INCOME TAXES

12 Months Ended

Dec. 31, 2016

15. INCOME TAXES

Prior to February 11, 2014, the Company had not been subject to U.S. federal income taxes as the predecessor entity was a Limited Liability Limited Partnership (“LLLP”), but had been subject to the New York City Unincorporated Business Tax (“NYC UBT”). As a result of the IPO, a portion of the Company’s income was subject to U.S. federal, state and local corporate income taxes and taxed at the prevailing corporate tax rates in addition to being subject to NYC UBT. Other than as described below, the Company is operating as a REIT effective January 1, 2015, the Company’s income will generally no longer be subject to U.S. federal, state and local corporate income taxes to the extent such income is distributed to shareholders.

Certain of the Company’s subsidiaries have elected to be treated as TRSs. TRSs permit the Company to participate in certain activities from which REITs are generally precluded, as long as these activities meet specific criteria, are conducted within the parameters of certain limitations established by the Code, and are conducted in entities which elect to be treated as taxable subsidiaries under the Code. To the extent these criteria are met, the Company will continue to maintain its qualification as a REIT. The Company’s TRSs are not consolidated for U.S. federal income tax purposes, but are instead taxed as corporations. For financial reporting purposes, a provision for current and deferred taxes is established for the portion of earnings recognized by the Company with respect to its interest in TRSs.

Components of the provision for income taxes consist of the following ($ in thousands):



	Year Ended December 31,
	2016			2015		2014

Current expense (benefit)
U.S. Federal	$	(386	)	$	9,020	$	23,609
State and local	4,838			2,637		10,170
Total current expense (benefit)	4,452			11,657		33,779
Deferred expense (benefit)
U.S. Federal	1,417			2,247		(4,357		)
State and local	451			653		(2,817		)
Total deferred expense (benefit)	1,868			2,900		(7,174		)
Provision for income tax expense (benefit)	$	6,320		$	14,557	$	26,605

There were $0.8 million, corporate taxes payable (receivable) as of December 31, 2016. Corporate taxes payable (receivable) as of December 31, 2015 were $4.3 million. There were $0.4 million NYC UBT taxes payable (receivable) at December 31, 2016. NYC UBT taxes payable (receivable) at December 31, 2015 were $1.1 million. Prepaid corporate taxes as of December 31, 2016 and December 31, 2015 were $13.4 million and $12.5 million, respectively.

A reconciliation between the U.S. federal statutory income tax rate and the effective tax rate for the years ended December 31, 2016, 2015 and 2014 is as follows:



	Year Ended December 31,
	2016			2015		2014

US statutory tax rate	35.00	%		35.00	%	35.00	%
REIT income not subject to corporate income tax	(34.38	)%		(32.37	)%	—	%
Increase due to state and local taxes	4.41	%	(1)	1.40	%	3.78	%
Deferred tax asset write-off upon conversion to REIT	—	%		1.44	%	—	%
Change in valuation allowance	0.42	%		3.29	%	—	%
Other	(0.19	)%		0.39	%	(17.37	)%
Effective income tax rate	5.26	%		9.15	%	21.41	%


(1)	The increase in state taxes shown above is primarily related to additional tax expense of $3.3 million pertaining to a New York State tax audit, further discussed below.

The differences between the Company’s statutory rate and effective tax rate are largely determined by the amount of income subject to tax by the Company’s TRS subsidiaries. The Company expects that its future effective tax rate will be determined in a similar manner.

As of December 31, 2016 and 2015, the Company’s net deferred tax assets were $2.1 million and $5.0 million, respectively, and are included in other assets in the Company’s combined consolidated balance sheets. The Company believes it is more likely than not that the net deferred tax assets will be realized in the future. Realization of the net deferred tax assets is dependent upon our generation of sufficient taxable income in future years in appropriate tax jurisdictions to obtain benefit from the reversal of temporary differences. The amount of net deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income change. The components of the Company’s deferred tax assets and liabilities are as follows ($ in thousands):



	December 31, 2016			December 31, 2015

Deferred Tax Assets
Basis difference in operating partnerships	$	2,023		$	3,998
Unrealized gains (losses)	99			971
Unrealized gains (losses) - derivatives	5,668			5,239
Valuation allowance	(5,668		)	(5,239		)
Total Deferred Tax Assets	$	2,122		$	4,969

As of December 31, 2016 and 2015, the Company had a deferred tax asset of $5.7 million and $5.2 million, respectively, relating to capital losses which it may only use to offset capital gains. These tax attributes will expire if unused in 2020. As the realization of these assets are not more likely than not before their expiration, the Company has provided a full valuation allowance against this deferred tax asset.

