Income Taxes

The taxable results of the Company’s U.S. operations are included in the consolidated income tax returns of Cowen Inc. as well as stand‑alone state and local tax returns. The Company has subsidiaries that are resident in foreign countries where tax filings have to be submitted on a stand‑alone basis. These subsidiaries are subject to tax in their respective countries and the Company is responsible for and, thus, reports all taxes incurred by these subsidiaries. The countries where the Company owns subsidiaries with tax filing obligations are the United Kingdom, Luxembourg, and Hong Kong.

The components of the Company's income tax expense for the years ended December 31, 2017, 2016 and 2015 are as follows:



	Year ended December 31,
	2017			2016			2015
	(dollars in thousands)
Current tax expense/(benefit)
Federal	$	421		$	1,268		$	(635	)
State and local	2,034			1,972			313
Foreign	428			262			348
Total	$	2,883		$	3,502		$	26
Deferred tax expense/(benefit)
Federal	$	44,071		$	(22,834	)	$	(37,979	)
State and local	(2,938		)	(1,900		)	(7,420		)
Foreign	37			2,140			(2,123		)
Total	41,170			(22,594		)	(47,522		)
Total Tax expense/(benefit)	$	44,053		$	(19,092	)	$	(47,496	)

Consolidated U.S. income/(loss) before income taxes was $3.9 million in 2017, $(29.5) million in 2016, and $8.0 million in 2015. The corresponding amounts for non-U.S.-based income/(loss) were $3.1 million in 2017, $(2.0) million in 2016, and $3.5 million in 2015.

The reconciliations of the Company's federal statutory rate to the effective income tax rate for the years ended December 31, 2017, 2016, and 2015 are as follows:



	Year ended December 31,
	2017		2016		2015
Pre-tax loss at U.S. statutory rate	35.0	%	35.0	%	35.0	%
Dividend received deduction	(25.9	)	—		—
Bargain purchase gain	(34.8	)	—		—
Basis adjustment on investments	65.2		—		—
Nondeductible expenses	14.2		—		—
Deferred asset recognition	—		—		(323.8	)
Unrecognized gains on foreign subsidiaries	—		38.7		—
Change in valuation allowance	—		(6.7	)	—
Impact of tax law change	669.8		—		(27.9	)
State and foreign tax	25.3		1.3		(39.6	)
Reversal of income attributable to redeemable non-controlling interests	(119.6	)	1.3		(46.5	)
Other, net	3.7		(9.0	)	(11.0	)
Total	632.9	%	60.6	%	(413.8	)%

As of December 31, 2017, the Company has net income taxes receivable of approximately $0.1 million representing federal tax overpayments, which is included in other assets on the accompanying consolidated statements of financial condition. The Company also has state and foreign income taxes payable of approximately $6.3 million, which is included in other liabilities on the accompanying consolidated statements of financial condition.

The components of the Company's deferred tax assets and liabilities as of December 31, 2017 and 2016 are as follows:



	As of December 31,
	2017			2016
	(dollars in thousands)
Deferred tax assets, net of valuation allowance
Net operating loss	$	78,650		$	126,037
Deferred compensation	39,992			44,966
Goodwill	1,042			4,758
Option liability	5,776			—
Fixed assets	—			3,541
Tax credits	4,419			2,898
Acquired lease liability	3,473			4,111
Other	2,696			2,238
Total deferred tax assets	136,048			188,549
Valuation allowance	(2,103		)	(2,119		)
Deferred tax assets, net of valuation allowance	133,945			186,430
Deferred tax liabilities
Unrealized gains on investments	(7,523		)	(20,774		)
Amortization of bond discount	(6,402		)	—
Other	(3,697		)	—
Total deferred tax liabilities	(17,622		)	(20,774		)
Deferred tax assets/(liabilities), net	$	116,323		$	165,656

Deferred tax assets, net of valuation allowance, are reported in the accompanying consolidated statements of financial condition. In addition to the deferred tax balances in the table above, the Company records balances related to its operating losses in Luxembourg, which are discussed below.

The Company records deferred tax assets and liabilities for the future tax benefit or expense that will result from differences between the carrying value of its assets for income tax purposes and for financial reporting purposes, as well as for operating or capital loss and tax credit carryovers. A valuation allowance is recorded to bring the net deferred tax assets to a level that, in management’s view, is more likely than not to be realized in the foreseeable future. This level will be estimated based on a number of factors, especially the amount of net deferred tax assets of the Company that are actually expected to be realized, for tax purposes, in the foreseeable future. The Company recorded approximately $2.1 million valuation allowance against its deferred tax assets of $136.0 million as of December 31, 2017 and recorded approximately $2.1 million valuation allowance against its deferred tax assets of $188.5 million as of December 31, 2016. Separately, the Company has deferred tax liabilities of $17.6 million as of December 31, 2017, and $20.8 million as of December 31, 2016.

