NOTE 10. INCOME TAXES
The components of income tax (provision) benefit for the years ended December 31, 2016 and 2015 are as follows:
| 2016 | 2015 | |||||||
| Current taxes: | ||||||||
| Federal | $ | — | $ | — | ||||
| State | — | — | ||||||
| Total current taxes | — | — | ||||||
| Deferred tax (provision) benefit | — | — | ||||||
| Income tax (provision) benefit | $ | — | $ | — |
A reconciliation of the income tax (provision) benefit at the statutory rate of 34% for the years ended December 31, 2016 and 2015 to the Company’s effective tax rate is as follows:
| 2016 | 2015 | |||||||
| U.S. Statutory tax rate | 34.0 | % | 34.0 | % | ||||
| State taxes, net of Federal benefit | 3.5 | % | 6.2 | % | ||||
| Executive compensation | (1.3 | )% | — | |||||
| Federal Research and development tax credits | 1.6 | % | 1.5 | % | ||||
| Stock based compensation | (2.1 | )% | 0.6 | % | ||||
| Common stock issued upon conversion of promissory note and related common stock purchase warrants | — | % | 3.3 | % | ||||
| Change in valuation reserve on deferred tax assets | (34.2 | )% | (45.0 | )% | ||||
| Other, net | (1.5 | )% | (0.6 | )% | ||||
| Income tax (provision) benefit | 0.0 | % | 0.0 | % | ||||
Significant components of the Company’s deferred tax assets (liabilities) as of December 31, 2016 and 2015 are as follows:
| 2016 | 2015 | |||||||
| Deferred tax assets: | ||||||||
| Stock-based compensation | $ | 1,615,000 | $ | 1,623,000 | ||||
| Start-up costs | 175,000 | 180,000 | ||||||
| Inventory reserves | 785,000 | 480,000 | ||||||
| Uniform capitalization of inventory costs | 110,000 | 150,000 | ||||||
| Allowance for doubtful accounts receivable | 30,000 | 30,000 | ||||||
| Other reserves | 5,000 | 2,000 | ||||||
| Equipment depreciation | 40,000 | — | ||||||
| Deferred revenue | 1,165,000 | 903,000 | ||||||
| Derivative liabilities | 15,000 | 26,000 | ||||||
| Accrued expenses | 340,000 | 210,000 | ||||||
| Net operating loss carryforward | 15,755,000 | 12,295,000 | ||||||
| Research and development tax credit carryforward | 1,955,000 | 1,747,000 | ||||||
| Alternative minimum tax credit carryforward | 90,000 | 90,000 | ||||||
| State jobs credit carryforward | 230,000 | 230,000 | ||||||
| State research and development credit carryforward | 280,000 | 280,000 | ||||||
| Charitable contributions carryforward | 60,000 | 50,000 | ||||||
| Total deferred tax assets | 22,650,000 | 18,296,000 | ||||||
| Valuation reserve | (22,455,000 | ) | (18,105,000 | ) | ||||
| Total deferred tax assets | 195,000 | 191,000 | ||||||
| Deferred tax liabilities: | ||||||||
| Equipment depreciation | — | (6,000 | ) | |||||
| Domestic international sales company | (195,000 | ) | (185,000 | ) | ||||
| Total deferred tax liabilities | (195,000 | ) | (191,000 | ) | ||||
| Net deferred tax assets (liability) | $ | — | $ | — | ||||
| Net deferred tax asset (liability) are classified in our consolidated balance sheets as follows: | ||||||||
| Current | $ | — | $ | — | ||||
| Non-current | $ | — | $ | — | ||||
The valuation allowance on deferred tax assets totaled $22,455,000 and $18,105,000 as of December 31, 2016 and December 31, 2015, respectively. We record the benefit we will derive in future accounting periods from tax losses and credits and deductible temporary differences as “deferred tax assets.” In accordance with Accounting Standards Codification (ASC) 740, “Income Taxes,” we record a valuation allowance to reduce the carrying value of our deferred tax assets if, based on all available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
The Company has incurred operating losses in 2016 and 2015 and we continue to be in a three-year cumulative loss position at December 31, 2016 and 2015. Accordingly, we determined there was not sufficient positive evidence regarding our potential for future profits to outweigh the negative evidence of our three-year cumulative loss position under the guidance provided in ASC 740. Therefore, we determined to increase our valuation allowance by $4,350,000 to continue to fully reserve our deferred tax assets at December 31, 2016. We expect to continue to maintain a full valuation allowance until we determine that we can sustain a level of profitability that demonstrates our ability to realize these assets. To the extent we determine that the realization of some or all of these benefits is more likely than not based upon expected future taxable income, a portion or all of the valuation allowance will be reversed. Such a reversal would be recorded as an income tax benefit and, for some portion related to deductions for stock option exercises, an increase in shareholders’ equity.
At December 31, 2016, the Company had available approximately $40,100,000 of net operating loss carryforwards available to offset future taxable income generated. Such tax net operating loss carryforwards expire between 2026 and 2036. In addition, the Company had research and development tax credit carryforwards totaling $1,955,000 available as of December 31, 2016, which expire between 2023 and 2036.
The Internal Revenue Code contains provisions under Section 382 which limit a company’s ability to utilize net operating loss carry-forwards in the event that it has experienced a more than 50% change in ownership over a three-year period. Current estimates prepared by the Company indicate that due to ownership changes which have occurred, approximately $765,000 of its net operating loss and $175,000 of its research and development tax credit carryforwards are currently subject to an annual limitation of approximately $1,151,000, but may be further limited by additional ownership changes which may occur in the future. As stated above, the net operating loss and research and development credit carryforwards expire between 2023 and 2036, allowing the Company to potentially utilize all of the limited net operating loss carry-forwards during the carryforward period.
As discussed in Note 1, “Summary of Significant Accounting Policies,” tax positions are evaluated in a two-step process. The Company first determines whether it is more likely than not that a tax position will be sustained upon examination. If a tax position meets the more-likely-than-not recognition threshold, it is then measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Management has identified no tax positions taken that would meet or exceed these thresholds and therefore there are no gross interest, penalties and unrecognized tax expense/benefits that are not expected to ultimately result in payment or receipt of cash in the consolidated financial statements.
The effective tax rate for the years ended December 31, 2016 and 2015 varied from the expected statutory rate due to the Company continuing to provide a 100% valuation allowance on net deferred tax assets. The Company determined that it was appropriate to continue the full valuation allowance on net deferred tax assets as of December 31, 2016 primarily because of the current year operating losses.