7. Income Taxes
The domestic and foreign components of the continuing income (loss) before (benefit) expense for income taxes were as follows:
|
|
|
Years Ended December 31, |
|
|||||||||
|
|
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
Domestic |
|
$ |
917 |
|
|
$ |
(3,695 |
) |
|
$ |
(2,432 |
) |
|
Foreign |
|
|
621 |
|
|
|
2,674 |
|
|
|
1,236 |
|
|
|
|
$ |
1,538 |
|
|
$ |
(1,021 |
) |
|
$ |
(1,196 |
) |
The (benefit) expense for income taxes of continuing operations consisted of the following:
|
|
|
Years Ended December 31, |
|
|||||||||
|
|
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
Current: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
$ |
0 |
|
|
$ |
(5 |
) |
|
$ |
30 |
|
|
State |
|
|
34 |
|
|
|
12 |
|
|
|
91 |
|
|
Foreign |
|
|
142 |
|
|
|
721 |
|
|
|
262 |
|
|
|
|
|
176 |
|
|
|
728 |
|
|
|
383 |
|
|
Deferred: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
(1,720 |
) |
|
|
10,123 |
|
|
|
(781 |
) |
|
State |
|
|
(878 |
) |
|
|
917 |
|
|
|
(107 |
) |
|
Foreign |
|
|
(49 |
) |
|
|
8 |
|
|
|
43 |
|
|
|
|
|
(2,647 |
) |
|
|
11,048 |
|
|
|
(845 |
) |
|
Total |
|
$ |
(2,471 |
) |
|
$ |
11,776 |
|
|
$ |
(462 |
) |
A reconciliation of the (benefit) expense for income taxes at the federal statutory rate compared to the expense (benefit) at the effective tax rate is as follows:
|
|
|
Years Ended December 31 |
|
|||||||||
|
|
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
Statutory federal income tax rate |
|
|
34 |
% |
|
|
34 |
% |
|
|
34 |
% |
|
State income tax, net of federal benefit |
|
|
3 |
% |
|
|
11 |
% |
|
|
1 |
% |
|
Tax effect of permanent differences |
|
|
-2 |
% |
|
|
0 |
% |
|
|
-3 |
% |
|
Change in valuation allowance |
|
|
-535 |
% |
|
|
-1238 |
% |
|
|
0 |
% |
|
Foreign Income Inclusion |
|
|
37 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
Effective state rate change to deferred tax assets |
|
|
-11 |
% |
|
|
9 |
% |
|
|
0 |
% |
|
Effective Federal rate change to deferred tax assets |
|
|
326 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
Stock Compensation shortfalls |
|
|
15 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
Release of FIN 48 liability |
|
|
-8 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
Foreign income taxed at different rates |
|
|
-6 |
% |
|
|
22 |
% |
|
|
6 |
% |
|
Tax on repatriation |
|
|
-7 |
% |
|
|
0 |
% |
|
|
-10 |
% |
|
Research and development credits |
|
|
-6 |
% |
|
|
6 |
% |
|
|
11 |
% |
|
Return to provision adjustments |
|
|
-2 |
% |
|
|
4 |
% |
|
|
0 |
% |
|
Other |
|
|
1 |
% |
|
|
-1 |
% |
|
|
0 |
% |
|
|
|
|
-161 |
% |
|
|
-1153 |
% |
|
|
39 |
% |
On December 22, 2017, the United States federal government enacted the Tax Act, marking a change from a worldwide tax system to a modified territorial tax system in the United States. As part of this change, the Tax Act, among other changes, provides for a Transition Tax on the accumulated unremitted foreign earnings and profits of foreign subsidiaries, a reduction of the U.S. federal corporate income tax rate from 34% to 21%, and an indefinite carryforward of net operating losses (“NOL’s”) incurred in 2018 and future periods.
In response to the enactment of the Tax Act in late 2017, the U.S. Securities and Exchange Commission issued SAB 118 to address situations where the accounting is incomplete for certain income tax effects of the Tax Act upon issuance of an entity’s financial statements for the reporting period in which the Tax Act was enacted. Under SAB 118, a company may record provisional amounts during a measurement period for specific income tax effects of the Tax Act for which the accounting is incomplete, but a reasonable estimate can be determined, and when unable to determine a reasonable estimate for any income tax effects, report provisional amounts in the first reporting period in which a reasonable estimate can be determined. The measurement period should not extend beyond one year.
