10. Income Taxes

The Company records federal and state income tax liabilities associated with its status as a corporation. The Company recognizes a tax liability on its share of pre-tax book income, exclusive of the non-controlling interest. JEH is not subject to income tax at the federal level and only recognizes Texas franchise tax expense.

The Company’s effective tax rate was (0.6)% and 18.1% for the three months ended March 31, 2017 and 2016, respectively. The effective tax rate reduction is primarily due to the effect of the valuation allowance recorded against the Company’s deferred tax assets. The effective rate differs from the statutory rate of 35% due to net income allocated to the non-controlling interest, percentage depletion, state income taxes, the valuation allowance recorded against deferred tax assets, and other permanent differences between book and tax accounting.

The Company’s income tax provision was an expense of less than $0.1 million and of $10.7 million for the three months ended March 31, 2017 and 2016, respectively.

The following table summarizes information related to the allocation of the income tax provision between the controlling and non-controlling interests:


	Three Months Ended March 31,
(in thousands of dollars)	2017		2016
Jones Energy, Inc.	$	14	$	10,569
Non-controlling interest		7		134
Income tax provision (benefit)	$	21	$	10,703

The Company had deferred tax assets for its federal and state net operating loss carry forwards at March 31, 2017 recorded in its deferred taxes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of March 31, 2017, we have a valuation allowance of $4.1 million as a result of management’s assessment of the realizability of federal and state deferred tax assets. Management believes that there will be sufficient future taxable income based on the reversal of temporary differences to enable utilization of substantially all other tax carryforwards.

Tax Receivable Agreement

In connection with the IPO, the Company entered into a Tax Receivable Agreement (the “TRA”) which obligates the Company to make payments to certain current and former owners equal to 85% of the applicable cash savings that the Company realizes as a result of tax attributes arising from exchanges of JEH Units and shares of the Company’s Class B common stock held by those owners for shares of the Company’s Class A common stock. The Company will retain the benefit of the remaining 15% of these tax savings. At the time of an exchange, the company records a liability to reflect the future payments under the TRA.

The actual amount and timing of payments to be made under the TRA will depend upon a number of factors, including the amount and timing of taxable income generated in the future, changes in future tax rates, the use of loss carryovers, and the portion of the Company’s payments under the TRA constituting imputed interest. In the event that the Company records a valuation allowance against its deferred tax assets associated with an exchange, the TRA liability will also be reduced as the payment of the TRA liability is dependent on the realizability of the deferred tax assets. As of March 31, 2017 and December 31, 2016, the amount of the TRA liability was reduced by $3.3 million and $2.7 million, respectively, as a result of the valuation allowance recorded against the Company’s deferred tax assets. To the extent the Company does not realize all of the tax benefits in future years or in the event of a change in future tax rates, this liability may change.

As of March 31, 2017 and December 31, 2016, the Company had recorded a TRA liability of $42.4 million and $43.0 million, respectively, for the estimated payments that will be made to the Class B shareholders who have exchanged shares, after adjusting for the TRA liability reduction, along with corresponding deferred tax assets, net of valuation allowance, of $49.7 million, and $50.6 million, respectively, as a result of the increase in tax basis generated arising from such exchanges.

As of March 31, 2017, the Company had not made any significant payments under the TRA to Class B shareholders who have exchanged JEH Units and Class B common stock for Class A common stock. The Company anticipates making a payment of approximately $0.6 million under the TRA with respect to cash savings that the Company will realize on its 2016 tax returns as a result of tax attributes arising from prior exchanges, to be paid in the first quarter of 2018.

Cash Tax Distributions

The holders of JEH Units, including Jones Energy, Inc., incur U.S. federal, state and local income taxes on their share of any taxable income of JEH. Under the terms of its operating agreement, JEH is generally required to make quarterly pro-rata cash tax distributions to its unitholders (including us) based on income allocated to its unitholders through the end of each relevant quarter, as adjusted to take into account good faith projections by the Company of taxable income or loss for the remainder of the calendar year, to the extent JEH has cash available for such distributions and subject to certain other restrictions.

A Special Committee of the Board of Directors comprised solely of directors who do not have a direct or indirect interest in such distribution approved, and JEH made, aggregate cash tax distributions during the three months ended March 31, 2017 of $1.7 million. The distributions were made pro-rata to all members of JEH, and included a $1.1 million payment to the Company and a $0.6 million payment to Class B shareholders. The tax distributions were paid as a result of JEH’s 2016 taxable income. During the three months ended March 31, 2016 the Company did not make any tax distributions.