Income Taxes

12 Months Ended

Dec. 31, 2019

An income tax benefit (expense) of $21.5 million, less than $(0.1) million and $6.6 million has been recognized for the years ending December 31, 2019, 2018, and 2017, respectively. Our loss before provision for income taxes was as follows (in thousands):



	For the Years Ended December 31,
	2019			2018			2017
Domestic	$	(328,161	)	$	(54,681	)	$	(76,404	)
Foreign	1,045			530			—
Loss before income taxes and non-controlling interests	$	(327,116	)	$	(54,151	)	$	(76,404	)

Components of income tax expense (benefit) (in thousands) consist of the following:



	For the Years Ended December 31,
	2019			2018			2017
Current
Federal	$	1,175		$	458		$	368
State and local	14			9			266
Foreign	399			251			—
Total current tax expense	1,588			718			634
Deferred
Federal	(27,334		)	(14,820		)	3,202
State and local	(5,046		)	(2,252		)	(3,102		)
Foreign	6			(49		)	—
Total deferred tax expense	(32,374		)	(17,121		)	100
Change in valuation allowance	9,250			16,443			(7,371		)
Total tax expense (benefit)	$	(21,536	)	$	40		$	(6,637	)

As of December 31, 2019 and 2018, the Company has accrued income taxes payable of $0.6 million and $0.5 million, respectively, which is recorded in accrued liabilities on the consolidated balance sheets.

A reconciliation of the U.S. statutory tax rate to our effective tax rate and our statutory rate is presented below:



	For the Years Ended December 31,
	2019		2018		2017
U.S. statutory tax rate	21.0	%	21.0	%	35.0	%
U.S. state income taxes, net of U.S. federal tax benefit	4.4	%	3.6	%	3.3	%
Foreign earnings at other than U.S. rates	(0.1	)%	(0.2	)%	—	%
Change in valuation allowance	(2.8	)%	(30.4	)%	(34.0	)%
Change in valuation allowance, tax reform	—	%	—	%	43.7	%
Impact of tax reform	—	%	—	%	(36.0	)%
Non-deductible goodwill impairment	(15.8	)%	—	%	—	%
Non-controlling interest	(0.3	)%	(0.7	)%	(4.6	)%
Excess tax benefits on stock-based compensation	(0.2	)%	3.9	%	3.1	%
Federal and state research tax credits	—	%	4.5	%	—	%
Change in uncertain tax positions	0.1	%	(1.1	)%	—	%
Effect of investment in MHG	(1.4	)%	—	%	—	%
Change in indefinite reinvestment assertion for domestic subsidiaries	2.6	%	—	%	—	%
Other, net	(0.8	)%	(0.7	)%	(1.8	)%
Effective rate	6.7	%	(0.1	)%	8.7	%

Deferred tax balances reflect the impact of temporary differences between the carrying amount of assets and liabilities and their tax basis and are stated at the tax rates in effect when the temporary differences are expected to be recovered or settled.

Significant components of the Company’s deferred tax assets and liabilities (in thousands) were as follows:



	As of December 31,
	2019			2018
Deferred Tax Assets
Start-up and organizational costs	$	149		$	160
Internally developed software costs	—			3,283
Goodwill	19,142			—
Operating lease liabilities	18,055			—
Accrued expenses	9,534			—
Stock based compensation	8,899			—
Net operating loss carryforwards	112,316			76,019
Federal and state research tax credits	1,828			1,828
Other	3,941			861
Subtotal	173,864			82,151
Valuation allowance	(50,815		)	(37,037		)
Total deferred tax assets	123,049			45,114

Deferred Tax Liabilities
Internally developed software costs	14,603			—
Intangible assets	58,655			26,710
Outside basis differences	5,865			43,492
Right-of-use assets - Operating	16,180			—
Contract fulfillment costs	9,510			—
Convertible debt	15,732			—
Fixed assets	796			—
Other	3,650			—
Total deferred tax liabilities	124,991			70,202
Net deferred tax assets (liabilities)	$	(1,942	)	$	(25,088	)

As a result of the Company’s acquisition of all remaining Class B units of Evolent Health, LLC, the Company has full ownership of the assets and liabilities of Evolent Health LLC. Therefore, the Company no longer provides for deferred taxes with respect to its outside basis difference in its investment in Evolent Health LLC and recognizes such based on the differences in the financial reporting and tax basis of Evolent Health LLC’s assets and liabilities.