To determine the amount of the Transition Tax, the Company must determine, in addition to other factors, the amount of post-1986 earnings and profits of relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The Company recorded provisional income tax expense of $0.6 million related to the deemed repatriation of the accumulated unremitted earnings and profits of the Company’s foreign subsidiaries. The income for the Transition Tax is included as a component of the Company’s 2017 net operating loss included within deferred tax assets. This provisional amount was based on information currently available, including estimated tax earnings and profits from foreign subsidiaries.
For the reduction in the corporate tax rate, the Company recorded provisional income tax expense of $5.0 million associated with the remeasurement of the Company’s gross deferred tax assets and an income tax benefit of $1.4 million associated with a remeasurement of the valuation allowance. While we were able to make a reasonable estimate of the impact of the reduction in the corporate rate, it may be affected by state treatment of the deemed repatriation of foreign profits and the Company’s Transition Tax.
The Company is continuing to gather additional information including refining the calculation of earnings and profits of foreign subsidiaries and is continuing to monitor the guidance from the I.R.S., states, and other government agencies to more precisely compute the amount of the Transition Tax and the state income tax impact of the deemed distributions of the foreign earnings and profits and in order to complete the accounting for the effects of the Transition Tax in 2018. The analyses will continue throughout 2018 and is expected to be completed when the Company files its income tax returns in late 2018.
The Company recorded a net income tax benefit of $2.5 million for the year ended December 31, 2017, income tax expense of $11.8 million for the year ended December 31, 2016, and an income tax benefit of $0.5 million for the year ended December 31, 2015. The 2017 effective tax rate differed from the Federal rate of 34% because we decreased the valuation allowance for our U.S. deferred tax assets by $8.2 million, offsetting the net income tax expense of $5.0 million related to the remeasurement of net deferred tax assets, and the $0.6 million of income tax expense related to the Transition Tax. The adjustment to the valuation allowance includes $1.4 million to reflect the new corporate tax rate of 21.0%.
The 2016 effective tax rate differed from the statutory Federal rate of 34% primarily due to adjustments to the deferred tax valuation allowance. The Company recorded adjustments of $12.6 million to the deferred tax valuation allowance in 2016. The 2015 effective tax rate differed from the statutory Federal rate of 34% primarily due to research and development credits and incremental tax on repatriation of funds from Israel.
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 used for income tax purposes.
The net deferred tax accounts consist of the following:
|
|
|
December 31, |
|
|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
Deferred Tax Assets: |
|
|
|
|
|
|
|
|
|
Amortization |
|
$ |
5,384 |
|
|
$ |
9,313 |
|
|
Net operating loss carryforwards |
|
|
3,658 |
|
|
|
4,029 |
|
|
Federal, foreign, and state credits |
|
|
1,627 |
|
|
|
1,307 |
|
|
Inventory reserves |
|
|
949 |
|
|
|
1,397 |
|
|
Stock compensation |
|
|
845 |
|
|
|
1,902 |
|
|
Accrued vacation |
|
|
257 |
|
|
|
461 |
|
|
Other |
|
|
635 |
|
|
|
298 |
|
|
Gross deferred tax assets |
|
|
13,355 |
|
|
|
18,707 |
|
|
Valuation allowance |
|
|
(5,234 |
) |
|
|
(13,300 |
) |
|
Net deferred tax asset |
|
|
8,121 |
|
|
|
5,407 |
|
|
Deferred Tax Liabilities: |
|
|
|
|
|
|
|
|
|
Depreciation |
|
|
(387 |
) |
|
|
(895 |
) |
|
Net Deferred Tax Assets |
|
$ |
7,734 |
|
|
$ |
4,512 |
|
At December 31, 2017, the Company had $7.7 million of net deferred tax assets, consisting of domestic net deferred tax assets of $7.6 million and foreign net deferred tax assets of $0.1 million. The net income tax expense related to the remeasurement of the deferred tax assets consisted of income tax expense of $5.0 million related to gross deferred tax assets and an income tax benefit of $1.4 million related to the valuation allowance. At December 31, 2016, the Company had $4.5 million of net deferred tax assets, consisting of domestic net deferred tax assets of $4.4 million and foreign net deferred tax assets of $0.1 million. The most significant balance within the net deferred tax assets at December 31, 2017 and 2016 relates to intangible assets acquired under purchase accounting which are amortized for tax purposes over 15 years, but for shorter periods under generally accepted accounting principles. The Company had a valuation allowance of $5.2 million and $13.3 million at December 31, 2017 and 2016, respectively.
