INCOME TAXES

The Company has elected to be treated as a REIT under federal income tax laws. As a REIT, the Company is generally not subject to federal income taxation at the corporate level to the extent that it distributes 100% of its taxable earnings to shareholders annually and does not engage in prohibited transactions. Certain activities of the Company that produce prohibited income are conducted through a taxable REIT subsidiary ("TRS"), FOAC, to protect REIT election and FOAC is therefore subject to tax as a U.S. C-Corporation. To maintain our REIT election, the Company must continue to meet certain ownership, asset and income requirements set forth in the Code. As further discussed below, the Company may be subject to non-income taxes on excess amounts of assets or income that cause a failure of any of the REIT testing requirements.

Impacts of Tax Reform:

On December 22, 2017, the Tax Cut and Jobs Act (H.R. 1) (the "Tax Act") was signed into law. The Tax Act contains significant changes to corporate taxation, including the reduction of the corporate income tax rate to 21%. The Company has substantially completed our assessment of the effects of the Tax Act and were able to determine reasonable estimates for the impacts of the items specified below. The Company continues to monitor and analyze the application of the “Tax Act” to our business and continue to assess our provision for income taxes as future guidance is issued.

The key impacts of the Tax Act on the Company's financial statements for the year ended December 31, 2017 were:

(1) the federal statutory tax rate was reduced to 21% down from 35% in previous years. The related re-measurement of the deferred tax asset resulted in a reduction of $364,000 as of December 31, 2017. This amount is fully offset by a corresponding reduction to the valuation allowance as discussed in the paragraph below; and

(2) taxpayers that have existing AMT credit from previously paid AMT tax will be allowed to offset their regular tax liability for any future taxable year. Additionally, the AMT credit will be refundable for any taxable year beginning after December 31, 2017 and before January 1, 2022 in an amount equal to 50% of the excess AMT credit for the taxable year over the amount of the credit allowable for the year against regular tax liability. In tax year 2021, 100% of any remaining excess AMT credit will be refunded. As a result, the valuation allowance attributable to prior years AMT credit in the amount of $19,000 is released and AMT credit accrued for the current year is recognized in the deferred tax asset.

The following table reconciles the Company’s TRS GAAP net income (loss) to taxable income (in thousands):



	Year Ended December 31,
	2018		2017
	(in thousands)		(in thousands)
GAAP consolidated net income (loss) attributable to Hunt Companies Finance Trust, Inc.	(3,950	)	4,707
GAAP net loss (income) from REIT operations	5,241		(4,645	)
GAAP net income (loss) of taxable subsidiary	1,291		62
Capitalized transaction fees	(41	)	(41	)
Unrealized gain (loss)	(20	)	639
Deferred income	(222	)	19
Tax income (loss) of taxable subsidiary before utilization of net operating losses	1,008		679
Utilizations of net operating losses	(288	)	(679	)
Net tax income of taxable subsidiaries	720		—

The following is a reconciliation of the statutory federal and state tax rates to the effective rates, for the years ended December 31, 2018 and 2017:



	Year Ended December 31,
	2018		2017
	(in thousands)		(in thousands)
U.S. Federal Statutory Income Tax	(830	)	1,601
State Taxes	61		1
REIT loss (income) not subject to federal income tax	1,101		(1,579	)
Tax effect of U.S. corporate rate change	—		364
REIT Testing Income Tax⁽¹⁾	1,956
Valuation Allowance	(767	)	(406	)
Total income tax provision (benefit)	1,522		(19	)
Effective income tax rate	(38.50	)%	0.41	%


(1)	Please see REIT Testing and Tax on 75% Income Test Failure

The TRS has a deferred tax asset (liability), comprised of the following (in thousands):



	As of December 31, 2018	As of December 31, 2017
Accumulated net operating losses of TRS	263	337
Unrealized gain (loss)	245	251
Capitalized transaction costs	112	122
Deferred income	—	57
AMT Credit	—	19
Deferred tax asset	620	786
Valuation allowance	—	(767	)
Net non-current deferred tax asset (liability)	620	19

The Company had provided a valuation allowance against it deferred tax assets for the year ended December 31, 2017, except for the refundable AMT credit as discussed above. The Company recorded a 100% valuation allowance related to the TRS net deferred tax asset because it believed it was more likely than not that the deferred tax asset would not be fully realized. During 2018, the TRS reported GAAP earnings of $1.3 million which, when combined with the prior two years of profit and loss, resulted in cumulative GAAP earnings for the prior three years. The history of earnings, combined with the introduction of a new investment at the TRS in the fourth quarter of 2018, results in the Company's determination that, as of December 31, 2018, it is more likely than not that the Company will realize benefit from its deferred tax assets in subsequent periods. Therefore, the Company has reversed the valuation allowance effective as of December 31, 2018, the impact of which is reported as part of the net deferred tax benefit in the current period. At December 31, 2018, and 2017, the TRS had net operating loss carryforwards for federal income tax purposes of $1.0 million and $1.3 million, which are available to offset future taxable income and begin expiring in 2034.

As of December 31, 2018, the Company is not aware of any material uncertain tax positions, but the Company could be subject to federal and state tax audits for its tax years of 2015, 2016 and 2017.

REIT Testing and Tax on 75% Income Test Failure:

During tax years 2017 and 2018 the Company passed all the requisite ownership, asset and income tests, with the exception of the 2018 test under Section 856(c)(3) of the Code, also known as the 75% Income Test. The 75% Income Test requires that at least 75% of the gross income earned by the Company be generated by qualifying real estate income, including interest income on mortgages and realized gain on the sale of real estate assets. In our case, the gains generated by the asset protection hedging strategy resulting from the complete disposition of the MBS asset portfolio during 2018 were determined to be non-qualified income for purpose of the 75% Income Test and resulted in a failure of the 75% Income Test for the year-ended December 31, 2018. As a result, the Company also owed an income tax on the amount of the gross income that exceeded the 75% Income Test threshold. The calculation of the tax under Section 857(b)(5) of the Code resulted in an accrued tax liability of $1.96 million for 2018, which is reflected as part of the "(Provision for) benefit from income taxes" in the Company's consolidated statement of operations and "Other accounts payable and accrued expenses" in the Company's consolidated balance sheet. The Company believes it more likely than not that our REIT election will not be impacted in the current or future periods.

Deficiency Dividend:

The Company declared and paid in the fourth quarter of 2016 a deficiency dividend relating to a determination of an inability to offset certain net gains on hedging transactions in 2013 against net capital losses on the sale of certain mortgage-backed securities. In connection with this declaration, the Company provisioned an amount of $1.86 million in 2016 for interest charges expected to be paid to the IRS following the payment of the dividend. On March 8, 2017, the Company paid an amount of $2.01 million to the IRS for interest charges related to the fourth quarter 2016 deficiency dividend payment. The amount paid exceeded the provision of $1.86 million taken in 2016 due to the timing of the payment and accordingly the Company recorded additional interest expense of $0.15 million, which is included in "Other interest expense" in the Company's consolidated statements of operations. The first quarter 2017 payment of $2.01 million is included in "cash paid for interest" in the Company's consolidated statements of cash flows.