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, 2016

Income Taxes

For the years ended December 31, 2016, 2015 and 2014, 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, certain derivative financial instruments 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, 2016, 2015 and 2014:



	Year Ended
	December 31,
(in thousands)	2016			2015			2014
Current tax (benefit) provision:
Federal	$	(1,630	)	$	(4,027	)	$	6,507
State	167			175			16
Total current tax (benefit) provision	(1,463		)	(3,852		)	6,523
Deferred tax provision (benefit)	13,766			(12,638		)	(80,261		)
Total provision for (benefit from) income taxes	$	12,303		$	(16,490	)	$	(73,738	)

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 consolidated 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, 2016, 2015 and 2014:



	Year Ended
	December 31,
	2016					2015					2014
(dollars in thousands)	Amount			Percent		Amount			Percent		Amount			Percent
Computed income tax expense at federal rate	$	127,953		35	%	$	166,502		35	%	$	32,691		35	%
State taxes, net of federal benefit, if applicable	108			—	%	114			—	%	10			—	%
Permanent differences in taxable income from GAAP net income	392			—	%	4,203			1	%	1,636			2	%
Dividends paid deduction	(116,150		)	(32	)%	(187,309		)	(39	)%	(108,075		)	(116	)%
Provision for (benefit from) income taxes/ Effective Tax Rate⁽¹⁾	$	12,303		3	%	$	(16,490	)	(3	)%	$	(73,738	)	(79	)%

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

The Company’s permanent differences in taxable income from GAAP net income in the years ended December 31, 2016 and 2015 were primarily due to net losses incurred by consolidated securitization trusts that are not subject to federal taxes and a recurring difference in compensation expense related to restricted stock dividends. 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 consolidated balance sheets, as of December 31, 2016 and December 31, 2015 contain the following current and deferred tax liabilities and assets, which are included in other assets, and are recorded at the taxable subsidiary level:



(in thousands)	December 31, 2016			December 31, 2015
Income taxes receivable
Federal income taxes receivable	$	1,532		$	5,216
State and local income taxes receivable	—			—
Income taxes receivable, net	1,532			5,216
Deferred tax assets (liabilities)
Deferred tax asset	111,636			69,441
Deferred tax liability	(54,275		)	(25,123		)
Total net deferred tax assets	57,361			44,318
Total tax assets, net	$	58,893		$	49,534

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 as of December 31, 2016 and December 31, 2015 were as follows:



(in thousands)	December 31, 2016			December 31, 2015
Available-for-sale securities	$	17,942		$	(8,673	)
Mortgage servicing rights	(9,492		)	6,363
Derivative assets and liabilities	(42,666		)	(4,492		)
Other assets	24			3
Other liabilities	2,713			978
Intangibles	235			256
Alternative minimum tax credit	1,904			420
Net operating loss carryforward	42,039			8,177
Capital loss carryforward	44,662			41,286
Total net deferred tax assets	$	57,361		$	44,318

At both December 31, 2016 and December 31, 2015, 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 $42.0 million, $1.3 million is scheduled to expire December 31, 2033, $2.5 million is scheduled to expire December 31, 2034, $4.3 million is scheduled to expire December 31, 2035 and $33.9 million is scheduled to expire December 31, 2036. Of the TRS net capital loss carryforward of $44.7 million, $0.1 million is scheduled to expire December 31, 2017, $20.1 million is scheduled to expire December 31, 2019, $21.1 million is scheduled to expire December 31, 2020 and $3.4 million is scheduled to expire December 31, 2021.

Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s consolidated 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.