WILLIAM LYON HOMES - 10-K filing on 2014-03-21

Income Taxes

12 Months Ended

Dec. 31, 2013

Since inception, the Company has operated solely within the United States.

The following summarizes the benefit (provision) from income taxes (in thousands):



	Successor						Predecessor
	Year Ended December 31,			Period from February 25 through December 31, 2012			Period from January 1 through February 24, 2012		Year Ended December 31,
	2013			Period from February 25 through December 31, 2012			Period from January 1 through February 24, 2012		2011
Current
Federal	$	(12,156	)	$	—		$	—	$	—
State	(1,132		)	(11		)	—		(10		)
Deferred
Federal	74,000			—			—		—
State	21,590			—			—		—
	$	82,302		$	(11	)	$	—	$	(10	)

Income taxes differ from the amounts computed by applying the applicable federal statutory rates due to the following (in thousands):



	Successor						Predecessor
	Year Ended December 31,			Period from February 25 through December 31, 2012			Period from January 1 through February 24, 2012			Year Ended December 31,
	2013			Period from February 25 through December 31, 2012			Period from January 1 through February 24, 2012			2011
(Provision) benefit for federal income taxes at the statutory rate	$	(18,656	)	$	3,098		$	(79,935	)	$	67,662
Increases/(decreases) in tax resulting from:
Provision for state income taxes, net of federal income tax benefits	13,297			(7		)	—			(6		)
Change in valuation allowance	153,526			(2,195		)	(14,991		)	(66,265		)
Nondeductible items-reorganization costs	—			(709		)	94,925			(1,379		)
Nondeductible items-other	2,778			(194		)	(3		)	(22		)
Cancellation of indebtedness attribute reduction	(70,993		)	—			—			—
Other, net (1)	2,350			(4		)	4			—
	$	82,302		$	(11	)	$	—		$	(10	)

(1) Consists primarily of amounts relating to the acquisition of the Company's Colorado segment, and the write-off of certain historical deferred amounts.

Temporary differences giving rise to deferred income taxes consist of the following (in thousands):



	December 31,
	2013			2012
Deferred tax assets
Impairment and other reserves	$	79,454		$	73,947
Compensation deductible for tax purposes when paid	5,430			987
State income tax provisions deductible when paid for federal tax purposes	309			4
Effect of book/tax differences for joint ventures	—			1,002
Effect of book/tax differences for capitalized interest/general and administrative	308			—
Goodwill and other intangibles	2,176			—
AMT credit carryover	1,384			2,698
Unused recognized built-in loss	25,914			16,349
Net operating loss	3,545			113,314
Valuation allowance	(3,959		)	(200,048		)
Other	817			318
	115,378			8,571
Deferred tax liabilities
Effect of book/tax differences for joint ventures	(6,077		)	(5,597		)
Effect of book/tax differences for capitalized interest/general and administrative	(9,568		)	(2,974		)
Compensation deductible for tax purposes when paid	(842		)	—
Fixed assets and intangibles	(2,518		)	—
Other	(793		)	—
	(19,798		)	(8,571		)
Total deferred tax assets, net	$	95,580		$	—

Management assesses its deferred tax assets quarterly to determine whether all or any portion of the asset is more likely than not unrealizable under ASC 740. The Company is required to establish a valuation allowance for any portion of the asset that management concludes is more likely than not to be unrealizable. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company's assessment considers all evidence, both positive and negative, including the nature, frequency and severity of our current and cumulative losses, taxable income in carry back years, the scheduled reversal of deferred tax liabilities, tax planning strategies, and projected future taxable income in making this assessment. During the year ended December 31, 2013, the Company recognized a $95.6 million income tax benefit that resulted from the reversal of all but $4.0 million of our deferred tax asset valuation allowance. The Company concluded this reversal was appropriate after determining that it was more likely than not that we would be able to realize the full amount of this income tax benefit as management believes the Company will generate sufficient taxable income to realize these deferred tax assets.

The Company's analysis demonstrated that even under the stress tested forecasts of future results which considered the potential impact of the negative evidence noted above, the Company would continue to generate sufficient taxable income in future periods to realize the majority of its deferred tax assets. This fact, coupled with other positive evidence described above, significantly outweighed the negative evidence and based on this analysis management concluded, in accordance with ASC 740, that it was more likely than not that the majority of its deferred tax assets as of December 31, 2013 would be realized.

The remaining valuation allowance at December 31, 2013 relates to projected excess realized built-in-losses and state net operating losses which may expire unused. For the year ended December 31, 2012, due to uncertainties surrounding the realization of the cumulative federal and state deferred tax assets, the Company had a full valuation allowance against the deferred tax assets for the year in the amount of $200.0 million (of which $80.7 million were reduced due to attribution reduction which was required as a result of the 2012 cancellation of indebtedness event).

