Rocky Mountain Chocolate Factory, Inc.

NOTE

- INCOME TAXES

Income tax expense

(benefit) is comprised of the following for the years ended

February

29:

	2017		2016			2015
Current
Federal	$	1,411,126	$	1,420,811		$	1,846,365
State		272,214		195,993			246,398
Total Current		1,683,340		1,616,804			2,092,763

Deferred
Federal		240,234		(1,725,918	)		(50,603	)
State		22,015		(152,286	)		(4,465	)
Total Deferred		262,249		(1,878,204	)		(55,068	)
Total	$	1,945,589	$	(261,400	)	$	2,037,695

A reconciliation of the statutory federal income tax rate and the effective rate as a percentage of pretax income is as follows for the years end

February

29:

	2017			2016			2015
Statutory rate		34.0	%		34.0	%		34.0	%
State income taxes, net of federal benefit		3.6	%		0.8	%		2.8	%
Domestic production deduction		(1.1	%)		(3.0	%)		(1.6	%)
Work opportunity tax credits		(0.4	%)		-			-
Statutory rate change		-			(1.6	%)		-	%
Other		0.0	%		0.5	%		0.1	%
U-Swirl loss carryforward recognized		-			(1.8	%)		(3.0	%)
Valuation allowance, U-Swirl Consolidated loss		-			(36.3	%)		3.0	%
Effective rate – provision (benefit)		36.1	%		(7.4	%)		35.3	%

The components of deferred income taxes at

February

are as follows:

Deferred Tax Assets	201 7			201 6
Allowance for doubtful accounts and notes	$	198,354		$	248,537
Inventories		90,027			96,698
Accrued compensation		188,002			183,898
Loss provisions and deferred income		1,175,351			1,299,191
Self-insurance accrual		37,000			28,923
Amortization		782,683			861,594
Restructuring charges		148,494			148,494
U-Swirl accumulated net loss		164,035			346,605
Valuation allowance		(148,494	)		(148,494	)
Net deferred tax assets		2,635,452			3,065,446

Deferred Tax Liabilities
Depreciation and amortization		(1,683,778	)		(1,537,653	)
Prepaid expenses		(92,800	)		(106,138	)
D eferred tax liabilities	$	(1,776,578	)	$	(1,643,791	)

Net deferred tax assets	$	858,874		$	1,421,655

The following table summarizes deferred income tax valuation allowances as of

February

29:

	201 7		201 6
Valuation allowance at beginning of period	$	148,494	$	349,010
Tax expense (benefits) realized by valuation allowance		-		81,340
Tax benefits released from valuation allowance		-		(281,856	)
Valuation allowance at end of period	$	148,494	$	148,494

The

tax benefit realized for the year ended

February

29,

2016,

compared to the tax expense in the prior years, is primarily due to the tax consequences of a change in the controlling interest in U-Swirl and foreclosure upon the stock of U-Swirl International, Inc. In FY

2014

we did not realize a tax benefit from the SWRL taxable loss causing our effective rate to increase for the year. During FY

2015

the taxable loss at SWRL was lower, resulting in a decrease to our effective rate. During FY

2016

an income tax benefit of approximately

$2,149,000

was recognized as a result of the company foreclosing upon the interest in U-Swirl and recognizing deferred tax assets and loss carry forwards that previously had full valuation allowances when RMCF had less than an

80%

ownership interest. Resulting from this foreclosure, RMCF will consolidate U-Swirl International, Inc. resulting in realization of U-Swirl International, Inc. deferred tax assets that previously had a full valuation allowance when filed with SWRL income tax returns. U-Swirl International, Inc. and RMCF will file consolidated income tax returns beginning with FY

2017.

SWRL will continue to file separate tax returns.

