Dollar Tree, 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

Jan. 28, 2017

Total income taxes were allocated as follows:



	Year Ended
(in millions)	January 28, 2017		January 30, 2016			January 31, 2015
Income from continuing operations	$	433.2	$	165.8		$	355.0
Shareholders' equity, tax benefit on exercises/vesting of equity-based compensation	—		(12.8		)	(4.5		)
	$	433.2	$	153.0		$	350.5

The provision for income taxes consists of the following:



	Year Ended
	January 28,			January 30,		January 31,
(in millions)	2017			2016		2015
Federal - current	$	480.5		$	126.9	$	325.1
State - current	79.5			14.6		47.6
Foreign - current	0.8			0.5		0.4
Total current	560.8			142.0		373.1

Federal - deferred	(37.7		)	7.4		(9.7		)
State - deferred	(89.9		)	3.3		(3.2		)
Foreign - deferred	—			13.1		(5.2		)
Total deferred	$	(127.6	)	$	23.8	$	(18.1	)

Included in current tax expense for the years ended January 28, 2017, January 30, 2016 and January 31, 2015, are amounts related to uncertain tax positions associated with temporary differences, in accordance with ASC 740.

A reconciliation of the statutory federal income tax rate and the effective rate follows:



	Year Ended
	January 28, 2017		January 30, 2016		January 31, 2015
Statutory tax rate	35.0	%	35.0	%	35.0	%
Effect of:
State and local income taxes, net of federal income tax benefit	3.0		3.0		3.3
Work Opportunity Tax Credit	(1.6	)	(3.8	)	(1.0	)
State tax election	(1.4	)	—		—
Deferred tax rate change	(1.6	)	—		—
Incremental tax benefit of exercises/vesting of equity-based compensation	(0.6	)	—		—
International taxes	—		(4.5	)	—
Change in valuation allowance	0.1		4.1		—
Nondeductible acquisition costs	—		1.5		—
Other, net	(0.3	)	1.7		(0.1	)
Effective tax rate	32.6	%	37.0	%	37.2	%

The decrease in the 2016 effective tax rate includes a one-time election allowing the Family Dollar acquisition to be treated as an asset purchase for certain state tax purposes, the adoption of ASU No. 2016-09 under which the incremental tax benefit recognized upon RSU vesting is recorded in income tax expense and a change in the statutory rate for North Carolina. On August 2, 2016, the state of North Carolina announced that it would lower its corporate income tax rate from 4% to 3% for tax years beginning on or after January 1, 2017. This change in North Carolina’s statutory rate significantly decreased the deferred tax liability related to the trade name intangible asset.

United States income taxes have not been provided on accumulated but undistributed earnings of the Company's foreign subsidiaries as the Company intends to permanently reinvest earnings. To date, the earnings and related taxes of the legacy Dollar Tree foreign subsidiaries are negligible. The Company has reserved United States income taxes on accumulated but undistributed earnings for Family Dollar's foreign subsidiaries as of the Acquisition Date.

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. All deferred tax assets and liabilities are classified on the accompanying consolidated balance sheets as noncurrent in accordance with ASU 2015-17 "Income Taxes (Topic 740)" and are netted based on taxing jurisdiction.

Significant components of the Company's net deferred tax assets (liabilities) follow:



(in millions)	January 28, 2017			January 30, 2016
Deferred tax assets:
Deferred rent	$	59.9		$	47.3
Accrued expenses	71.4			73.2
Net operating losses and credit carryforwards	71.4			53.1
Accrued compensation expense	71.3			77.8
State tax election	20.4			—
Other	3.4			0.3
Total deferred tax assets	297.8			251.7
Valuation allowance	(49.7		)	(48.4		)
Deferred tax assets, net	248.1			203.3
Deferred tax liabilities:
Property and equipment	(331.3		)	(369.3		)
Other intangibles	(1,368.7		)	(1,415.9		)
Prepaid expenses	—			(3.3		)
Inventory	(7.0		)	(1.4		)
Total deferred tax liabilities	(1,707.0		)	(1,789.9		)
Net deferred tax liability	$	(1,458.9	)	$	(1,586.6	)

Deferred tax liabilities have been provided for the tax effects of the differences between the book and tax bases in the assets acquired from Family Dollar. The decrease in the deferred tax liability was primarily related to the tax effects of the decrease in the statutory rate in North Carolina, a one-time election allowing the Family Dollar acquisition to be treated as an asset purchase for certain state tax purposes, amortization of favorable lease rights and depreciation of property plant and equipment.

At January 28, 2017, the Company had certain state tax credit carryforwards, net operating loss carryforwards and capital loss carryforwards totaling approximately $71.4 million. These carryforwards will expire, if not utilized, beginning in 2017 through 2036.

A valuation allowance of $49.7 million, net of federal tax benefits, has been provided principally for certain state credit carryforwards, net operating loss and capital loss carryforwards. Since January 30, 2016, the valuation allowance has been increased as a result of an increased valuation allowance against our Canadian operations deferred tax assets and a decreased valuation allowance on capital loss carryforwards. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred taxes will not be realized. Based upon the availability of carrybacks of future deductible amounts to the past two years’ taxable income and the Company's projections for future taxable income over the periods in which the deferred tax assets are deductible, the Company believes it is more likely than not the remaining existing deductible temporary differences will reverse during periods in which carrybacks are available or in which the Company generates net taxable income.

The Company is participating in the Internal Revenue Service (“IRS”) Compliance Assurance Program (“CAP”) for the 2016 fiscal year and will participate in the program for fiscal year 2017. This program accelerates the examination of key transactions with the goal of resolving any issues before the tax return is filed. The Dollar Tree segment's federal tax returns have been examined and all issues have been settled through the fiscal 2014 tax year. The federal statute of limitations is still open for Family Dollar's tax returns for the fiscal year ended August 31, 2013 and forward. Several states completed their examinations during fiscal 2016. In general, fiscal years 2013 and forward are within the statute of limitations for state tax purposes. The statute of limitations is still open prior to 2013 for some states.

The balance for unrecognized tax benefits at January 28, 2017 was $71.2 million. The total amount of unrecognized tax benefits at January 28, 2017 that, if recognized, would affect the effective tax rate was $16.3 million (net of the federal tax benefit).

The following is a reconciliation of the Company’s total gross unrecognized tax benefits:



(in millions)	January 28, 2017			January 30, 2016
Beginning Balance	$	71.4		$	6.5
Additions, Acquisition of Family Dollar	—			64.4
Additions, based on tax positions related to current year	5.9			1.9
Additions for tax positions of prior years	3.7			1.6
Settlements	(2.2		)	(1.8		)
Lapses in statutes of limitation	(7.6		)	(1.2		)
Ending balance	$	71.2		$	71.4

The Company believes it is reasonably possible that $20.0 million to $27.0 million of the reserve for uncertain tax positions may be reduced during the next 12 months principally as a result of the effective settlement of outstanding issues. It is also possible that state tax reserves will be reduced for audit settlements and statute expirations within the next 12 months. At this point it is not possible to estimate a range associated with the resolution of these audits. The Company does not expect any change to have a significant impact to its consolidated financial statements.

As of January 28, 2017, the Company has recorded a liability for potential interest and penalties of $7.9 million.