Income Taxes

Our expense (benefit) from income taxes from continuing operations consists of the following for the periods presented:



	Fiscal Year Ended September 30,
(In thousands)	2016		2015			2014
Current federal	$	—	$	(64	)	$	(44,789	)
Current state	595		520			322
Deferred federal ^(a)	5,574		(314,651		)	2,385
Deferred state ^{(a) (b)}	10,329		(10,374		)	285
Total	$	16,498	$	(324,569	)	$	(41,797	)

^(a) Fiscal 2015 benefit is due to release of a substantial portion of the valuation allowance on our deferred tax assets; refer to discussion below titled “Valuation Allowance.”

^(b) Fiscal 2016 expense includes $8.6 million of additional valuation allowance on our state deferred tax assets due to a number of changes to the legal forms of our operating entities; refer to discussion below titled “Valuation Allowance.”

The expense (benefit) from income taxes from continuing operations differs from the amount computed by applying the federal income tax statutory rate as follows for the periods presented:



	Fiscal Year Ended September 30,
(In thousands)	2016			2015			2014
Income tax computed at statutory rate	$	7,596		$	7,711		$	(2,406	)
State income taxes, net of federal benefit	4,974			2,485			(172		)
Decrease in valuation allowance - IRS Settlement	—			—			(26,846		)
Increase (decrease) in valuation allowance - other ^{(a) (b)}	6,457			(334,605		)	3,023
Changes for uncertain tax positions	(40		)	42			(14,276		)
IRS interest refund	—			—			(1,714		)
State rate change	(678		)	—			—
Tax credits	(2,134		)	—			—
Other, net	323			(202		)	594
Total	$	16,498		$	(324,569	)	$	(41,797	)

^(a)For fiscal 2015, amount includes $335.2 million release of a substantial portion of the valuation allowance on our deferred tax assets; refer to discussion below titled “Valuation Allowance.”

^(b)For fiscal 2016, amount includes $8.6 million of additional valuation allowance on our state deferred tax assets due to a number of changes to the legal forms of our operating entities; refer to discussion below titled “Valuation Allowance.”

The principal differences between our effective tax rate and the U.S. federal statutory rate relate to state taxes, changes in our valuation allowance and tax credits.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of our assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant temporary differences that give rise to the net deferred tax assets are as follows as of September 30, 2016 and September 30, 2015:



(In thousands)	September 30, 2016			September 30, 2015
Deferred tax assets:
Federal and state tax carryforwards	$	298,426		$	292,346
Inventory adjustments	62,985			87,335
Warranty and other reserves	16,943			14,913
Incentive compensation	15,390			10,780
Property, equipment and other assets	2,896			2,866
Uncertain tax positions	1,721			1,917
Other	809			3,814
Total deferred tax assets	399,170			413,971
Deferred tax liabilities:
Deferred revenues	(22,950		)	(30,939		)
Total deferred tax liabilities	(22,950		)	(30,939		)
Net deferred tax assets before valuation allowance	376,220			383,032
Valuation allowance ^(a)	(66,265		)	(57,659		)
Net deferred tax assets	$	309,955		$	325,373

^(a) For fiscal 2016, amount includes $8.6 million of additional valuation allowance on our state deferred tax assets due to a number of changes to the legal forms of our operating entities; refer to discussion below titled “Valuation Allowance.”

As of September 30, 2016, our gross deferred tax assets above included $252.5 million for federal net operating loss carryforwards, $31.6 million for state net operating loss carryforwards, $9.8 million for an alternative minimum tax credit and $7.1 million for general business credits. The net operating loss carryforwards expire at various dates through 2033, and the general business credits expire at various dates through 2036. The alternative minimum tax credit has an unlimited carryforward period. We experienced an “ownership change” as defined in Section 382 of the Internal Revenue Code (Section 382) as of January 12, 2010. Section 382 contains rules that limit the ability of a company that undergoes an “ownership change” to utilize its net operating loss carryforwards (NOLs) and certain built-in losses or deductions recognized during the five-year period after the ownership change to offset future taxable income. Because the five-year period has expired, we have determined the actual impact and final classification of those amounts, which are properly reflected in the amounts presented above. The actual realization of our deferred tax assets is difficult to predict and is dependent on future events.

We recognized income tax expense from continuing operations of $16.5 million in our fiscal 2016, compared to income tax benefits from continuing operations of $324.6 million and $41.8 million in our fiscal 2015 and fiscal 2014, respectively. The income tax expense in our fiscal 2016 primarily resulted from income in the current year and the additional valuation allowance on some of our state deferred tax assets (refer to additional discussion below, titled “Valuation Allowance”), offset by the generation of federal tax credits. The income tax benefit in our fiscal 2015 primarily resulted from the release of a substantial portion of the valuation allowance on our deferred tax assets. In fiscal 2014, our income tax benefit was due to the resolution of a federal tax audit, which resulted in a refund of $26.8 million, as well as the recognition of unrecognized tax benefits of $14.3 million. Due to the effects of changes in our valuation allowance on our deferred tax balance and changes in our unrecognized tax benefits, our effective tax rates in fiscal 2016, 2015 and 2014 are not meaningful metrics, as our income tax amounts were not directly correlated to the amount of our pretax income (loss) for those periods.