For the year ended

February

29,

2016

and prior periods, the financial statements presented represent the consolidated statements of

two

separate consolidated groups for income tax purposes. RMCF has filed income tax returns consolidating the results of Rocky Mountain Chocolate Factory and its wholly owned subsidiary, Aspen Leaf Yogurt, LLC. U-Swirl Inc. has filed a separate consolidated income tax return for the results of U-Swirl, Inc. and its wholly owned subsidiary, U-Swirl International, Inc. RMCF and SWRL have filed separate income tax returns because RMCF owned only

39%

of SWRL. Beginning on

March

2016

the results of U-Swirl International, Inc. will be included in RMCF

’s consolidated income tax return, and on the same date, will be removed from U-Swirl, Inc.’s consolidated tax return. This is a result of the foreclosure of RMCF on the outstanding stock of U-Swirl in satisfaction of debt between RMCF and SWRL. The consolidated tax return for RMCF for future periods will include all operating results of U-Swirl. SWRL will file separate income tax returns in future periods. However, there are no remaining operating assets held by SWRL.

The Company files income tax returns in the U.S. federal and various state taxing jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal and state tax examinations in its major tax jurisdictions for periods before

2012.

The Company’s federal income tax returns have been examined for the years ended

February

28,

2015

and

2014

and the examination did not result in any changes to the income tax returns filed for these years.

Realization of the Company's deferred tax assets is dependent upon the Company generating sufficient taxable income, in the appropriate tax jurisdictions, in future years to obtain benefit from the reversal of net deductible temporary differences. The amount of deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income are changed. Management believes that it is more likely than not that

RMCF will realize the benefits of its deferred tax assets as of

February

28,

2017.

The Company accounts for uncertainty in income taxes by recognizing the tax benefit from an uncertain tax position 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 Company measures the tax benefits recognized in the

consolidated financial statements from such a position based on the largest benefit that has a greater than

50%

likelihood of being realized upon ultimate resolution. The application of income tax law is inherently complex. As such, the Company is required to make judgments regarding income tax exposures. Interpretations of and guidance surrounding income tax law and regulations change over time and

may

result in changes to the Company's judgments which can materially affect amounts recognized in the balance sheets and statements of operations. The result of the assessment of the Company's tax positions did not have an impact on the consolidated financial statements for the years ended

February

29,

2016

2015.

The Company does not have any significant unrecognized tax benefits and does not anticipate a significant increase or decrease in unrecognized tax benefits within the next

twelve

months. Amounts are recognized for income tax related interest and penalties as a component of general and administrative expense in the statement of income and are immaterial for years ended

February

29,

2017

and

2016.

As of

February

2016

we had foreclosed on the outstanding equity of U-Swirl International, Inc. and U-Swirl International, Inc. was consolidated for income tax purposes. SWRL, along with U-Swirl International, Inc., has historically filed its own consolidated federal income tax return and reported its own Federal net operating loss carry forward. As of

February

28,

2015,

SWRL had recorded a full valuation allowance related to the realization of its deferred income tax assets. This full valuation allowance was eliminated as of

February

29,

2016,

in recognition of the likelihood that the loss carry forwards would be realized as a result of RMCF and U-Swirl International, Inc. filing a consolidated income tax return.

In accordance with

Section

382

of the Internal Revenue Code, deductibility of SWRL’s and U-Swirl International, Inc.’s Federal net operating loss carryovers

may

be subject to annual limitation in the event of a change in control. We have performed a preliminary evaluation as to whether a change in control has taken place, and have concluded that there was a change of control with respect to the net operating losses of U-Swirl when the Company acquired its controlling ownership interest in

January

2013.

The initial limitations will continue to limit deductibility of SWRL’s and U-Swirl International Inc.’s net operating loss carryovers, but the annual loss limitation will be deductible to RMCF and U-Swirl International Inc. upon the filing of joint tax returns in FY

2017

and future years.

We estimate that the potential future tax deductions of

U-Swirl International, Inc.’s Federal net operating losses, limited by section

382,

to be approximately

$443,000

with a resulting deferred tax asset of approximately

$164,000.

U-Swirl International Inc.’s Federal net operating loss carryovers will expire at various dates beginning in

2026.