Sonic Automotive, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Income Taxes

Income Taxes

12 Months Ended

Dec. 31, 2019

The provision for income taxes for continuing operations - benefit (expense) consists of the following:


	Year Ended December 31,
	2019		2018		2017
	(In thousands)
Current:
Federal	$	(62,016)	$	(37,028)	$	(34,877)
State	(12,563)		(7,411)		(7,292)
Total current	(74,579)		(44,439)		(42,169)
Deferred	19,471		21,517		28,198
Total provision for income taxes for continuing operations - benefit (expense)	$	(55,108)	$	(22,922)	$	(13,971)

The provision for income taxes for continuing operations - benefit (expense) includes a benefit of $28.4 million related to the remeasurement of the net deferred tax liability as of December 31, 2017, due to a reduction in the U.S. statutory federal income tax rate from 35.0% to 21.0% (beginning in 2018) resulting from enactment of the Tax Act which was signed into law in December 2017. The effect of this benefit is shown separately in the following rate reconciliation table. The reconciliation of the U.S. statutory federal income tax rate with our federal and state overall effective income tax rate from continuing operations is as follows:


	Year Ended December 31,
	2019		2018		2017
U.S. statutory federal income tax rate	21.00	%	21.00	%	35.00	%
Effective state income tax rate	4.10	%	4.60	%	4.58	%
Valuation allowance adjustments	(0.18)	%	0.20	%	(0.59)	%
Uncertain tax positions	(0.45)	%	0.17	%	0.71	%
Effect of change in future U.S. statutory federal income tax rate	0.00	%	0.00	%	(26.27)	%
Non-deductible compensation	1.48	%	3.06	%	0.23	%
Other	1.65	%	1.41	%	(0.74)	%
Effective income tax rate	27.60	%	30.44	%	12.92	%

Deferred income taxes reflect the net tax effects of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Significant components of our deferred tax assets and liabilities are as follows:


	December 31, 2019		December 31, 2018
	(In thousands)
Deferred tax assets:
Accruals and reserves	$	27,271	$	24,948
State net operating loss carryforwards	10,771		12,687
Basis difference in property and equipment	20,923		11,515
Interest and state taxes associated with the liability for uncertain income tax positions	938		1,175
Fair value of interest rate swaps and interest rate caps	1,153		—
Basis difference in liabilities related to right-of-use assets	93,808		—
Other	2,146		1,778
Total deferred tax assets	157,010		52,103

Deferred tax liabilities:
Fair value of interest rate swaps and caps	—		(462)
Basis difference in inventories	(804)		(838)

Basis difference in goodwill	(61,397)		(69,646)
Basis difference in right-of-use assets	(90,679)		—
Other	(2,316)		(2,544)
Total deferred tax liabilities	(155,196)		(73,490)
Valuation allowance	(7,775)		(8,138)
Net deferred tax asset (liability)	$	(5,961)	$	(29,525)

Net long-term deferred tax asset balances were approximately $3.0 million and $3.7 million at December 31, 2019 and 2018, respectively, and are recorded in other assets on the accompanying consolidated balance sheets. Net long-term deferred tax liability balances were approximately $8.9 million and $33.2 million at December 31, 2019 and 2018, respectively, and are recorded in deferred income taxes on the accompanying consolidated balance sheets.

We have approximately $248.4 million in gross state net operating loss carryforwards that will expire between 2020 and 2039. Management reviews these carryforward positions, the time remaining until expiration and other opportunities to realize these carryforwards in making an assessment as to whether it is more likely than not that these carryforwards will be realized. The results of future operations, regulatory framework of the taxing authorities and other related matters cannot be predicted with certainty and, therefore, differences from the assumptions used in the development of management’s judgment could occur. As of December 31, 2019, we had recorded a valuation allowance amount of approximately $7.8 million related to certain state net operating loss carryforward deferred tax assets as we determined that we would not be able to generate sufficient state taxable income in the related entities to realize the accumulated net operating loss carryforward balances.

At January 1, 2019, we had liabilities of approximately $5.5 million recorded related to unrecognized tax benefits. Included in the liabilities related to unrecognized tax benefits at January 1, 2019, was approximately $0.6 million related to interest and penalties which we have estimated may be paid as a result of our tax positions. It is our policy to classify the

expense related to interest and penalties to be paid on underpayments of income taxes within income tax expense. A summary of the changes in the liability related to our unrecognized tax benefits is presented below.


	2019		2018		2017
	(In thousands)
Unrecognized tax benefit liability, January 1 (1)	$	4,901	$	4,645	$	4,357
New positions	—		—		653
Prior period positions:
Increases	1,795		7		491
Decreases	(2,697)		(199)		(539)
Increases from current period positions	582		714		692
Settlements	(653)		—		—
Lapse of statute of limitations	(8)		(69)		(781)
Other	(81)		(197)		(228)
Unrecognized tax benefit liability, December 31 (2)	$	3,839	$	4,901	$	4,645

(1) Excludes accrued interest and penalties of $0.6 million, $0.6 million and $0.8 million at January 1, 2019, 2018 and 2017, respectively.

(2) Excludes accrued interest and penalties of $0.5 million, $0.6 million and $0.6 million at December 31, 2019, 2018 and 2017, respectively. Amount presented is net of state net operating losses of $0.0 million, $0.0 million and $0.1 million at December 31, 2019, 2018 and 2017, respectively.

Approximately $3.8 million and $4.9 million of the unrecognized tax benefits as of December 31, 2019 and 2018, respectively, would ultimately affect the income tax rate if recognized. Included in the December 31, 2019 recorded liability is approximately $0.5 million related to interest and penalties which we have estimated may be paid as a result of our tax positions. We do not anticipate any significant changes in our unrecognized tax benefit liability within the next 12 months.

Sonic and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. Sonic’s 2016 through 2019 U.S. federal income tax returns remain open to examination by the U.S. Internal Revenue Service. Sonic and its subsidiaries’ state income tax returns remain open to examination by state taxing authorities for years ranging from 2015 to 2019.

The primary effect of the change in the U.S. federal income tax rate from 35.0% to 21.0%, as required by the Tax Act, related to the adjustment of deferred income tax balances. In periods prior to the year ended December 31, 2017, the income tax benefit or expense related to the reversal of deferred income tax assets and liabilities was expected to be realized at a federal income tax rate of 35.0%. Because of the Tax Act, the reversal of deferred income tax asset and liabilities in subsequent periods is recorded assuming a federal income tax rate of 21.0%. There were no significant provisional amounts considered in our recorded income tax balances at December 31, 2019. However, as the Tax Act was signed into law on December 22, 2017, clarifications of the Tax Act’s provisions may be issued at later dates that alter our understanding of the Tax Act’s provisions and thus may affect recorded income tax balances. Interpretations related to the Tax Act’s provisions concerning depreciation, interest and compensation deductibility could impact recorded income tax balances.