Valuation Allowance

A reduction of the carrying amounts of deferred tax assets by a valuation allowance is required if, based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed periodically based on the more-likely-than-not realization threshold criterion. In the assessment for a valuation allowance, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carryforward periods, the Company's experience with loss carryforwards not expiring unused and tax planning alternatives.

Based upon an evaluation of all available evidence, the most important of which was recent losses incurred, we established a valuation allowance for substantially all of our deferred tax assets during our fiscal 2008. We have continued to evaluate the need for our valuation allowance by assessing all positive and negative evidence indicating our ability to realize our deferred tax assets. In these evaluations, we gave more significant weight to objective evidence, such as our actual financial condition and results of operations, as compared to subjective evidence.

The positive evidence we considered as part of our analysis during the fourth quarter of 2015 included our recent trends in cumulative income from continuing operations, along with our growth in backlog units, closings and ASP for both backlog and actual closings. Our levels of backlog (in both units and dollars) supported our expectations of future profitability. The negative evidence we considered as part of our analysis centered around significant quarterly losses that the Company incurred through the quarter ended March 31, 2013, which rolled-off our 36-month cumulative income position during the first half of our fiscal 2016. The removal of these losses from our analysis provided a significant increase in our recent earnings trend and, coupled with our actual improvements in continuing operations, pointed to an objectively verifiable increase in our earnings profile.

Therefore, during the quarter ended September 30, 2015, we concluded that it was more likely than not that a substantial amount of our deferred tax assets would be realized. This conclusion was based on an evaluation of all relevant evidence, both positive and negative, as discussed above, as well as a generally improving housing market and stabilization in broader economic conditions. The principal positive evidence that led us to this determination was our improved pre-tax earnings profile, particularly over our most recent fiscal years. Given the remaining recovery period for the majority of our deferred tax assets, our recent historical operating results continued to support the realization of a significant amount of our deferred tax assets. The valuation allowance on our deferred tax assets was $57.7 million as of September 30, 2015. The remaining valuation allowance was balanced between various federal and state attributes for which the Company had concluded it is not more likely than not that these attributes would be realized at that time.

During our fiscal 2016, we continued to monitor the various factors that led to our determination of the realization of a significant portion of our deferred tax assets during the prior fiscal year. Our fiscal 2016 income from continuing operations, less certain charges including loss on extinguishment of debt and impairments and abandonments, continues to reflect the positive trends of recent years, along with increases in closings and ASP from closings. We continue to maintain levels of backlog and community count to support our expectations of future profitability. During the current fiscal year, the Company enacted a plan to repurchase portions of its outstanding debt, which altered its debt maturity and interest rate profile through new issuances and redemptions of prior issuances. The change in the Company's debt portfolio will create future interest expense savings that further support its estimates of future profitability, and may result in the realization of additional deferred tax assets in the future. As of September 30, 2016, the Company will have to cumulatively generate approximately $760.0 million in pre-tax income over the course of its carryforward period to realize its deferred tax assets prior to their expiration, which, as previously discussed, is the Company's fiscal 2036.

During our current fiscal year, we contemplated various tax planning strategies based on our operations profile. This planning resulted in a restructuring effort immediately following the close of our fiscal 2016, where we executed certain tax elections and a number of changes to the legal forms of our operating entities, which will significantly reduce our income profile in certain state jurisdictions going forward. We expect this restructuring to reduce our effective tax rate in fiscal 2017 to an amount that is in-line with our peers through a significant reduction in our state effective tax rate. In addition, the restructure provides cash tax savings in various jurisdictions where we no longer have significant state loss carryforwards available. In conjunction with the restructure, we also evaluated our ability to realize certain state components of our deferred tax asset. Given this change, we evaluated both positive and negative evidence, including consideration of a change in expected future taxable earnings in the separate state jurisdictions that will be impacted by the restructuring. Based on those evaluations, we recorded an additional $8.6 million in valuation allowance during the quarter ended September 30, 2016 for state deferred tax assets we concluded are no longer more likely than not to be realized.

The remaining valuation allowance of $66.3 million as of September 30, 2016 was balanced between various federal and state attributes for which the Company has concluded it is not more likely than not that these attributes would be realized at that time.

Unrecognized Tax Benefits

A reconciliation of our unrecognized tax benefits is as follows for the beginning and end of each period presented:



	Fiscal Year Ended September 30,
(In thousands)	2016			2015			2014
Balance at beginning of year	$	4,721		$	4,616		$	17,464
(Reductions in) additions for tax positions related to current year	(180		)	251			150
Additions for tax positions related to prior years	—			—			1,365
Reductions in tax positions of prior years	—			(10		)	(14,201		)
Lapse of statute of limitations	—			(136		)	(162		)
Balance at end of year	$	4,541		$	4,721		$	4,616

If we were to recognize our $4.5 million of gross unrecognized tax benefits remaining as of September 30, 2016, substantially all would impact our effective tax rate. Additionally, we had $0.3 million and $0.4 million, respectively, of accrued interest and penalties as of September 30, 2016 and 2015. Our income tax expense includes tax-related interest.

In the normal course of business, we are subject to audits by federal and state tax authorities regarding various tax liabilities. Certain state income tax returns for various fiscal years are under routine examination. The statute of limitations for our major tax jurisdictions remains open for examination for fiscal years 2007 and subsequent years. As of September 30, 2016, it is reasonably possible that none of our uncertain tax positions will reverse within the next twelve months.