LANNETT CO INC

Note 19. Income Taxes

The provision for income taxes consisted of the following for the fiscal years ended June 30:

(In thousands)	June 30, 2017			June 30, 2016			June 30, 2015
Current Income Tax Expense (Benefit)
Federal	$	764		$	34,932		$	80,124
State and Local	638			1,887			572

Total Current Income Tax Expense	1,402			36,819			80,696

Deferred Income Tax Expense (Benefit)
Federal	(2,210		)	(17,529		)	(5,245		)
State and Local	1,905			(1,968		)	1,979

Total Deferred Income Tax Benefit	(305		)	(19,497		)	(3,266		)

Total Income Tax Expense	$	1,097		$	17,322		$	77,430

A reconciliation of the differences between the effective rates and federal statutory rates was as follows:

	June 30, 2017		June 30, 2016		June 30, 2015

Federal income tax at statutory rate	35.0	%	35.0	%	35.0	%
State and local income tax, net	293.6	%	(0.1	)%	0.1	%
Nondeductible expenses	45.4	%	0.8	%	—
Foreign rate differential	49.9	%	0.5	%	0.1	%
Income tax credits	(160.9	)%	(3.0	)%	(0.4	)%
Domestic production activity deduction	—		(5.2	)%	(1.3	)%
Change in tax laws	—		—		0.6	%
Excess tax benefits on share-based compensation	(134.3	)%	—		—
Other	70.8	%	(0.1	)%	(0.1	)%

Effective income tax rate	199.5	%	27.9	%	34.0	%

The principal types of differences between assets and liabilities for financial statement and tax return purposes are accruals, reserves, impairment of intangibles, accumulated amortization, accumulated depreciation and share-based compensation expense. A deferred tax asset is recorded for the future benefits created by the timing of accruals and reserves and the application of different amortization lives for financial statement and tax return purposes. The Company’s deferred tax liability is mainly attributable to different depreciation methods for financial statement and tax return purposes. A deferred tax asset valuation allowance is established if it is more likely than not that the Company will be unable to realize certain of the deferred tax assets. As of June 30, 2017 and 2016, temporary differences which give rise to deferred tax assets and liabilities were as follows:

(In thousands)	June 30, 2017			June 30, 2016
Deferred tax assets:
Accrued expenses	$	1,869		$	1,636
Share-based compensation expense	6,031			5,074
Reserve for returns	15,032			14,583
Reserves for rebates	11,194			19,235
Reserves for accounts receivable and inventory	2,026			6,305
Intangible impairment	2,176			3,312
Federal net operating loss	736			736
State net operating loss	2,944			1,469
Impairment on Cody note receivable	1,913			1,941
Accumulated amortization on intangible assets	25,505			5,301
Settlement Liability	6,019			7,014
Foreign net operating loss	736			579
Other	290			901

Total deferred tax asset	76,471			68,086
Valuation allowance	(6,391		)	(3,927		)

Total deferred tax asset less valuation allowance	70,080			64,159

Deferred tax liabilities:
Prepaid expenses	267			263
Property, plant and equipment	16,807			11,381
Other	253			67

Total deferred tax liability	17,327			11,711

Net deferred tax asset	$	52,753		$	52,448

The net deferred tax asset as of June 30, 2017 and 2016 is reduced by a valuation allowance of $6.4 million and $3.9 million, respectively, which are primarily related to deferred tax assets for various states, the impairment on the Cody note receivable as well as foreign net operating losses. The Company increased the valuation allowance in Fiscal 2017 primarily related to an increase of state deferred tax assets.

On April 10, 2007, the Company entered into a Stock Purchase Agreement to acquire Cody by purchasing all of the remaining shares of common stock of Cody. As a result of the acquisition, the Company recorded deferred tax assets related to Cody’s federal net operation loss (NOL) carry-forwards totaling $3.8 million at the date of acquisition with $1.9 million expiring in 2026 and $1.9 million in 2027.

The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits (exclusive of interest and penalties) was as follows:

(In thousands)	Balance
Balance at June 30, 2015	$	578
Additions for tax positions of the current year	742
Additions for tax positions of prior years	109
Additions from acquisitions	4,858
Reductions for tax positions of prior years	—
Settlements	—
Lapse of statute of limitations	(43		)

Balance at June 30, 2016	$	6,244
Additions for tax positions of the current year	168
Additions for tax positions of prior years	16
Additions from acquisitions	—
Reductions for tax positions of prior years	—
Settlements	—
Lapse of statute of limitations	(486		)

Balance at June 30, 2017	$	5,942

The amount of unrecognized tax benefits at June 30, 2017, 2016 and 2015 was $5.9 million, $6.2 million and $578 thousand respectively, of which $4.2 million, $4.4 million and $578 thousand would impact the Company’s effective tax rate, respectively, if recognized.

The Company has not recorded any interest and penalties for the periods ended June 30, 2017, 2016 and 2015 in the statement of operations and no cumulative interest and penalties have been recorded either in the Company’s consolidated balance sheet as of June 30, 2017 and 2016. The Company will recognize interest accrued on unrecognized tax benefits in interest expense and any related penalties in operating expenses. The cumulative amount of unrecognized tax benefits as of June 30, 2017 includes approximately $3.0 million of state reserves related to the acquisition of KUPI, which are expected to be recognized in Fiscal 2018 due to a lapse of statute of limitations.

The Company files income tax returns in the United States federal jurisdiction and various states. The Company’s tax returns for Fiscal Year 2013 and prior generally are no longer subject to review as such years generally are closed. The Company believes that an unfavorable resolution for open tax years would not be material to the financial position of the Company.