Changes in our valuation allowance (in thousands) were as follows:



	For the Years Ended December 31,
	2019		2018			2017
Balance at beginning-of-year	$	37,037	$	53,201		$	26,376
Charged to costs and expenses	9,250		16,443			(7,371		)
Charged to other accounts ⁽¹⁾	4,528		(32,607		)	34,196
Balance at end-of-year	$	50,815	$	37,037		$	53,201


⁽¹⁾	Amounts charged to other accounts includes an increase of $4.5 million and a decrease of $32.6 million and an increase of $34.2 million charged to additional paid-in-capital for the years ended December 31, 2019, 2018 and 2017, respectively.

For the year ended December 31, 2019, the effective tax rate was 6.7%, and the corresponding tax benefit recorded was $21.5 million. Our effective tax rate in 2019 was impacted by the tax expense for the impairment of non-deductible goodwill, change in valuation allowance for current year losses, and offset in part by the tax effects resulting from the Company’s acquisition of all remaining Class B units of Evolent Health, LLC, resulting in it becoming a disregarded entity for U.S. federal and state income purposes on December 26, 2019. The change in Evolent Health, LLC’s tax status results in a tax benefit from the reversal of the Company’s deferred tax liability related to its investment in certain U.S. corporate subsidiaries through Evolent Health, LLC, offset by an increase in valuation allowance. In addition, the Company intends to file a consolidated tax return beginning January 1, 2020, which results in a tax benefit offsetting the change in valuation allowance to the extent the deferred tax liabilities of our U.S. corporate subsidiaries can be used as a source of future taxable income to support the Company’s deferred tax assets. Our valuation allowance assessment is made without considering deferred tax liabilities of $1.9 million established with respect to certain indefinite-lived components that cannot be utilized against indefinite-lived deferred tax assets or components that are expected to reverse outside of the net operating loss carryover period, as these are not considered a source of future taxable income for realizing our deferred tax assets.

For the year ended December 31, 2018, the effective tax rate was (0.1)%, due to the impact of the valuation allowance recorded against the Company’s net deferred tax assets, with the exception of indefinite lived components and those expected to reverse outside of the net operating loss carryover period as part of the outside basis difference in our partnership interest in Evolent Health LLC.

For the year ended December 31, 2017, the effective tax rate was 8.7%, due to the impact of the valuation allowance recorded against the Company’s net deferred tax assets, with the exception of indefinite lived components and those expected to reverse outside of the net operating loss carryover period as part of the outside basis difference in our partnership interest in Evolent Health LLC. The benefit recorded during the year primarily relates to the effects of the Tax Act, largely due to the revaluation of our deferred tax assets and liabilities for the new statutory income tax rate, and release of valuation allowance related to indefinite-lived intangible deferred tax liabilities now considered a source of income as support for the realization of future indefinite-lived NOL deferred tax assets.

On December 22, 2017, the U.S. government enacted the Tax Act. The Tax Act establishes new U.S. tax laws impacting the Company, which included a reduction of the U.S. corporate income tax rate from 35% to 21% effective for tax years beginning after December 31, 2017, an indefinite carryforward period and 80% taxable income limitation on NOLs arising after December 31, 2017, and the repeal of the corporate alternative minimum tax. As of December 31, 2017, the Company had recorded a provisional estimate of $5.8 million tax benefit for the financial statement impact of the Tax Act in accordance with SEC Staff Accounting Bulletin No. 118. As of December 22, 2018, the Company had completed the analysis based on legislative updates relating to the Tax Act currently available, which resulted in an additional SAB 118 tax benefit of $0.3 million.

