We account for income taxes under the provisions of ASC Topic 740, Income taxes, which provides for an asset and liability approach for income taxes. Under this approach, deferred tax assets and liabilities are recognized based on anticipated future tax consequences, using currently enacted tax laws, attributable to temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts calculated for income tax purposes.
Our provision for income taxes for the years ended December 31, 2016 and 2015 consisted of the following:
| December 31, | ||||||||
| 2016 | 2015 | |||||||
| Current taxes | $ | – | $ | – | ||||
| Deferred tax provision (benefit), as part of discontinued operations | – | (6,593,040 | ) | |||||
| Valuation allowance | – | – | ||||||
| Net income tax provision (benefit) | $ | – | $ | (6,593,040 | ) | |||
The effective income tax rate for the years ended December 31, 2016 and 2015 consisted of the following:
| December 31, | ||||||||
| 2016 | 2015 | |||||||
| Federal statutory income tax rate | 35.00% | 35.00% | ||||||
| State income taxes | 3.26% | 4.13% | ||||||
| Effect of statutory rate change on deferred taxes | 1.68% | (0.44% | ) | |||||
| Permanent differences | 0.00% | 0.00% | ||||||
| Change in valuation allowance | (39.34% | ) | (30.12% | ) | ||||
| Net effective income tax rate | 0.00% | 8.57% | ||||||
The Company’s state income tax rate as of December 31, 2016 decreased by 1.13% from 4.13% as of December 31, 2015, to 3.26%. This decrease in the effective tax rate is attributable to changes in the Company’s state apportionment factors in the current year. In 2015, due to the settled derivatives being sourced to the state of Minnesota for income tax purposes, a larger percentage of the Company’s activity was expected to be apportioned to that state. The derivative gains, reported in discontinued operations, were substantially lower in 2016. As compared to North Dakota and Montana, the other states the Company files tax returns in which have a corporate income tax rate of 4.31% and 6.75%, respectively, the state of Minnesota has a 9.80% corporate income tax rate.
The components of the deferred tax assets and liabilities as of December 31, 2016 and 2015 are as follows:
| December 31, | ||||||||
| 2016 | 2015 | |||||||
| Deferred tax assets: | ||||||||
| Federal and state net operating loss carryovers | $ | 9,025,553 | $ | 9,294,824 | ||||
| Stock compensation | 2,715,486 | 2,531,641 | ||||||
| Ceiling test impairment, intangible drilling costs and other exploration costs capitalized for financial reporting purposes | – | 12,186,927 | ||||||
| Derivative liabilities | – | – | ||||||
| Reorganization costs | 51,258 | 52,415 | ||||||
| Asset retirement obligation | – | 144,005 | ||||||
| Total deferred tax assets | $ | 11,792,297 | $ | 24,209,812 | ||||
| Deferred tax liabilities: | ||||||||
| Ceiling test impairment, intangible drilling costs and other exploration costs capitalized for financial reporting purposes | $ | – | $ | – | ||||
| Derivative assets | – | (451,628 | ) | |||||
| Property and equipment | (3,731 | ) | (7,006 | ) | ||||
| Total deferred liabilities | (3,731 | ) | (458,634 | ) | ||||
| Net deferred tax assets (liabilities) | 11,788,566 | 23,751,178 | ||||||
| Less: valuation allowance | (11,788,566 | ) | (23,751,178 | ) | ||||
| Deferred tax assets (liabilities) | $ | – | $ | – | ||||
As of December 31, 2016, the Company has net operating loss carryover of approximately $23,590,835. Under existing Federal law, the net operating loss may be utilized to offset taxable income through the year ended December 31, 2036. A portion of the net operating loss carryover begins to expire in 2030.
ASC Topic 740 provides that a valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. In 2015, the Company increased its valuation allowance from $579,522 to $23,751,178. As of December 31, 2016, the Company has decreased its valuation allowance from $23,751,178 to $11,788,566. This decrease was to adjust for the decrease in net deferred tax assets due to the transfer of oil and assets in connection with the Company’s restructuring. The Company believes it is more likely than not that the benefit of these remaining assets will not be realized.
The Company files annual US Federal income tax returns and annual income tax returns for the states of Minnesota, North Dakota and Montana. We are not subject to income tax examinations by tax authorities for years before 2010 for all returns. Income taxing authorities have conducted no formal examinations of our past federal or state income tax returns and supporting records.
The Company adopted the provisions of ASC Topic 740 regarding uncertainty in income taxes. The Company has found no significant uncertain tax positions as of any date on or before December 31, 2016.