RLJ ENTERTAINMENT, INC.

Note 17.

Income Taxes

RLJE files income tax returns in the U.S. Federal jurisdiction and various state jurisdictions. Our subsidiaries in the United Kingdom and Australia continue to file income tax returns in their foreign jurisdictions.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent that it is more likely than not that such deferred tax assets will not be realized, we must establish a valuation allowance.

As of December 31, 2017, we have a valuation allowance against 100% of our deferred tax assets, which are composed primarily of net operating loss (or NOL) carryforwards that were either acquired in the Business Combination or generated in the years following. Even though we have reserved all of these net deferred tax assets for book purposes, we would still be able to utilize them to reduce future income taxes payable should we have future taxable earnings. To the extent our deferred tax assets relate to NOL carryforwards, the ability to use such NOLs against future earnings will be subject to applicable carryforward periods. As of December 31, 2017, we had NOL carryforwards for Federal and state tax purposes of approximately $113.6 million and approximately $61.0 million, respectively, which are available to offset taxable income through 2037. Our NOL carryforwards began to expire in 2017. NOL carryforwards that were acquired in the Business Combination reflect our assessment of an annual limitation on the utilization of these carryforwards due to ownership change limitations as required by Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), as well as similar state limitations.

Income tax expense is summarized below:

	Years Ended December 31,
(In thousands)	2017		2016
Current
Federal	$	—	$	—
State		18		(17	)
Foreign		203		(144	)
		221		(161	)
Deferred
Federal		—		—
State		—		—
Foreign		1,013		316
		1,013		316
Total Tax Expense	$	1,234	$	155

Loss from continuing operations before provision for income taxes is as follows:

	Years Ended December 31,
(In thousands)	2017			2016
Domestic	$	(11,877	)	$	(20,234	)
Foreign		6,985			1,792
	$	(4,892	)	$	(18,442	)

The tax effects of temporary differences that give rise to a significant portion of the net deferred tax assets and liabilities are presented below:

	December 31,
	2017						2016
(In thousands)	U.S. Federal and State			Foreign			U.S. Federal and State			Foreign
Deferred tax assets
Intangible assets	$	4,594		$	—		$	9,066		$	—
Provision for lower of cost or market inventory write- downs		1,686			—			2,452			—
Net operating loss carryforwards		27,763			1,078			41,384			984
Allowance for sales returns		951			—			1,223			—
Allowance for doubtful accounts receivable		18			—			17			—
Marketing discounts and price protection reserves		680			—			905			—
Accrued salary and stock-based compensation		812			—			247			—
Tax credits carryforwards		2,925			—			2,942			—
Warrant and other derivative liabilities		119			—			—			—
Other		206			—			—			—
Deferred tax assets		39,754			1,078			58,236			984
Less valuation allowance		(39,754	)		(1,078	)		(57,623	)		(984	)
Deferred tax assets		—			—			613			—
Deferred tax liabilities
Warrant and other derivative liabilities		—			—			(432	)		—
Equity income in ACL		—			(2,933	)		—			(1,715	)
Other		—			—			(181	)		—
Deferred tax liabilities		—			(2,933	)		(613	)		(1,715	)
Net deferred tax assets and liabilities	$	—		$	(2,933	)	$	—		$	(1,715	)

A reconciliation of income tax benefit based on the federal statutory rate to actual income tax expense (benefit) is as follows:

	Years Ended December 31,
(In thousands)	2017			2016
Expected federal income tax benefit at 34% on continuing operations	$	(1,663	)	$	(6,270	)
Expected state income tax benefit on continuing operations, net of federal benefit		(189	)		(711	)
Expected federal and state income tax benefit on discontinued operations		—			(1,240	)
Current state income taxes		18			(17	)
Change in federal and state statutory tax rates		18,462			(319	)
Nondeductible expenses		30			31
Change in valuation allowance for U.S. tax purposes only		(17,869	)		6,941
Foreign income taxes, including change in valuation allowance		1,216			172
Change in prior year deferred taxes and other		1,229			1,568
Total tax expense	$	1,234		$	155

Our significant tax returns are filed in the following jurisdictions: United States, United Kingdom and in the following states: Maryland and California. The tax years for 2009 through 2017 remain open to examination. We are not currently under examination by any of the jurisdictions where we file significant tax returns. We believe that our tax filing positions and deductions will be sustained if audited, and we do not anticipate any adjustments that would result in a material adverse effect on our financial condition, results of operations, or cash flow. Therefore, no reserves or related interest and penalties for uncertain tax positions have been recorded.