Income Taxes

12 Months Ended

Dec. 31, 2022

Income Tax Disclosure [Abstract]

Income Taxes

Income Taxes

Income Tax Expense

For the years ended December 31, 2022 and 2021, the Company recorded income tax expense of $7.0 million and $18.4 million, respectively, which reflects an effective tax rate of (18.8)% and (37.0)%, respectively. The Company's income tax expense in 2022 was primarily driven by change in the valuation allowance on German and U.S. Federal and State deferred tax assets, impairment of goodwill and the foreign tax rate differential. The Company's income tax expense in 2021 was primarily driven by U.S. Federal and state taxes, change in the valuation allowance on Federal and state deferred tax assets and German net operating losses and interest carryforwards, and non-deductible German share-based compensation arrangements.

The components of the loss before income taxes are as follows:

	Year Ended December 31,
(in thousands)	2022		2021
Germany	$	(7,290)	$	(5,852)
Foreign	(29,908)		(43,905)
Total	$	(37,198)	$	(49,757)

The components of the income tax expense (benefit) are as follows:

	Years Ended December 31,
(in thousands)	2022		2021
Current tax expense:
Germany	721		2,260
Foreign	38		797
Total current tax expense	$	759	$	3,057
Deferred tax expense (benefit):
Germany	6,903		239
Foreign	(670)		15,102
Total deferred tax expense	$	6,233	$	15,341
Income tax expense	$	6,992	$	18,398

The statutory income tax rate of the Company is determined by the tax rate of Spark Networks SE, consisting of the German corporate income tax of 15.8%, including the solidarity surcharge, as well as the trade tax of 14.4%.

Reported income tax expense differed from the amounts computed by applying the combined German corporate and trade income tax rate of 30.2% in both 2022 and 2021 to loss before income taxes as a result of the following:

	Year Ended December 31,
(in thousands)	2022		2021
Income tax (benefit) at statutory rate	$	(11,225)	$	(15,014)
Foreign tax rate differential	2,090		10,538
Impairment of goodwill	4,657		4,575
Change in valuation allowance	11,478		16,659
Share-based payment arrangements	469		832
Unrecognized tax benefits	(574)		255
Tax credits	—		340
Other	97		213
Income tax expense	$	6,992	$	18,398

Components of Deferred Tax Assets and Liabilities

Significant components of deferred tax assets (liabilities) are as follows:

	Years Ended December 31,
(in thousands)	2022		2021
Deferred tax assets:
Property and equipment	$	129	$	49
Intangible assets	337		401
Accrued employee compensation and benefits	133		26
Deferred revenue	284		737
Lease liabilities	941		1,289
Interest expense carryforwards	7,573		4,567
Other	1,455		1,753
Capitalized research & development costs	637		—
Tax credit carryforwards	8,884		9,323
Tax loss carryforwards	35,625		38,018
Total deferred tax assets	55,998		56,163
Less: valuation allowance	(50,628)		(40,233)
Deferred tax assets, net of valuation allowance	5,370		15,930
Deferred tax liabilities:
Intangible assets	(3,399)		(7,013)
Right-of-use assets	(883)		(1,006)
Property and equipment	(695)		(356)
Other	(802)		(1,009)
Total deferred tax liabilities	(5,779)		(9,384)
Net deferred tax assets	$	(409)	$	6,546

At December 31, 2022, the Company had German and foreign net operating losses of approximately $109.2 million and $145.1 million, respectively. At December 31, 2021, the Company had German and foreign net operating losses of approximately $111.4 million and $155.0 million, respectively. The foreign net operating loss carryforward is made up of U.S. Federal and state and Israeli losses. The U.S. Federal net operating loss carryforward will expire beginning December 31, 2025 through December 31, 2037. The U.S. state net operating loss carryforward will expire beginning December 31, 2030 through December 31, 2040. The German and Israel net operating losses have an unlimited carryforward period. Of the total U.S. Federal net operating loss carryforward, $18.7 million will carry forward indefinitely.

The U.S. Internal Revenue Code ("IRC") of 1986, as amended, imposes substantial restrictions on the utilization of carryforwards in the event of an “ownership change” of a corporation. Accordingly, a company’s ability to use net operating losses may be limited as prescribed under Internal Revenue Code Section 382 (“IRC Section 382”). Events which may cause limitations in the amount of the net operating losses that the Company may use in any one year include, but are not limited to, a cumulative ownership change of more than 50% over a three-year period. Due to the effects of historical equity issuances, the Company has determined that the future utilization of the Zoosk pre-acquisition portion of its net operating losses is limited annually pursuant to IRC Section 382 to $3.3 million. Furthermore, under current German tax laws, certain substantial changes in the Group’s ownership and business may further limit the amount of German net operating loss carryforwards, which could otherwise be utilized annually to offset future taxable income.

At December 31, 2022 and 2021, the Company has U.S. Federal and state tax credit carryforwards of approximately $13.1 million and $13.7 million, respectively, which primarily relate to Research and Development ("R&D") tax credits. These tax credits will expire beginning December 31, 2027 through December 31, 2039 for U.S. Federal purposes and December 31, 2023 through December 31, 2028 for U.S. state purposes. The U.S. state R&D tax credits of $6.4 million have an unlimited carryforward period.