The Company’s tax returns are subject to audit by taxing authorities. Generally, as of December 31, 2016, the tax years 2012, 2013, 2014 and 2015 remain open to examination by the major taxing jurisdictions in which the Company is subject to taxes. The Company acquired certain corporate entities in the IPO Reorganization Transactions. The related acquisition agreements provided an indemnification to the Company by the transferor of any amounts due for any potential tax liabilities owed by these entities for tax years prior to their acquisition. During the three months ended September 30, 2016, management proposed a settlement pertaining to a New York State tax audit for these corporate entities (which are now wholly owned). As a result of the settlement, management recorded income tax expense in the amount of $3.3 million and a corresponding payable to the State of New York. The settlement was finalized during the three months ended December 31, 2016. Pursuant to the indemnification, Management expected to recover such amounts and, accordingly, recorded fee and other income in the amount of $3.3 million as well as a corresponding receivable from the indemnity counterparties. As of December 31, 2016, the Company had recovered $0.5 million, and as of January 31, 2017, the Company recovered all amounts owed by the indemnity counterparties. The IRS has recently begun a routine audit of the Company’s U.S. federal income tax return for tax year 2014. The Company does not expect the audit to result in any material changes to the Company’s financial position. The Company does not expect tax expense to have an impact on either short or long-term liquidity or capital needs.

Under U.S. GAAP, a tax benefit related to an income tax position may be recognized when it is more likely than not that the position will be sustained upon examination by the tax authorities based on the technical merits of the position. A position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized upon settlement. As of December 31, 2016 and 2015, the Company’s unrecognized tax benefit is a liability for $0.8 million and is included in the accrued expenses in the Company’s combined consolidated balance sheets. This unrecognized tax benefit, if recognized, would have a favorable impact on our effective income tax rate in future periods. As of December 31, 2016 and 2015, the Company has not recognized any interest or penalties related to uncertain tax positions. In addition, the Company does not believe that it has any tax positions for which it is reasonably possible that it will be required to record a significant liability for unrecognized tax benefits within the next twelve months.

Tax Receivable Agreement

Upon consummation of the IPO, the Company entered into a Tax Receivable Agreement with the Continuing LCFH Limited Partners. Under the Tax Receivable Agreement the Company generally is required to pay to those Continuing LCFH Limited Partners that exchange their interests in LCFH and Class B shares of the Company for Class A shares of the Company, 85% of the applicable cash savings, if any, in U.S. federal, state and local income tax that the Company realizes (or is deemed to realize in certain circumstances) as a result of (i) the increase in tax basis in its proportionate share of LCFH’s assets that is attributable to the Company as a result of the exchanges and (ii) payments under the Tax Receivable Agreement, including any tax benefits related to imputed interest deemed to be paid by the Company as a result of such agreement. The Company may make future payments under the Tax Receivable Agreement if the tax benefits are realized. We would then benefit from the remaining 15% of cash savings in income tax that we realize. For purposes of the Tax Receivable Agreement, cash savings in income tax will be computed by comparing our actual income tax liability to the amount of such taxes that we would have been required to pay had there been no increase to the tax basis of the assets of LCFH as a result of the exchanges and had we not entered into the Tax Receivable Agreement.

Payments to a Continuing LCFH Limited Partner under the Tax Receivable Agreement are triggered by each exchange and are payable annually commencing following the Company’s filing of its income tax return for the year of such exchange. The timing of the payments may be subject to certain contingencies, including the Company having sufficient taxable income to utilize all of the tax benefits defined in the Tax Receivable Agreement.

As of December 31, 2016 and December 31, 2015, pursuant to the Tax Receivable Agreement, the Company had $2.5 million and $1.9 million, respectively, included in amount payable pursuant to tax receivable agreement in the combined consolidated balance sheets for Continuing LCFH Limited Partners. The amount and timing of any payments may vary based on a number of factors, including the absence of any material change in the relevant tax law, the Company continuing to earn sufficient taxable income to realize all tax benefits, and assuming no additional exchanges that are subject to the Tax Receivable Agreement. Depending upon the outcome of these factors, the Company may be obligated to make substantial payments pursuant to the Tax Receivable Agreement. The actual payment amounts may differ from these estimated amounts, as the liability will reflect changes in prevailing tax rates, the actual benefit the Company realizes on its annual income tax returns, and any additional exchanges.

To determine the current amount of the payments due, the Company estimates the amount of the Tax Receivable Agreement payments that will be made within twelve months of the balance sheet date. As described in Note 1 above, the Tax Receivable Agreement was amended and restated in connection with our REIT Election, effective as of December 31, 2014, in order to preserve a portion of the potential tax benefits currently existing under the Tax Receivable Agreement that would otherwise be reduced in connection with our REIT Election. The purpose of the TRA Amendment was to preserve the benefits of the Tax Receivable Agreement to the extent possible in a REIT, although, as a result, the amount of payments made to the TRA Members under the TRA Amendment is expected to be less than the amount that would have been paid under the original Tax Receivable Agreement. The TRA Amendment continues to share such benefits in the same proportions and otherwise has substantially the same terms and provisions as the prior Tax Receivable Agreement.