As of December 31, 2019, the Company had $203 million of federal and $257 million of state NOL carryforwards available to offset future taxable income that begin to expire in 2032 and 2022, respectively, and $236 million federal and $137 million of state NOLs with an indefinite carryforward period, subject to a utilization limit of 80% of taxable income in any given year. However, as realization of such tax benefit is not more likely than not, based on our evaluation, we have established a valuation allowance. Internal Revenue Code Section 382 imposes limitations on the utilization of NOLs in the event of certain changes in ownership of the Company, which may have occurred or could occur in the future. This could impose an annual limit on the Company’s ability to utilize NOLs and could cause U.S. federal income taxes to be paid earlier than otherwise would be paid if such limitations were not in effect.

As of December 31, 2019, the Company had $2.1 million and $0.3 million of research and development credits for federal and state income tax purposes, which could expire unutilized beginning in 2037 and 2028, respectively. The Company has established valuation allowance against those credits.

Changes in our unrecognized tax benefits (in thousands) were as follows:



	For the Years Ended December 31,
	2019			2018			2017
Balance at beginning-of-year	$	934		$	762		$	—
Gross increases - tax positions in prior period	—			934			1,108
Gross decreases - tax positions in prior period	—			(762		)	—
Gross increases - tax positions in current period	—			—			74
Lapse of statute of limitations	(181		)	—			—
Change in tax rate	—			—			(420		)
Balance at end-of-year	$	753		$	934		$	762

We are subject to taxation in various jurisdictions in the U.S. and India. Tax years 2011 an all subsequent periods remain subject to examination by the U.S. federal and state taxing jurisdictions due to the availability of NOL carryforwards. Included in the balance of unrecognized tax benefits as of December 31, 2019, are $0.8 million of tax benefits that, if recognized, would not affect the overall effective tax rate, due to the offsetting impact on the Company’s valuation allowance. The Company has not recognized interest and penalties related to uncertain tax positions due to the current NOL position. The Company had recognized $0.9 million of uncertain tax positions as of December 31, 2018, and $0.8 million as of December 31, 2017. The Company and its subsidiaries are not currently subject to income tax audits in any U.S. state or local jurisdiction, or any foreign jurisdiction, for any tax year.

Tax Receivables Agreement

Pursuant to the Offering Reorganization, Class B Exchanges are expected to increase our tax basis in our share of Evolent Health LLC’s tangible and intangible assets. These increases in tax basis are expected to increase our depreciation and amortization deductions and create other tax benefits and, therefore, may reduce the amount of tax that we would otherwise be required to pay in the future. In addition, certain NOLs of Evolent Health Holdings (and of an affiliate of TPG) are available to us as a result of the Offering Reorganization.

In connection with the Offering Reorganization, we entered into the TRA with the holders of Class B common units. The agreement requires us to pay to such holders 85% of the cash savings, if any, in U.S. federal, state and local and foreign income tax (as applicable) we realize as a result of any deductions attributable to future increases in tax basis following the Class B Exchanges (calculated assuming that any post-offering transfer of Class B common units had not occurred) or deductions attributable to imputed interest or future increases in tax basis following payments made under the TRA. We are accounting for these payments as contingent liabilities and will recognize them in our Consolidated Statements of Operations and Comprehensive Income (Loss) when their realization is probable. Additionally, pursuant to the same agreement we will pay the former stockholders of Evolent Health Holdings 85% of the amount of the cash savings, if any, in U.S. federal, state and local and foreign income tax that we realize as a result of the utilization of the NOLs of Evolent Health Holdings (and the affiliate of TPG) attributable to periods prior to the Offering Reorganization, approximately $79.3 million, as well as deductions attributable to imputed interest on any payments made under the agreement.

We will benefit from the remaining 15% of any realized cash savings. The TRA was effective upon the completion of the Offering Reorganization and will remain in effect until all such tax benefits have been used or expired, or until the agreement is terminated. See Note 9 for additional discussion of the implications of the TRA.