Net Element, Inc.

NOTE 16. INCOME TAXES

The components of income (loss) before income tax provision are as follows:

	December 31,		December 31,
	2016		2015
United States	$	(11,615,285)	$	(11,748,447)
Foreign		(2,000,791)		(1,579,479)
	$	(13,616,076)	$	(13,327,926)

There was no current U.S. income tax or deferred income tax provision for years ended December 31, 2016 and December 31, 2015. There were current foreign tax provisions of $49,375 and $79,000 for the years ended December 31, 2016 and December 31, 2015 respectively.

The following is a reconciliation of the effective income tax rate with the U.S. federal statutory income tax rate at December 31, 2015 and December 31, 2016:

	December 31,			December 31,
	2016			2015
U. S. Federal statutory income tax rate		34.0	%		34.0	%
State income tax, net of federal tax benefit		4.1	%		4.1	%
Debt Extinguishment		0.0	%		0.0	%
Currency translation adjustment		-0.9	%		3.9	%
Stock based compensation related permanent differences		0.0	%		-5.9	%
Dividend on preferred stock related permanent differences		0.0	%		-3.6	%
Foreign taxes		-0.4	%		-0.5	%
Difference in foreign tax rates		3.4	%		0.1	%
Change in valuation allowance		-40.5	%		-32.7	%
Effective income tax rate		-0.4	%		-0.5	%

The effective tax rate on operations of -0.3% at December 31, 2016 varied from the statutory rate of 34%, primarily due to the permanent difference related to difference in foreign tax rates and the increase in our valuation allowance. The effective rate on operations of -0.6% at December 31, 2015 varied from the statutory rate of 34% primarily due to dividends paid on preferred stock, stock based compensation and the increase in our valuation allowance.

Significant components of our deferred tax assets and liabilities as of December 31, 2016 and December 31, 2015 are as follows:

	December 31,		December 31,
	2016		2015
Deferred tax assets:
Net operating loss carry forwards	$	19,556,555	$	17,086,460
Stock based compensation		906,087		572,004
Contingent legal expenses		0		235,259
Basis difference in goodwill		2,604,306		3,038,988
Basis difference in fixed assets		19,899		62,710
Basis difference in intangible assets		1,714,761		1,447,782
Stock price guarantee adjustment		1,416,870		0
Valuation allowance for deferred tax assets		(26,218,478)		(22,443,203)
Total deferred tax assets		-		-

Deferred tax liabilities:
Basis difference in fixed assets		-		-
Basis difference in intangible assets		-		-
Total deferred tax liabilities		-		-

Net deferred taxes	$	-	$	-

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 of assets and liabilities used for income tax purposes. At December 31, 2016, we had cumulative federal and state net operating losses (“NOLs”) carry forwards of approximately $51.4 million. At December 31, 2015, we had cumulative federal and state NOLs carry forwards of approximately $44.9 million. We also have $11.9 million and $10.4 million in foreign NOLs as of December 31, 2016 and 2015, respectively. The valuation allowance was increased by $3.6 million in fiscal year 2016. The fiscal 2016 increase was primarily related to additional operating loss incurred, and difference in tax and book basis of goodwill and other intangible assets. We have considered all the evidence, both positive and negative, that the NOLs and other deferred tax assets may not be realized and have recorded a valuation allowance for $26 million. The federal NOLs begin to expire in December 2025 while the foreign NOLs begin to expire in 2023.

The timing and manner in which we will be able to utilize some of its NOLs is limited by Section 382 of the Internal Revenue Code of 1986, as amended (IRC). IRC Section 382 imposes limitations on a corporation’s ability to use its NOLs when it undergoes an “ownership change.” Generally, an ownership change occurs if one or more shareholders, each of whom owns 5% or more in value of a corporation’s stock, increase their percentage ownership, in the aggregate, by more than 50% over the lowest percentage of stock owned by such shareholders at any time during the preceding three-year period. Because on June 10, 2014, we underwent an ownership change as defined by IRC Section 382, the limitation applies to us. The losses generated prior to the ownership change date (pre-change losses) are subject to the Section 382 limitation. The pre-change losses may only become available to be utilized by us at the rate of $2.4 million per year. Any unused losses can be carried forward, subject to their original carryforward limitation periods. In the year 2016, approximately $2.4 million in the pre-change losses was released from the Section 382 loss limitation. We can still fully utilize the NOLs generated after the change of the ownership, which was approximately $11.1 million. Thus, the total of approximately $15.2 million as of December 31, 2016 is available to offset future income.