WINMARK CORP

10. Income Taxes:

A reconciliation of the expected federal income tax expense based on the federal statutory tax rate to the actual income tax expense is provided below:


	Year Ended
	December 30, 2017		December 31, 2016		December 26, 2015
Federal income tax expense at statutory rate (35%)	$	12,750,900	$	12,581,100	$	12,328,700
Change in valuation allowance		7,500		13,800		(4,400)
State and local income taxes, net of federal benefit		1,056,500		1,021,600		956,000
Permanent differences, including stock option expenses		(628,400)		84,300		158,100
Adjustment to uncertain tax positions		77,800		2,900		10,400
Rate change		(1,540,300)		—		—
Other, net		142,000		24,700		(23,700)
Actual income tax expense	$	11,866,000	$	13,728,400	$	13,425,100

Components of the provision for income taxes are as follows:


	Year Ended
	December 30, 2017		December 31, 2016		December 26, 2015
Current:
Federal	$	11,143,400	$	12,016,000	$	13,486,500
State		1,732,100		1,598,700		1,654,800
Foreign		365,900		396,600		425,900
Current provision		13,241,400		14,011,300		15,567,200
Deferred:
Federal		(1,405,000)		(274,600)		(1,983,200)
State		29,600		(8,300)		(158,900)
Deferred provision		(1,375,400)		(282,900)		(2,142,100)
Total provision for income taxes	$	11,866,000	$	13,728,400	$	13,425,100

The tax effects of temporary differences that give rise to the net deferred income tax assets and liabilities are presented below:


	December 30, 2017		December 31, 2016
Deferred tax assets:
Accounts receivable and lease reserves	$	179,800	$	347,400
Non-qualified stock option expense		1,800,600		2,370,700
Deferred franchise and software license fees		561,800		817,500
Trademarks		44,300		76,800
Lease deposits		1,110,000		1,674,300
Loss from and impairment of equity and note investments		2,634,500		4,065,200
Valuation allowance		(2,634,500)		(4,065,200)
Other		190,600		413,100
Total deferred tax assets		3,887,100		5,699,800
Deferred tax liabilities:
Lease revenue and initial direct costs		(5,707,000)		(8,802,800)
Depreciation and amortization		(136,600)		(228,900)
Total deferred tax liabilities		(5,843,600)		(9,031,700)
Total net deferred tax liabilities	$	(1,956,500)	$	(3,331,900)

On December 22, 2017, the Tax Cut and Jobs Act (the “Tax Act”) was signed into law. The Tax Act makes changes to the U.S. tax code that affected our income tax rate in 2017, notably the reduction of the U.S. federal corporate income tax rate from 35% to 21% beginning in 2018. Accounting guidance applicable to income taxes requires us to recognize the impact of the change in tax rate on our existing deferred tax assets and liabilities as of the date that the Tax Act was signed into law. We recorded a reduction in our 2017 income tax expense of $1.5 million and a corresponding reduction in our net deferred income tax liabilities as a result of the decrease in the federal income tax rate.

During the years ended December 30, 2017, December 31, 2016 and December 26, 2015, $0, $599,400 and $26,300, respectively, was directly credited to stockholders’ equity to account for excess tax benefits related to stock option exercises. (See Note 2 – “Recently Adopted Accounting Pronouncements”)

The Company has assessed its taxable earnings history and prospective future taxable income. Based upon this assessment, the Company has determined that it is more likely than not that its deferred tax assets will be realized in future periods and no valuation allowance is necessary, except for the deferred tax assets related to the loss from and impairment of equity and note investments (which are capital losses for tax purposes). As a result, valuation allowances of $2.6 million and $4.1 million as of December 30, 2017 and December 31, 2016, respectively, have been recorded.

The amount of unrecognized tax benefits, including interest and penalties, as of December 30, 2017 and December 31, 2016, was $583,100 and $502,000, respectively, primarily for potential state taxes.

The Company recognizes interest accrued related to unrecognized tax benefits and penalties as income tax expense for all periods presented. The Company had accrued approximately $32,000 and $22,500 for the payment of interest and penalties at December 30, 2017 and December 31, 2016, respectively.

The following table summarizes the activity related to the Company’s unrecognized tax benefits:


	Total
Balance at December 26, 2015	$	469,900
Increases related to current year tax positions		128,500
Subtractions for tax positions of prior years		(5,300)
Expiration of the statute of limitations for the assessment of taxes		(113,600)
Balance at December 31, 2016		479,500
Increases related to current year tax positions		192,900
Subtractions for tax positions of prior years		(8,300)
Expiration of the statute of limitations for the assessment of taxes		(113,000)
Balance at December 30, 2017	$	551,100

The Company and its subsidiaries file income tax returns in the U.S. federal, numerous state and certain foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2013. The Internal Revenue Service concluded its examination of our U.S. federal tax return for the fiscal year ended 2014 in 2017. We expect various statutes of limitation to expire during the next 12 months. Due to the uncertain response of taxing authorities, a range of outcomes cannot be reasonably estimated at this time.