At December 31, 2013, the Company had no remaining federal net operating loss carryforwards and $78.0 million remaining state net operating loss carryforwards. State net operating loss carryforwards begin to expire in 2014. In addition, as of December 31, 2013, the Company had unused federal and state built-in losses of $67.6 million and $37.7 million, respectively. The 5 year testing period for built-in losses expires in 2017 and the unused built-in loss carryforwards begin to expire in 2033. The Company had AMT credit carryovers of $1.4 million at December 31, 2013, which had an indefinite life.

The Company’s effective income tax rate was (154.5)%, 0.01%, and 0.0% for the year ended December 31, 2013 the period from February 25, 2012 through December 31, 2012, and the period from January 1, 2012 through February 24, 2012, respectively. The primary driver of the Company’s effective tax rate was the release of the majority of the valuation allowance against its deferred tax assets. Other factors impacting the effective rate included the Company’s positive operating results, the estimated domestic productions activities deduction, the reduction of tax attributes described below related to the emergence from bankruptcy, and adjustments related to the filing of the 2012 Federal tax return.

In connection with the Company’s emergence from the Chapter 11 bankruptcy proceedings, the Company experienced an “ownership change” as defined in Section 382 of the Internal Revenue Code, or the IRC, as of February 25, 2012. Section 382 of the IRC contains rules that limit the ability of a company that undergoes an “ownership change” to utilize its net operating loss carryforwards and certain built-in losses or deductions recognized during the five-year period after the ownership change. The Company is able to retain a portion of its U.S. federal and state net operating loss, built in losses and tax credit carryforwards, or the “Tax Attributes”, in connection with the ownership change. However, the IRC Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its Tax Attributes against future U.S. taxable income in the event of a change in ownership. In the Company’s situation, the limitation under the IRC is based on the value of the equity (for purposes of the applicable tax rules) on or immediately following the time of emergence. As a result, the Company’s future U.S. taxable income may not be fully offset by the Tax Attributes if such income exceeds the Company’s annual limitation of $3.6 million during the 20 year carryforward period allowed under tax law, and the Company may incur a tax liability with respect to such income. In addition, subsequent changes in ownership for purposes of the IRC could further diminish the Company’s ability to utilize Tax Attributes.

In addition to the impact on Tax Attributes listed above, the Company is also subject to Tax Attribute reduction pursuant to various provisions contained in IRC Section 108(e) related to the Company’s issuance of 5,429,485 shares of Parent’s new Class A Common Stock, $0.01 par value per share, and a $75 million principal amount 12% Senior Subordinated Secured Note due 2017, issued by California Lyon in conjunction with the Company’s restructure, in exchange for the claims held by the holders of the formerly outstanding notes of California Lyon. These transactions resulted in Cancellation of Debt (COD) income for income tax purposes of approximately $203 million. IRC Section 108(a)(1)(A) provides that COD income is excluded from gross income when the discharge occurs in a Title 11 case under the jurisdiction of the bankruptcy court. However, pursuant to IRC Section 108(b)(1), if COD income is excluded due to the application of the bankruptcy exception, the amount of excluded COD income must generally be applied to reduce certain tax attributes of the debtor. In general, such attributes would normally be reduced in the following order: (1) net operating losses (current and carryforward); (2) general business tax credits; (3) minimum tax credits; (4) capital loss carryovers; (5) tax basis of the taxpayer’s assets; (6) passive activity losses and credit carryovers; and (7) foreign tax credit carryovers. This Tax Attribute reduction occurred on January 1, 2013, and resulted in a $69.2 million reduction to the value of our net operating losses with an offsetting reduction to our deferred tax asset valuation allowance.

Under a provision of the federal tax code which was clarified in July 2013 by a final treasury regulation, the Company employed a tax strategy in its 2012 federal tax return to utilize its federal NOLs by electing to accelerate the recognition of a deferred gain, resulting in positive taxable income and a tax liability for the 2012 tax year. This additional liability and tax provision of approximately $1.2 million was recognized with the filing of the 2012 income tax returns in 2013.

Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”) which is now codified as FASB ASC Topic 740, Income Taxes (“ASC 740”). ASC 740 prescribes a recognition threshold and a measurement criterion for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be considered more likely than not to be sustained upon examination by taxing authorities. The Company records interest and penalties related to uncertain tax positions as a component of the provision for income taxes. The Company has no unrecognized tax benefits.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is subject to U.S. federal income tax examination for calendar tax years ending 2010 through 2013. The Company is subject to various state income tax examinations for calendar tax years ending 2009 through 2013. The Company does not have any tax examinations currently in progress.