On a regular basis, the Company evaluates the recoverability of deferred tax assets and the need for a valuation allowance. Such evaluations involve the application of significant judgment. The Company considers multiple factors in its evaluation of the need for a valuation allowance. The Company’s net deferred tax assets consist of assets related to net operating losses and credits as well as assets related to timing differences. The Company’s net operating losses and credits have a finite life primarily based on the 20-year carryforward rule for federal NOL’s generated as of December 31, 2017. The timing differences have a ratable reversal pattern over 13 years. Under the new rules enacted with the Tax Act, tax losses incurred in 2018 and future periods will not expire, thereby extending the period by which the Company’s deferred tax assets can be realized. In continuing operations, the Company recorded pre-tax book income for the year ended December 31, 2017, but for the cumulative three-year period, the Company has recorded pretax book losses of $0.7 million. As of December 31, 2017, the Company’s future projections for U.S. book income have increased due to the sale of Engineering Services in July 2017 and from growth in U.S. business for both segments compared to historical periods. The Company’s Engineering Services business incurred pre-tax book losses of $7.8 million and $1.3 million for the years ended December 31, 2016 and 2015, respectively.
For the deferred tax assets related to net operating losses and credits, the Company believes that it is more likely than not that these deferred tax assets will not be realized based on the negative evidence of the cumulative loss and expiration of the NOL’s. For the Company’s deferred tax assets related to timing differences, the Company believes it is more likely than not that the deferred tax assets will be realized based on the positive evidence which includes a trend of higher future book income and the indefinite carryforwards for NOL’s incurred in 2018 and future periods. The valuation allowance at December 31, 2017 reflects an allowance on its deferred tax assets related to expiring net operating losses and credits and no valuation allowance on its deferred tax assets related to timing differences. Based on its assessment, the Company reduced its valuation allowance for deferred tax assets by $8.2 million. This adjustment to the valuation allowance includes $1.4 million to reflects the new corporate tax rate of 21.0%. The analysis that the Company prepared to determine the valuation allowance required significant judgment and assumptions regarding future market conditions as well as forecasts for profits, taxable income, and taxable income by jurisdiction. Due to the sensitivity of the analysis, changes to the assumptions in subsequent periods could have a material effect on the valuation allowance.
The valuation allowance at December 31, 2016 was primarily because the Company did not believe it would generate sufficient US taxable income to realize a significant portion of its deferred tax assets. In 2016, the Company recorded adjustments of $12.6 million to increase its valuation allowance for deferred tax assets. During 2016, the cumulative three-year US book income had turned to a loss. In addition, the Company reduced its domestic profit forecast because it lowered its long-term forecast for its services business and increased the contribution of the profits from its China subsidiary.
Accounting for Uncertainty for Income Taxes
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
|
|
|
December 31, |
|
|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
Beginning of period |
|
$ |
870 |
|
|
$ |
850 |
|
|
Addition related to tax positions in current year |
|
|
13 |
|
|
|
20 |
|
|
Reversals for uncertain tax positions |
|
|
(183 |
) |
|
|
0 |
|
|
End of period |
|
$ |
700 |
|
|
$ |
870 |
|
Included in the balance of total unrecognized tax benefits at December 31, 2017 are potential benefits of $0.7 million that, if recognized, would affect the effective rate on income before taxes. The Company does not anticipate that its unrecognized tax benefits significantly increase or decrease within the next twelve months.
The Company recognizes all interest and penalties, including those relating to unrecognized tax benefits as income tax expense. There was no income tax expense related to interest and penalties for the years ended December 31, 2017, 2016, and 2015.
Audits
The Company and its subsidiaries file income tax returns in the U.S. and various foreign jurisdictions. The Company’s U.S. federal tax returns remain subject to examination for 2015 and subsequent periods. The Company’s state tax returns remain subject to examination for 2012 and subsequent periods. The Company’s foreign tax returns remain subject to examination for 2010 and subsequent periods.
Summary of Carryforwards
At December 31, 2017, the Company has a federal net operating loss carryforward of $12.7 million that expires between 2031 and 2037, state net operating loss carryforwards of $14.2 million that expire between 2025 and 2037. Additionally, the Company has $1.0 million of federal research credits that expire between 2030 and 2037 and $1.5 million of state research credits with no expiration.
Investment in Foreign Operations
In 2015, the Company provided U.S. income taxes of $0.1 million related to the expected repatriation of earnings from its subsidiary in Israel. The Company adjusted this amount to reflect the provisional amount calculated from the Transition Tax. The Company expects to liquidate this entity and repatriate the earnings in 2018. As of December 31, 2017, there are no business activities in this subsidiary. While the Company recorded income tax related to the deemed dividend of earnings of its China subsidiary, the Company considers such earnings permanently reinvested. Upon repatriation of these earnings, the Company would be subject to local withholding taxes.