Two Harbors Investment Corp. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Income Taxes (Notes)

Income Taxes (Notes)

12 Months Ended

Dec. 31, 2014

For the years ended December 31, 2014, 2013 and 2012, the Company qualified to be taxed as a REIT under the Code for U.S. federal income tax purposes. As long as the Company qualifies as a REIT, the Company generally will not be subject to U.S. federal income taxes on its taxable income to the extent it annually distributes its net taxable income to stockholders and does not engage in prohibited transactions. The Company intends to distribute 100% of its REIT taxable income and comply with all requirements to continue to qualify as a REIT. The majority of states also recognize the Company’s REIT status. The Company’s TRSs file separate tax returns and are fully taxed as standalone U.S. C-Corporations. The tables below reflect the net taxes accrued at the TRS level and the tax attributes included in the consolidated financial statements. It is assumed that the Company will retain its REIT status and will incur no REIT level taxation as it intends to comply with the REIT regulations and annual distribution requirements.

Certain activities the Company performs may produce income that will not be qualifying income for REIT purposes. These activities include the designated portion of MSR treated as normal mortgage servicing, swaptions, credit default swaps, TBAs and other risk-management instruments. The Company has designated its TRSs to engage in these activities. The Company also purchases and sells mortgage loans through the secondary whole loan market and/or securitization market and has designated its TRSs to engage in these activities.

The following table summarizes the tax (benefit) provision recorded at the taxable subsidiary level for the years ended December 31, 2014, 2013 and 2012:



	Year Ended December 31,
(in thousands)	2014			2013		2012
Current tax provision (benefit):
Federal	$	6,507		$	808	$	(4,586	)
State	16			5		3
Total current tax provision (benefit)	6,523			813		(4,583		)
Deferred tax (benefit) provision	(80,261		)	83,598		(37,636		)
Total (benefit from) provision for income taxes	$	(73,738	)	$	84,411	$	(42,219	)

The Company’s taxable income before dividend distributions differs from its pre-tax net income for U.S. GAAP purposes primarily due to unrealized gains and losses, the recognition of credit losses for U.S. GAAP purposes but not tax purposes, differences in timing of income recognition due to market discount, and original issue discount and the calculations surrounding each. These book to tax differences in the REIT are not reflected in the financial statements as the Company intends to retain its REIT status.

The following is a reconciliation of the statutory federal and state rates to the effective rates, for the years ended December 31, 2014, 2013 and 2012:



	Year Ended December 31,
	2014					2013					2012
(dollars in thousands)	Amount			Percent		Amount			Percent		Amount			Percent
Computed income tax expense at federal rate	$	32,691		35	%	$	225,573		34	%	$	84,894		34	%
State taxes, net of federal benefit, if applicable	10			—	%	4			—	%	2			—	%
Permanent differences in taxable income from GAAP net income	1,636			2	%	17,681			3	%	118			—	%
Dividends paid deduction	(108,075		)	(116	)%	(158,847		)	(24	)%	(127,233		)	(51	)%
(Benefit from) provision for income taxes/Effective Tax Rate⁽¹⁾	$	(73,738	)	(79	)%	$	84,411		13	%	$	(42,219	)	(17	)%

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(1)	The (benefit from) provision for income taxes is recorded at the taxable subsidiary level.

The Company’s permanent differences in taxable income from GAAP net income in the year ended December 31, 2014 were due primarily to the statutory federal rate change from 34% to 35% and corresponding adjustment to the measurement of beginning deferred tax assets and liabilities. The Company’s permanent differences in taxable income from GAAP net income in the year ended December 31, 2013 were due primarily to dividends received by the REIT from the TRSs.

The Company’s consolidated balance sheet, as of December 31, 2014 and December 31, 2013, contains the following current and deferred tax liabilities and assets, which are included in other liabilities and other assets, respectively, and are recorded at the taxable subsidiary level:



(in thousands)	December 31, 2014				December 31, 2013
Income taxes (payable) receivable
Federal income taxes (payable) receivable	$	(1,375	)		$	(757	)
State and local income taxes (payable) receivable	—				—
Income taxes (payable) receivable, net	(1,375		)		(757		)
Deferred tax assets (liabilities)
Deferred tax asset	60,575			⁽¹⁾	14,927
Deferred tax liability	(19,728		)		(54,341		)
Total net deferred tax assets (liabilities)	40,847				(39,414		)
Total tax assets and liabilities, net	$	39,472			$	(40,171	)

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(1)	Net of valuation allowance of $0.1 million.

Deferred Tax Assets and Liabilities

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting and tax purposes at the TRS level. Components of the Company’s deferred tax assets and liabilities as of December 31, 2014 and December 31, 2013 are as follows:



(in thousands)	December 31, 2014			December 31, 2013
Derivative assets and liabilities	$	5,978		$	(45,740	)
Trading securities	(478		)	(1,380		)
Mortgage servicing rights	4,494			(846		)
Other assets	16			—
Other liabilities	859			—
Capitalized start-up and organizational costs	277			515
Alternative minimum tax credit	98			—
Net operating loss carryforward	9,448			7,986
Capital loss carryforward	20,155			51
Total net deferred tax assets (liabilities)	$	40,847		$	(39,414	)

At December 31, 2014, a $0.1 million valuation allowance was established because the Company determined that it is more likely than not that the associated deferred tax asset will not be realized. At December 31, 2013, the Company had not recorded a valuation allowance for any portion of its deferred tax assets as it did not believe, at a more likely than not level, that any portion of its deferred tax assets would not be realized. Of the TRS net operating loss carryforward of $9.4 million, $6.9 million is scheduled to expire December 31, 2033 and $2.5 million is scheduled to expire December 31, 2034. The TRS net capital loss carryforward of $20.2 million is scheduled to expire December 31, 2019. The Company estimates, based on existence of sufficient evidence, the ability to realize the remainder of its deferred tax assets. Any adjustments to such estimates will be made in the period such determination is made.

Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s financial statements of a contingent tax liability for uncertain tax positions. Additionally, there were no amounts accrued for penalties or interest as of or during the periods presented in these consolidated financial statements.

- Definition

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

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