For the year 2017, the Company’s total deferred tax expense is $41.2 million predominantly related to the impact of the Tax Cuts and Jobs Act, discussed in detail below, and the reversal of timing differences in the normal course of business. The deferred tax benefit of $22.6 million in 2016 was derived by the release of deferred tax liabilities related to the previous acquisitions by a local subsidiary, and reversal of temporary items during the course of normal operations. The deferred tax benefit of $47.5 million in 2015 mainly represented the deferred tax benefits generated by an acquisition of a local subsidiary.

The Company has the following net operating loss carryforwards at December 31, 2017:



	Federal		New York State		New York City		Hong Kong
Jurisdiction:
Net operating loss (in millions)		$248.4		$93.4		$130.8		$12.8
Year of expiration	2036		2036		2036		Indefinite

In addition to the net operating loss carryforwards in the table above, the Company also has net operating loss carryforwards in Luxembourg. These loss carryforwards are only accessible to the extent of taxable income generated by the Luxembourg reinsurance companies, including any deferred income that will be generated in the future. Consequently, the Company recorded a deferred tax asset of $146.0 million, net of deferred tax liabilities of $349.1 million in connection with future taxable income, and an offsetting valuation allowance of $146.0 million against its Luxembourg net operating loss carryforwards that are in excess of such taxable income.

The Company underwent a change of control under Section 382 of the Internal Revenue Code (“Section 382”) on November 2, 2009. Accordingly, a portion of the Company’s deferred tax assets, in particular a portion of its net operating loss, are subject to an annual limitation. The deduction limitation is approximately $2.4 million annually and applies to approximately $1.8 million of pre-transaction losses. Further, as a result of an acquisition of a subsidiary with net operating loss carryovers in June 2011, a portion of the Company’s deferred tax assets, are subject to an annual limitation under Section 382. The deduction limitation is approximately $6.7 million annually and applies to approximately $50.1 million of net operating losses. The Company is not expected to lose any deferred tax assets as a result of these limitations.

The components of unrecognized tax benefits are as follows:



	As of December 31,
	2017		2016
	(dollars in thousands)
Beginning balance at January 1	$	—	$	—
Increases due to acquisition	2,847		—
Increases due to current year positions	1,100		—
Ending balance at December 31	$	3,947	$	—

The amount of the unrecognized tax benefits of $3.9 million that would impact the effective tax rate of the Company is $1.1 million. The total amount of income tax-related interest and penalties recognized in the consolidated statement of operations for the year ended December 31, 2017 is expense of $0.3 million. The total amount of income tax-related interest and penalties recognized in the consolidated statement of financial condition at December 31, 2017 is $1.5 million.

The Company is subject to examination by the United States Internal Revenue Service as well as state, local and foreign tax authorities in jurisdictions where the Company has significant business operations, such as New York, United Kingdom, and Luxembourg. Currently, the Company is under audit by the Internal Revenue Service for the 2014 tax year, and New York State for the 2010 to 2012 tax years. Management is not expecting a material tax liability from these audits.

The Company continues to permanently reinvest the capital and accumulated earnings of its United Kingdom and Hong Kong subsidiaries.

Effects of the Tax Cuts and Job Act

New tax legislation, commonly referred to as the Tax Cuts and Jobs Act, was enacted on December 22, 2017. ASC 740, Accounting for Income Taxes, requires companies to recognize the effect of tax law changes in the period of enactment even though the effective date for most provisions is for tax years beginning after December 31, 2017, or in the case of certain other provisions, January 1, 2018.

Given the significance of the legislation, the SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), which allows registrants to record provisional amounts during a one year “measurement period” similar to that used when accounting for business combinations. However, the measurement period is deemed to have ended earlier when the registrant has obtained, prepared and analyzed the information necessary to finalize its accounting. During the measurement period, impacts of the law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be recognized and adjusted as information becomes available, prepared or analyzed.

The SAB summarizes a three-step process to be applied at each reporting period to account for and qualitatively disclose: (1) the effects of the change in tax law for which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law where accounting is not complete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with law prior to the enactment of the Tax Cuts and Jobs Act.

The new law includes a reduction in the U.S. corporate income tax rate from 35% to 21%. This change resulted in the Company reporting a deferred income tax expense of $46.6 million in 2017 due to the re-measurement of its deferred tax assets using the new 21% rate applicable upon reversal of these items. This accounting estimate for this matter is complete.

The new law includes a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreign subsidiaries. The Company has performed an earnings and profits analysis of its foreign subsidiaries, and as a result of accumulated deficits, there is no current or deferred income tax effect in this period. Therefore, the accounting estimate for this matter is complete.

The new law includes commissions and performance based compensation in determining the excessive compensation limitation. This calculation could impact the deductibility of certain compensation related deferred tax assets. The Company analyzed the deferred tax assets related to commission and performance based compensation and concluded that no adjustments were required. Therefore, the accounting estimate for this matter is complete.

The Company has evaluated other significant provisions of the law and has not identified any material impact these provisions may have on the Company's 2017 year-end financial statements. Management will continue to monitor the application of these provisions on the Company and make necessary policy elections if and when needed.