management revised its estimated utilization of NOL carryforwards in future periods, which resulted in an increase in the deferred tax valuation asset allowance recorded in 2018.

The income tax (benefit) provision included in the consolidated statements of operations consists of the following for the years ended December 31, 2019 and 2018:

(in thousands)
		2019		2018
Current	$	(196)	$	(195)
Deferred		(10,800)		21,322
Income tax (benefit) provision, net	$	(10,996)	$	21,127

The net income tax provision differs from the amount computed by applying the federal income tax statutory rate of 21 percent on income or loss before income tax expense. A reconciliation for the years ended December 31, 2019 and 2018 is presented in the table below.

(in thousands)
		2019		2018
Federal tax (benefit) based on statutory rate applicable for each year	$	634	$	(1,187)
State income tax (benefit)		164		(311)
(Decrease) increase of deferred tax asset valuation allowance		(11,824)		22,512
Other		30		113
Income tax (benefit) provision	$	(10,996)	$	21,127

Deferred tax assets consisted of the following as of December 31, 2019 and 2018:

(in thousands)
			2019		2018
Deferred tax assets:
	Net operating loss carryforwards	$	58,250	$	58,737
	Orchid Island Capital, Inc. common stock		3,338		3,318
	MBS		(377)		1,976
	Capital loss carryforwards		1,743		875
	Management agreement		813		813
	Other		1,148		219
			64,915		65,938
Valuation allowance			(30,912)		(42,735)
Net deferred tax assets		$	34,003	$	23,203

As of December 31, 2019 and 2018, Bimini Capital had tax capital loss carryforwards of approximately $0.1 million and $0.3 million, respectively, which can be used to offset future realized tax capital gains. The capital loss carryforwards will expire at December 31, 2020, if they are unused. In addition, as of December 31, 2019 and 2018, Bimini Capital had estimated federal NOL carryforwards of approximately $19.0 million and $18.8 million, respectively, and estimated Florida NOL carryforwards of $18.4 million and $18.1 million, respectively. The NOL carryforwards can be used to offset future taxable income and will begin to expire in 2030.

As of December 31, 2019 and 2018, Royal Palm had tax capital loss carryforwards of approximately $6.8 million and $3.2 million, respectively, which can be used to offset future realized tax capital gains. The capital loss carryforwards will begin to expire in 2022. In addition, as of December 31, 2019, Royal Palm had estimated federal NOL carryforwards of approximately $248.1 million and estimated available Florida NOLs of approximately $20.7 million. As of December 31, 2018, Royal Palm had estimated federal NOL carryforwards of approximately $250.2 million and estimated available Florida NOL carryforwards of approximately $22.8 million. These NOLs can be used to offset future taxable income and will begin to expire in 2025.

In connection with Orchid’s 2013 IPO, Bimini Advisors paid for, and expensed for GAAP purposes, certain offering costs totaling approximately $3.2 million. For tax purposes, these offering costs created an intangible asset related to the management agreement with a tax basis of $3.2 million. The deferred tax asset related to the intangible asset at December 31, 2019 and 2018 totaled approximately $0.8 million and $0.8 million, respectively.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of capital loss and NOL carryforwards is dependent upon the generation of future capital gains and taxable income in periods prior to their expiration. The valuation allowance is based on management’s estimated projections of future taxable income, and the projected ability to utilize the separate NOL carryforwards of Bimini Capital and Royal Palm to offset that projected taxable income before the NOLs expire. Management has undertaken tax planning strategies in an effort to maximize the potential for future NOL utilization, including the restructuring of certain subsidiaries and assets of the Company. With respect to the taxable income projections, management must estimate the dividends to be received on its Orchid share holdings as well as the management fees and overhead sharing payments it will receive from Orchid. With respect to the MBS portfolio, management makes estimates of various metrics such as the yields on the assets it will acquire, its future funding and interest costs, future prepayment speeds and net interest margin, among others. Estimates are also made for other assets and expenses. Changes in the taxable income projections have a direct impact on the amount of the valuation allowance, and the impact in any reporting period may be significant. Utilization of the NOLs is based on these estimates and the assumptions that management will be able to reinvest retained earnings in order to grow the MBS portfolio going forward and that market value will not be eroded due to adverse market conditions or hedging inefficiencies. These estimates and assumptions may change from year to year to the extent Orchid’s book value changes, thus changing projected management fees and overhead sharing payments, and/or market conditions, including changes in interest rates, such that estimates with respect to the portfolio metrics warrant revisions.

Royal Palm holds residual interests in various real estate mortgage investment conduits (“REMICs”), some of which generate excess inclusion income (“EII”), a type of taxable income pursuant to specific provisions of the Code. During 2010 (as part of the filing of its 2009 tax returns), Royal Palm reached a tax filing position related to the EII taxable income that was different from what was reported in previous periods, and included a notice of inconsistent treatment in its tax returns. Royal Palm continues to file its tax returns following its 2009 tax filing position, and it continues to include a notice of inconsistent treatment in each return. During 2018, the Company completed a transaction whereby certain securitizations associated with its REMIC positions were terminated by exercising the Company’s optional early termination rights. However, the tax filing position which began in 2009 will continue with respect to the remaining securitizations.

The Company does not believe it has any unrecognized tax benefits included in its consolidated financial statements. The Company has not had any settlements in the current period with taxing authorities, nor has it recognized tax benefits as a result of a lapse of the applicable statute of limitations.