FALCONSTOR SOFTWARE INC

Income Taxes

Information pertaining to the Company’s loss before income taxes and the applicable provision for income taxes is as follows:



	December 31,
	2016			2015
Loss before income taxes:
Domestic loss	$	(10,998,240	)	$	(2,310,565	)
Foreign income	586,653			756,747
Total loss before income taxes:	(10,411,587		)	(1,553,818		)
Provision (benefit) for income taxes:
Current:
Federal	$	(17,626	)	$	3,939
State and local	1,886			16,002
Foreign	723,502			482,242
	707,762			502,183
Deferred:
Federal	$	154,641		$	(167,634	)
State and local	1,766			7,006
Foreign	(276,962		)	33,988
	(120,555		)	(126,640		)
Total provision for income taxes:	$	587,207		$	375,543

During 2016, the Company recorded a tax provision of $587,207 related to state and local and foreign income taxes, inclusive of a tax provision of $122,004 as a result of the Company's change in estimate with respect to the realizability of its AMT credits. During 2015 the Company recorded a tax provision of $375,543 related to state and local and foreign income taxes and is inclusive of a tax benefit of $180,021 related to certain AMT tax credits that became realizable on a more-likely-than-not basis as a result of recent federal tax legislation enacted in December 2015.

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



	December 31,
	2016			2015
Deferred Tax Assets:
Allowance for receivables	$	100,414		$	72,539
Deferred revenue	3,648,029			2,939,462
Share-based compensation	2,254,428			3,095,723
Accrued expenses and other liabilities	418,483			307,565
Domestic net operating loss carryforwards	30,714,934			26,023,318
Foreign net operating loss carryforwards	9,761			99,544
Tax credit carryforwards	574,997			574,997
AMT tax credit carryforwards	460,607			483,285
Capital loss carryforwards	78,296			77,586
Fixed assets	489,105			554,154
Intangibles	1,435,994			1,762,519
Sub-total	40,185,048			35,990,692
Valuation allowance	(38,800,877		)	(35,121,608		)
Total Deferred Tax Assets	1,384,171			869,084
Deferred Tax Liabilities:
Deferred state income tax	(923,553		)	(541,359		)
Foreign withholding taxes	(137,659		)	(128,261		)
Total Deferred Tax Liabilities	(1,061,212		)	(669,620		)
Net Deferred Tax Assets	$	322,959		$	199,464

As of each reporting date, the Company considers new evidence, both positive and negative, that could affect its view of the future realization of deferred tax assets. During 2015, the Company considered the impact of new legislation regarding potential refunds of its AMT tax credits and determined that there is sufficient positive evidence to conclude that it is more-likely-than-not that AMT credits of $180,021 are realizable which resulted in a reduction to the valuation allowance and a benefit to income tax expense. During 2016, the Company revised its estimate of potential refundable AMT credits and recorded an income tax provision of $122,004. The Company determined its other net domestic deferred tax assets are not realizable on a more-likely-than-not basis.

As of December 31, 2016, the Company had federal net operating loss carryforwards of approximately $84.7 million which are set to expire beginning in 2030 through 2036, if not utilized. As of December 31, 2016, the Company had approximately $3.6 million of various tax credit carryforwards, of which, approximately $3.1 million related to research and development tax credit carryforwards which expire at various dates beginning in 2023 through 2028, if not utilized. As of December 31, 2016, the Company had approximately $0.5 million related to AMT credit carryforwards, which may be carried forward indefinitely.

As of December 31, 2016, the Company had not provided for the United States income or additional foreign withholding taxes on approximately $4.2 million of undistributed earnings of its subsidiaries operating outside of the United States, with the exception of China. It is the Company’s practice and intention to reinvest those earnings permanently. Generally, such amounts become subject to United States taxation upon remittance of dividends and under certain other circumstances. Determination of the amount of any unrecognized deferred tax liability related to investments in these foreign subsidiaries is not practicable.

The effective tax rate before income taxes varies from the current statutory federal income tax rate as follows:



	December 31,
	2016			2015
Tax at Federal statutory rate	$	(3,644,056	)	$	(543,836	)
Increase (reduction) in income taxes resulting from:
State and local taxes	2,172			3,195
Non-deductible expenses	(28,812		)	(31,199		)
Net effect of foreign operations	232,858			235,850
Uncertain tax positions	12,440			26,814
Change in valuation allowance	4,011,710			680,780
Other	895			3,939
	$	587,207		$	375,543

A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows:



	2016			2015
Balance at January 1,	$	217,289		$	224,637
Increases to tax positions taken in prior years	4,510			9,306
Decreases to tax positions taken in prior years	—			—
Increase for tax positions taken during the current year	—			—
Expiration of statutes of limitation	(3,323		)	—
Translation	(1,015		)	(16,654		)
Balance at December 31,	$	217,461		$	217,289

At December 31, 2016, $328,739 including interest, if recognized, would reduce the Company’s annual effective tax rate. As of December 31, 2016, the Company had approximately $111,278 of accrued interest. The Company believes it is reasonably possible that $96,907 of its unrecognized tax benefits will reverse within the next 12 months. The Company records any interest and penalties related to unrecognized tax benefits in income tax expense.

The Company files federal, state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2013 through 2016 tax years generally remain subject to examination by federal and most state tax authorities. In addition to the U.S., the Company’s major taxing jurisdictions include China, Taiwan, Japan, France and Germany.