Note 15—Income Taxes

The Company files U.S. federal and state corporate income tax returns for PFSI and partnership returns for PennyMac. The Company’s federal tax returns are subject to examination for 2015 and forward and its state tax returns are generally subject to examination for 2014 and forward. PennyMac’s federal partnership returns are subject to examination for 2015 and forward, and its state tax returns are generally subject to examination for 2014 and forward. No returns are currently under examination.

As a result of the Reorganization, the Company recorded through equity a net deferred tax liability attributable to the noncontrolling interest in the amount of $320.5 million. Beginning from November 1, 2018, the Company’s income subject to the corporate federal and state statutory rates will include the portion of its income formerly attributed to the conversion of the noncontrolling interest. As a result, the Company expects an increase in the effective tax rate.

The Reorganization is to be treated as an integrated transaction that qualifies as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code and/or a transfer described in Section 351(a) of the Internal Revenue Code.

PFSI received a ruling from the California Franchise Tax Board in November 2018 which allows the Company to apply a reduced California statutory rate of 8.84% compared to the 10.84% rate previously applied by the Company. As a result, the Company recorded a tax benefit of $8.5 million due to remeasurement of deferred tax assets and tax liabilities.

The Company’s tax expense for the year ended December 31, 2017 was significantly impacted by the Tax Act. The Tax Act reduces the U.S. federal corporate tax rate to 21% from the previous maximum rate of 35%, effective January 1, 2018. Other than the change in the applicable federal rate, the changes introduced by the Tax Act did not have a significant impact on the 2018 tax expense.

In the fourth quarter of 2017, the Company recorded a tax benefit of $13.7 million due to a re-measurement of deferred tax assets and liabilities resulting from a decrease in the federal tax rate. The re-measurement of the deferred tax assets and liabilities is predominantly based on a reduction to the federal rate as described above which will result in lower tax expense when these deferred tax assets and liabilities are realized.

Revaluation of the deferred tax asset resulting from PennyMac unitholder exchanges under the tax receivable agreement resulted in the repricing of the Company’s corresponding liability under the tax receivable agreement. The Company recorded a reduction of $32.0 million in the Payable to exchanged Private National Mortgage Acceptance Company, LLC unitholders under the tax receivable agreement for the year ended December 31, 2017 as a result of the Tax Act.

The following table details the Company’s income tax expense:


	Year ended December 31,
	2018		2017		2016
	(in thousands)
Current expense:
Federal	$	12	$	(81)	$	(1,622)
State		274		56		(244)
Total current expense		286		(25)		(1,866)
Deferred expense:
Federal		23,395		14,674		38,082
State		(427)		9,738		9,887
Total deferred expense		22,968		24,412		47,969
Total provision for income taxes	$	23,254	$	24,387	$	46,103

As the result of the Company’s reclassification of the noncontrolling interest to paid-in capital pursuant to the Reorganization on November 1, 2018, the liability for deferred taxes for the year ended December 31, 2018 reflects each individual adjustment item in the underlying investment in PennyMac. The provision for deferred income taxes for the years ended December 31, 2017, and 2016 primarily relates to the Company’s investment in PennyMac partially offset by the Company’s generation and utilization of a net operating loss and generation of tax credits. The portion attributable to its investment in PennyMac primarily relates to MSRs that PennyMac received pursuant to sales of mortgage loans held for sale at fair value and Carried Interest from the Investment Funds.

The following table is a reconciliation of the Company’s provision for income taxes at statutory rates to the provision for income taxes at the Company’s effective tax rate:


	Year ended December 31,
	2018		2017		2016
Federal income tax statutory rate	21.0	%	35.0	%	35.0	%
Less: Income attributable to noncontrolling interest	(12.3)	%	(22.0)	%	(24.8)	%
State income taxes, net of federal benefit	2.3	%	2.2	%	1.6	%
Tax rate revaluation	(2.2)	%	(8.0)	%	0.0	%
Other	(0.1)	%	0.1	%	0.2	%
Effective tax rate	8.7	%	7.3	%	12.0	%

The components of the Company’s provision for deferred income taxes are as follows:


	Year ended December 31,
	2018		2017		2016
	(in thousands)
Mortgage servicing rights	$	46,064	$	—	$	—
Investment in PennyMac		—		34,011		40,493
Net operating loss		(14,902)		(9,675)		8,110
Compensation accruals		(3,596)		—		—
Reserves and losses		(1,848)		—		—
Additional tax basis in partnership from exchanges of partnership units into the Company's common stock		(1,391)		—		—
Other		(1,302)		—		—
Tax credits		(57)		76		(634)
Total provision for deferred income taxes	$	22,968	$	24,412	$	47,969

The components of Income taxes payable are as follows:


	December 31,
	2018		2017
	(in thousands)
Taxes currently payable (receivable)	$	218	$	(2,126)
Deferred income tax liability, net		400,328		54,286
Income taxes payable	$	400,546	$	52,160

The tax effects of temporary differences that gave rise to deferred income tax assets and liabilities are presented below:


	December 31,
	2018		2017
	(in thousands)
Deferred income tax assets:
Additional tax basis in partnership from exchanges of partnership units into the Company's common stock	$	44,165	$	—
Compensation accruals		28,752		—
Reserves and losses		26,589		—
Net operating loss carryforward		25,104		10,202
Tax credits carryforward		616		558
Gross deferred tax assets		125,226		10,760
Deferred income tax liabilities:
Mortgage servicing rights		517,042		—
Investment in PennyMac		—		65,046
Other		8,512		—
Gross deferred tax liabilities		525,554		65,046
Net deferred income tax liability	$	400,328	$	54,286

The Company recorded a deferred tax asset of $25.1 million related to a net operating loss of approximately $93.5 million. For federal income tax purposes, as it relates to net operating loss carryforwards, $1.3 million arising in 2015 expires in 2035, $35.2 million arising in 2017 expires in 2037, and $57.0 million arising in 2018 has no expiration date. Net operating losses arising in tax years beginning after December 31, 2017 are limited in annual use to 80% of taxable income (without regard to net operating loss deduction) but can be carried forward indefinitely. For state income tax purposes, net operating losses arising in years 2015, 2017, and 2018 generally expire in 2035, 2037, and 2038, respectively. The Company has tax credits of $0.6 million, which generally have no expiration date.

At December 31, 2018 and 2017, the Company had no unrecognized tax benefits and does not anticipate any unrecognized tax benefits. Should the recognition of any interest or penalties relative to unrecognized tax benefits be necessary, it is the Company’s policy to record such expenses in the Company’s income tax accounts. No such accruals existed at December 31, 2018 and 2017.