Periodically, the Company considers both positive and negative evidence related to the likelihood of realization of its deferred tax assets to determine, based on the weight of available evidence, whether it is more likely-than-not that some or all of the deferred tax assets will not be realized. As of December 31, 2022, the Company's valuation allowance on its U.S. Federal and state deferred tax assets was $25.8 million primarily related to net operating loss and tax credit carryforwards and $2.6 million related to Israel net deferred tax assets, primarily made up of cumulative loss carryforwards. As of December 31, 2021, the Company's valuation allowance on its U.S. Federal and state deferred tax assets was $23.8 million primarily related to net operating losses and tax credit carryforwards and $2.5 million related to Israel net deferred tax assets, primarily made up of cumulative loss carryforwards. As of December 31, 2022, the Company has a valuation allowance on all of its Federal, state, and Israel deferred tax assets with the exception of $0.4 million which could be offset against deferred tax payables. The Company has determined, after evaluating all positive and negative historical and prospective evidence, that it is more-likely-than-not that these U.S. assets will not be realized. The U.S. valuation allowance increased by $2.0 million during 2022 which was primarily due to establishing an additional valuation allowance on certain Federal deferred tax assets. The change was as a result of increases in U.S. deferred tax assets for which there existed uncertainty about our future ability to fully utilize the assets.

In addition, as of December 31, 2022 and 2021, management determined that a valuation allowance of $22.3 million and $13.9 million, respectively, was required for certain German deferred tax assets that are not more-likely-than-not to be realized due to the negative evidence which outweighed the positive evidence. The $8.4 million increase in the valuation allowance during 2022 is primarily due to the going concern opinion.

The Company has determined that its offshore earnings will be indefinitely reinvested outside of Germany. As a result, the Company has not recorded a deferred tax liability related to undistributed earnings of foreign subsidiaries as of December 31, 2022 and December 31, 2021. The Company will continue to evaluate its reinvestment policy on a quarterly basis and will adjust its deferred tax liability accordingly to the extent there is a change and adjustment is required. As of December 31, 2022, the amount of undistributed earnings was $18.5 million. Upon distribution of these earnings, we would be subject primarily to German income taxes and foreign withholding taxes. Assuming the indefinitely reinvested earnings were repatriated under the laws and rates applicable at December 31, 2022, the incremental taxes are estimated to be $1.2 million.

In assessing whether unrecognized tax benefits should be recognized in its financial statements, the Company first determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the Company presumes that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. For tax positions that meet the more-likely-than-not recognition threshold, the Company measures the amount of benefit recognized in the financial statements at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. For each reporting period, management applies a consistent methodology to measure unrecognized tax benefits, and all unrecognized tax benefits are reviewed periodically and adjusted as circumstances warrant.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

	Year Ended December 31,
(in thousands)	2022		2021
Balance at the beginning of the year	$	4,731	$	4,593
Increases for current year tax positions	276		242
Increases (decreases) for prior year tax positions	—		(104)
Statute of limitation expirations	(498)		—
Settlements with taxing authorities	—		—
Balance at the end of the year	$	4,509	$	4,731

As of December 31, 2022 and 2021, the Company has $4.5 million and $4.7 million of unrecognized tax benefits, respectively. As of December 31, 2022 and 2021, the Company has recognized $0.8 million and $0.7 million of interest and penalties respectively. The Company recognized an increase to interest and penalties of $0.1 million. Of the $4.5 million of unrecognized tax benefits as of December 31, 2022, $0.4 million would impact the effective tax rate if recognized. The Company’s policy is to classify interest and penalties on uncertain tax positions as a component of income tax expense.

The Company is subject to income taxes in Germany and multiple other foreign jurisdictions. The Company remains subject to examination in Germany for years beginning with the 2016 tax year. U.S. Federal income tax returns of the Company are subject to IRS examination for years beginning with the 2019 tax year. U.S. state income tax returns are subject to examination beginning with the 2018 tax year. The Company is subject to examination in Israel beginning with the 2018 tax year and in France beginning with the 2015 tax year.

As a matter of course, the Company may be audited by Germany, U.S. Federal, U.S. state, Israel, France, the U.K. and other foreign jurisdictions within which it operates. From time to time, these audits result in proposed assessments. The Company was notified during 2020 that the Israeli tax authorities were auditing Spark Networks Ltd. for the tax years 2018-2019. There is minimal activity in the entity and, while we do not expect adverse findings, any potential finding would result in a reduction of the net operating loss carryforward which has a full valuation allowance against it. The Company was notified that the German tax authorities are auditing Spark SE for the tax years 2017-2018, as well as Spark GmbH for the tax years 2016-2018. In the fourth quarter of 2022 we received draft reports from the German tax authorities and we are not expecting any material assessment.

Based on the current status of Germany, U.S. Federal, state, local and other foreign audits, the Company does not expect the amount of unrecognized tax benefits to significantly decrease in the next 12 months as a result of settlements of tax audits and/or the expiration of statutes of limitations.

On August 16, 2022 the Inflation Reduction Act of 2022 (the "IRA") was signed into law. This legislation includes significant changes relating to tax, climate change, energy and healthcare. Among other provisions, the IRA introduces a book minimum tax assessed on financial statement income of certain large corporations and an excise tax on share repurchases. The Company does not anticipate that these tax provisions will have a material impact on our results of operations or financial condition, when such provisions become effective.