INCOME TAXES

Overview

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act tax reform legislation. This legislation creates significant change in U.S. tax law, including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. The legislation did reduce the U.S. corporate tax rate from the current rate of 34% to 21% for tax periods beginning after December 31, 2017. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities at the enacted federal and state rate in effect during their scheduled reversals, the federal of which is 21%. This revaluation of deferred tax assets resulted in an expense of $5,476,000 to income tax expense in continuing operations and a corresponding reduction in the deferred tax assets. Net operating losses generated prior to tax periods beginning after December 31, 2017 will not be limited in usage. However, net operating losses generated during tax periods beginning after December 31, 2017 will have limitations, but will carry-forward indefinitely. The other provisions of the Tax Cuts and Jobs Act do not have an expected material impact on the fiscal 2018 consolidated financial statements.

The Company considers the accounting for the deferred tax re-measurements and other items to be complete, but ongoing accounting guidance and interpretation could result in adjustments to the consolidated financial statements. The impact of the enactment of the Tax Act for fiscal year 2017 is reflected in the table below.

The provision (benefit) for income taxes on continuing operations for the years ended December 31, 2017, 2016 and 2015 is summarized as follows:



	Year Ended December 31,
	2017			2016			2015
Current provision (benefit) :
Federal	$	274,000		$	17,000		$	1,191,000
State	472,000			522,000			947,000
	746,000			539,000			2,138,000
Deferred provision (benefit):
Federal	6,585,000			(1,284,000		)	(783,000		)
State	(588,000		)	(285,000		)	(439,000		)
	5,997,000			(1,569,000		)	(1,222,000		)
Provision (benefit) for income taxes of continuing operations	$	6,743,000		$	(1,030,000	)	$	916,000

A reconciliation of taxes computed at statutory income tax rates on income (loss) from continuing operations is as follows:



	Year Ended December 31,
	2017			2016			2015
Provision (benefit) for federal income taxes at statutory rates	$	711,000		$	(889,000	)	$	1,247,000
Provision for state income taxes, net of federal benefit	421,000			120,000			688,000
Valuation allowance changes affecting the provision for income taxes	(372,000		)	(45,000		)	(534,000		)
Employment tax credits	(217,000		)	(529,000		)	(1,249,000		)
Nondeductible expenses	496,000			453,000			862,000
Stock based compensation expense	(35,000		)	(62,000		)	(105,000		)
Effect of Tax Cuts and Jobs Creation Act	5,476,000			—			—
Other	263,000			(78,000		)	7,000
Provision (benefit) for income taxes of continuing operations	$	6,743,000		$	(1,030,000	)	$	916,000

Deferred Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets are reduced by a valuation allowance if, based upon the weight of available evidence, it is more likely than not that we will realize only some portion of the deferred tax assets. The net deferred tax assets and liabilities, at the respective income tax rates, are as follows:



	December 31,
	2017			2016
Deferred tax assets (liabilities):
Net operating loss and other carryforwards	$	495,000		$	1,260,000
Credit carryforwards	3,237,000			3,162,000
Allowance for doubtful accounts	3,626,000			3,772,000
Prepaid expenses	(731,000		)	(867,000		)
Deferred lease costs	32,000			107,000
Depreciation	1,190,000			2,122,000
Tax goodwill and intangibles	(972,000		)	(1,296,000		)
Stock-based compensation	476,000			629,000
Accrued liabilities	773,000			5,011,000
Accrued rent	1,892,000			3,118,000
Kentucky and Kansas acquisition costs	4,000			6,000
Impairment of long-lived assets	186,000			269,000
Interest rate swap	(14,000		)	49,000
Hedge Ineffectiveness	(106,000		)	(69,000		)
Noncurrent self-insurance liabilities	5,443,000			4,633,000
Other	—			11,000
	15,531,000			21,917,000
Less valuation allowance	(377,000		)	(732,000		)
	$	15,154,000		$	21,185,000

Deferred Tax Valuation Allowance

The assessment of the amount of value assigned to our deferred tax assets under the applicable accounting standards is highly judgmental. We are required to consider all available positive and negative evidence in evaluating the likelihood that we will be able to realize the benefit of our deferred tax assets in the future. Such evidence includes scheduled reversals of deferred tax assets and liabilities, projected future taxable income, tax-planning strategies, and the results of recent operations. Since this evaluation requires consideration of historical and future events, there is significant judgment involved, and our conclusion could be materially different should certain of our expectations not transpire.

When assessing all available evidence, we consider the weight of the evidence, both positive and negative, based on the objectivity of the underlying evidence and the extent to which it can be verified. For the three-year period ended December 31, 2017, the Company has a cumulative pre-tax income from continuing operations of $2,838,000, which includes $1,944,000 of income attributable to the year ended December 31, 2017. Additionally, the Company recognized governmental and regulatory changes have put downward revenue pressure on the long-term care industry as a piece of negative evidence in our analysis. As a result of this negative evidence, the Company performed a thorough assessment of the available positive and negative evidence in order to ascertain whether it is more-likely-than-not that in future periods the Company will generate sufficient pre-tax income to utilize all of our federal deferred tax assets and our net operating loss and other carryforwards and credits. State deferred tax assets are considered for valuation separately and on a state-by-state basis.

The Company also identified several pieces of objective positive evidence which were considered and weighed in the analysis performed regarding the valuation of deferred tax assets, including, but not limited to the expected accretive strategic acquisitions completed by us during the three-year period, corporate and regional restructuring expected to reduce costs while maintaining revenue levels, the long-term expiration dates of a majority of the net operating losses and credits, our history of not having carryforwards or credits expire unutilized, and the completed divestiture of the centers in Mississippi in 2017 and Ohio in 2016.

In performing the analysis, the Company contemplated utilization of the deferred tax assets under multiple scenarios. After consideration of these factors, the Company determined that it was more likely than not that future taxable income would be sufficient to realize substantially all of the recorded value of the Company's deferred tax assets for federal income tax purposes.

Realization of the deferred tax assets is not assured and future events could result in a change in judgment. If future events result in a conclusion that realization is no longer more likely than not to occur, the Company would be required to establish a valuation allowance on the deferred tax assets at that time, which would result in a charge to income tax expense and a potentially material decrease in net income in the period in which the factors change our judgment.

At December 31, 2017, the Company had $6,480,000 of net operating losses, which expire at various dates beginning in 2019 and continue through 2021. The use of a portion of these loss carryforwards is limited by change in ownership provisions of the Federal tax code to a maximum of approximately $1,614,000. The Company has reduced the deferred tax asset and the corresponding valuation allowances for net operating loss deductions permanently lost as a result of the change in ownership provisions.

With respect to state deferred tax assets, the Company reduced the valuation allowance by approximately $357,000 in 2017, primarily related to the expectation that deferred tax assets for which valuation allowances had previously been applied would more-likely-than-not be utilized as a result of the increase in taxable income during the year ended December 31, 2017. In 2016 and 2015, the Company recorded a deferred tax provision to adjust approximately $47,000 and $315,000, respectively, of the valuation allowance on state deferred tax assets. The changes in valuation allowance were based on the Company's assessment of the realization of certain individual tax assets. The Company did not record a valuation allowance as of December 31, 2017.

Under the Work Opportunity Tax Credit ("WOTC") program, the Company recorded $210,000, $550,000 and $737,000 in Work Opportunity Tax Credits during 2017, 2016 and 2015, respectively.

The Company received a notice of an audit by the Internal Revenue Service related to the 2012 tax year, which was closed in 2016. As of December 31, 2017, the Company’s tax years for 2013 forward are subject to examination by tax authorities.