SLEEP NUMBER CORP

Income Taxes

Income tax expense consisted of the following (in thousands):



	2017		2016			2015
Current:
Federal	$	19,153	$	21,634		$	7,272
State	4,046		5,289			3,870
	23,199		26,923			11,142
Deferred:
Federal	2,734		(105		)	13,567
State	28		(2,302		)	202
	2,762		(2,407		)	13,769
Income tax expense	$	25,961	$	24,516		$	24,911

The following table provides a reconciliation between the statutory federal income tax rate and our effective income tax rate:



	2017		2016		2015
Statutory federal income tax	35.0	%	35.0	%	35.0	%
State income taxes, net of federal benefit	2.5		2.6		3.0
Manufacturing deduction	(3.5	)	(3.3	)	(1.7	)
Effect of 2018 deferred tax rate change	(1.9	)	—		—
Changes in unrecognized tax benefits	(0.6	)	1.2		0.3
Non-taxable acquisition-related transactions	—		—		(2.6	)
Other	(3.0	)	(3.2	)	(1.0	)
Effective income tax rate	28.5	%	32.3	%	33.0	%

We file income tax returns with the U.S. federal government and various state jurisdictions. In the normal course of business, we are subject to examination by federal and state taxing authorities. We are no longer subject to federal income tax examinations for years prior to 2014 or state income tax examinations prior to 2013.

On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted. The TCJA reduces the statutory federal tax rate from 35% to 21% starting in 2018. In addition, there were various other tax law changes that impacted us. In connection with the reduction of the federal tax rate, we recognized a provisional tax benefit of $1.7 million for the year ended December 30, 2017. This provisional tax benefit is related to the re-measurement of U.S. deferred tax assets and liabilities using a federal tax rate of 21%, which, under the TCJA, is expected to be in place when such deferred assets and liabilities reverse in future periods.

The other provisions of the TCJA did not have a significant impact on our consolidated financial statements for the year ended December 30, 2017, but may impact our effective tax rate in subsequent periods.

The TCJA has significant complexity and our final tax liability may differ from these estimates, due to, among other things, guidance that may be issued by the U.S. Treasury Department and the Internal Revenue Service, and related interpretations and clarifications of tax law. For the re-measurement of the deferred tax assets and liabilities, further analysis may be required to refine our calculations and related account balances.

We will complete the remaining elements of our analysis during 2018, and any adjustments to the provisional tax benefit will be included in income tax expense in the appropriate period, in accordance with the U.S. generally accepted accounting principles.

Deferred Income Taxes

The tax effects of temporary differences that give rise to deferred income taxes were as follows (in thousands):



	2017			2016
Deferred tax assets:
Stock-based compensation	$	6,940		$	9,834
Deferred rent and lease incentives	6,007			8,388
Warranty and returns liabilities	6,602			7,948
Net operating loss carryforwards and credits	3,240			6,368
Compensation and benefits	3,315			4,115
Other	3,321			5,264
Total gross deferred tax assets	29,425			41,917
Valuation allowance	(615		)	(620		)
Total deferred tax assets after valuation allowance	28,810			41,297
Deferred tax liabilities:
Property and equipment	21,475			27,049
Deferred revenue	723			3,279
Other	3,987			6,302
Total gross deferred tax liabilities	26,185			36,630
Net deferred tax assets	$	2,625		$	4,667

At December 30, 2017, we had net operating loss carryforwards for federal purposes of $3 million, which will expire between 2025 and 2034, and for state income tax purposes of $6 million, which will expire between 2028 and 2037.

We evaluate our deferred income taxes quarterly to determine if valuation allowances are required. As part of this evaluation, we assess whether valuation allowances should be established for any deferred tax assets that are not considered more likely than not to be realized, using all available evidence, both positive and negative. This assessment considers, among other matters, the nature, frequency, and severity of historical losses, forecasts of future profitability, taxable income in available carryback periods and tax planning strategies. In making such judgments, significant weight is given to evidence that can be objectively verified. We have provided a $0.6 million valuation allowance resulting primarily from our inability to utilize certain foreign net operating losses, and federal net operating losses associated with our acquisition of BAM Labs, Inc.

Unrecognized Tax Benefits

Reconciliations of the beginning and ending amounts of unrecognized tax benefits for 2017, 2016 and 2015 were as follows (in thousands):



	Federal and State Tax
	2017			2016			2015
Beginning balance	$	3,460		$	2,077		$	742
Increases related to current-year tax positions	330			326			1,277
Increases related to prior-year tax positions	87			1,594			113
Decreases related to prior-year tax positions	(1,038		)	—			—
Lapse of statute of limitations	—			(333		)	(55		)
Settlements with taxing authorities	—			(204		)	—
Ending balance	$	2,839		$	3,460		$	2,077

As of December 30, 2017 and December 31, 2016, we had $3 million and $4 million, respectively, of unrecognized tax benefits, which if recognized, would affect our effective tax rate. The amount of unrecognized tax benefits is not expected to change materially within the next 12 months.