NOTE 12 – INCOME TAXES

Deferred income tax assets and liabilities:

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and also include the tax effect of carryforwards.

The following table identifies significant components of the Company’s net deferred tax liabilities included in “Deferred income taxes” on the accompanying Consolidated Balance Sheets as of December 31, 2017 and 2016 (in thousands):



	December 31,
	2017			2016
Deferred tax assets:
Allowance for doubtful accounts	$	1,885		$	2,686
Tax credits	7,179			9,363
Other accruals	97,247			153,955
Net operating losses	346			304
Other	14,784			19,870
Total deferred tax assets	121,441			186,178

Deferred tax liabilities:
Inventories	55,965			76,694
Property and equipment	122,354			157,228
Other	28,528			42,422
Total deferred tax liabilities	206,847			276,344

Net deferred tax liabilities	$	(85,406	)	$	(90,166	)

Provision for income taxes:

The following tables reconcile the amounts included in “Provision for income taxes” on the accompanying Consolidated Statements of Income for the years ended December 31, 2017, 2016 and 2015 (in thousands):



	For the Year Ended December 31, 2017
	Current		Deferred			Total
Federal income tax expense (benefit)	$	467,577	$	(13,053	)	$	454,524
State income tax expense	41,183		8,293			49,476
Net income tax expense (benefit)	$	508,760	$	(4,760	)	$	504,000



	For the Year Ended December 31, 2016
	Current		Deferred		Total
Federal income tax expense	$	540,090	$	7,558	$	547,648
State income tax expense	49,016		2,836		51,852
Net income tax expense	$	589,106	$	10,394	$	599,500



	For the Year Ended December 31, 2015
	Current		Deferred			Total
Federal income tax expense (benefit)	$	504,558	$	(21,973	)	$	482,585
State income tax expense (benefit)	47,242		(677		)	46,565
Net income tax expense (benefit)	$	551,800	$	(22,650	)	$	529,150

The following table outlines the reconciliation of the “Provision for income taxes” amounts included on the accompanying Consolidated Statements of Income to the amounts computed at the federal statutory rate for the years ended December 31, 2017, 2016 and 2015 (in thousands):



	For the Year Ended December 31,
	2017			2016			2015
Federal income taxes at statutory rate	$	573,231		$	573,020		$	511,128
State income taxes, net of federal tax benefit	39,062			35,285			32,137
Excess tax benefit from share-based compensation	(48,688		)	—			—
Revaluation of deferred tax liability	(53,240		)	—			—
Other items, net	(6,365		)	(8,805		)	(14,115		)
Total provision for income taxes	$	504,000		$	599,500		$	529,150

As a result of the adoption of the required, new share-based compensation accounting standard, ASU 2016-09, during the three months ended March 31, 2017, the excess tax benefit associated with the exercise of non-qualified stock options has been included in “Provision for income taxes” on the accompanying Consolidated Statements of Income for the year ended December 31, 2017. Prior to the year ended December 31, 2017, the excess tax benefit associated with the exercise of non-qualified stock options was included in “Additional paid-in capital” on the accompanying Consolidated Balance Sheets. See Note 1 for further information concerning the Company’s adoption of ASU 2016-09.

The U.S. Tax Cuts and Jobs Act, enacted in December 2017 (“Tax Act”), significantly reduced the federal corporate income tax rate for tax years beginning in 2018, requiring the Company to revalue its deferred income tax liabilities. The Company recorded a one-time tax benefit of $53.2 million in “Provision for income taxes” on the accompanying Consolidated Statements of Income for the year ended December 31, 2017, to reflect the reduced federal corporate income tax rate in the tax years the deferred tax differences are expected to reverse. This provisional tax benefit from the revaluation of the Company’s deferred income tax liabilities was recorded based on the Company’s initial evaluation of the impact of the Tax Act and is subject to change in 2018 as the Company continues to refine, analyze and update the underlying data, computations and assumptions used to prepare this provisional amount during the measurement period.

As of December 31, 2017, the Company had tax credit carryforwards available for state tax purposes, net of federal impact, in the amount of $7.2 million. As of December 31, 2017, the Company had net operating loss carryforwards available for state purposes in the amount of $9.5 million. The Company’s state net operating loss carryforwards generally expire in 2028, and the Company’s tax credits generally expire in 2024.

Unrecognized tax benefits:

The following table summarizes the changes in the gross amount of unrecognized tax benefits, excluding interest and penalties, for the years ended December 31, 2017, 2016 and 2015 (in thousands):



	2017			2016			2015
Unrealized tax benefit, balance at January 1,	$	34,798		$	36,928		$	49,598
Additions based on tax positions related to the current year	6,299			6,116			5,405
Additions based on tax positions related to prior years	—			—			995
Payments related to items settled with taxing authorities	—			(195		)	(4,012		)
Reductions due to the lapse of statute of limitations and settlements	(5,709		)	(8,051		)	(15,058		)
Unrealized tax benefit, balance at December 31,	$	35,388		$	34,798		$	36,928

For the years ended December 31, 2017, 2016 and 2015, the Company recorded a reserve for unrecognized tax benefits, including interest and penalties, in the amounts of $40.9 million, $40.6 million and $43.6 million, respectively. All of the unrecognized tax benefits recorded as of December 31, 2017, 2016 and 2015, respectively, would affect the Company’s effective tax rate if recognized, generally net of the federal tax effect of approximately $8.3 million. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2017, 2016 and 2015, the Company had accrued approximately $5.5 million, $5.8 million and $6.7 million, respectively, of interest and penalties related to uncertain tax positions before the benefit of the deduction for interest on state and federal returns. During the years ended December 31, 2017, 2016 and 2015, the Company recorded tax expense related to an increase in its liability for interest and penalties in the amounts of $2.0 million, $2.4 million and $2.8 million, respectively. Although unrecognized tax benefits for individual tax positions may increase or decrease during 2018, the Company expects a reduction of $7.5 million of unrecognized tax benefits during the one-year period subsequent to December 31, 2017, resulting from settlement or expiration of the statute of limitations.

The Company’s United States federal income tax returns for tax years 2015 and beyond remain subject to examination by the Internal Revenue Service (“IRS”). The IRS concluded an examination of the O’Reilly consolidated 2012 and 2013 federal income tax returns in the second quarter of 2015. The statute of limitations for the Company’s federal income tax returns for tax years 2013 and prior expired on September 15, 2017. The statute of limitations for the Company’s U.S. federal income tax return for 2014 will expire on September 15, 2018, unless otherwise extended. The IRS is currently conducting an examination of the Company’s consolidated returns for tax years 2014 and 2015. The Company’s state income tax returns remain subject to examination by various state authorities for tax years ranging from 2006 through 2016.