OTE 13 – 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, 2018 and 2017 (in thousands):



	December 31,
	2018			2017
Deferred tax assets:
Allowance for doubtful accounts	$	1,944		$	1,885
Tax credits	5,606			7,179
Other accruals	105,894			97,247
Net operating losses	—			346
Other	14,770			14,784
Total deferred tax assets	128,214			121,441

Deferred tax liabilities:
Inventories	62,846			55,965
Property and equipment	140,019			122,354
Other	30,915			28,528
Total deferred tax liabilities	233,780			206,847

Net deferred tax liabilities	$	(105,566	)	$	(85,406	)

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, 2018, 2017 and 2016 (in thousands):



	For the Year Ended December 31, 2018
	Current		Deferred		Total
Federal income tax expense	$	289,953	$	16,309	$	306,262
State income tax expense	59,487		3,851		63,338
Net income tax expense	$	349,440	$	20,160	$	369,600



	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

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, 2018, 2017 and 2016 (in thousands):



	For the Year Ended December 31,
	2018			2017			2016
Federal income taxes at statutory rate	$	355,758		$	573,231		$	573,020
State income taxes, net of federal tax benefit	56,345			39,062			35,285
Excess tax benefit from share-based compensation	(34,703		)	(48,688		)	—
Revaluation of deferred tax liability	(1,262		)	(53,240		)	—
Other items, net	(6,538		)	(6,365		)	(8,805		)
Total provision for income taxes	$	369,600		$	504,000		$	599,500

As a result of the adoption of 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 beginning with 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.

The U.S. Tax Cuts and Jobs Act, enacted in December 2017 (the “Tax Act”), significantly reduced the federal corporate income tax rate for tax years beginning in 2018 and required 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. During the year ended December 31, 2018, the Company completed its evaluation of the impact of the Tax Act and recorded an additional $1.3 million of tax benefit, finalizing the revaluation of its deferred income tax liabilities due to the Tax Act, which was recorded in “Provision for income taxes” on the accompanying Consolidated Statements of Income for the year ended December 31, 2018.

As of December 31, 2018, the Company had tax credit carryforwards available for state tax purposes, net of federal impact, in the amount of $5.6 million, which 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, 2018, 2017 and 2016 (in thousands):



	2018			2017			2016
Unrealized tax benefit, balance at January 1,	$	35,388		$	34,798		$	36,928
Additions based on tax positions related to the current year	3,550			6,299			6,116
Additions based on tax positions related to prior years	4,255			—			—
Payments related to items settled with taxing authorities	(2,792		)	—			(195		)
Reductions due to the lapse of statute of limitations and settlements	(6,635		)	(5,709		)	(8,051		)
Unrealized tax benefit, balance at December 31,	$	33,766		$	35,388		$	34,798

For the years ended December 31, 2018, 2017 and 2016, the Company recorded a reserve for unrecognized tax benefits, including interest and penalties, in the amounts of $38.9 million, $40.9 million and $40.6 million, respectively. All of the unrecognized tax benefits recorded as of December 31, 2018, 2017 and 2016, respectively, would affect the Company’s effective tax rate if recognized, generally net of the federal tax effect of approximately $8.2 million. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2018, 2017 and 2016, the Company had accrued approximately $5.1 million, $5.5 million and $5.8 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, 2018, 2017 and 2016, the Company recorded tax expense related to an increase in its liability for interest and penalties in the amounts of $2.3 million, $2.0 million and $2.4 million, respectively. Although unrecognized tax benefits for individual tax positions may increase or decrease during 2019, the Company expects a reduction of $8.1 million of unrecognized tax benefits during the one-year period subsequent to December 31, 2018, 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 2014, 2015 and 2016 federal income tax returns in the third quarter of 2018. The Company’s state income tax returns remain subject to examination by various state authorities for tax years ranging from 2007 through 2017.