Income Taxes

Components of income (loss) from continuing operations before taxes are as follows, (in thousands):



	Year Ended December 31,
	2012			2013			2014
Income (loss) from continuing operations before taxes:
United States	$	(7,211	)	$	9,051		$	12,569
Foreign	(2,442		)	(3,460		)	(4,287		)
Total income (loss) from continuing operations before taxes	$	(9,653	)	$	5,591		$	8,282

Components of the income tax provision (benefit) are as follows, (in thousands):



	Year Ended December 31,
	2012		2013			2014
Current:
Federal	$	—	$	(28	)	$	(26	)
State and local	67		99			161
Foreign	682		85			89
	749		156			224
Deferred:
Federal	—		—			—
State, local and foreign	—		(105		)	3
	—		(105		)	3
Total income tax provision	$	749	$	51		$	227

The reconciliation of the income tax provision computed using the federal statutory income tax rate to the recognized income tax provision (benefit) is as follows, (in thousands):



	Year Ended December 31,
	2012			2013			2014
Federal statutory rate	$	(3,282	)	$	1,901		$	2,816
State and local income taxes, net of federal benefit	(16		)	65			106
State rate change and other adjustments	531			—			(49		)
Adjustments to state deferred taxes	—			(590		)	389
Increase (decrease) in valuation allowance	597			(1,672		)	(3,332		)
Foreign tax rate differential	915			24			(59		)
Research and development credits	127			(365		)	(267		)
Share-based compensation	518			491			245
Uncertain tax positions	767			(43		)	57
Adjustments to federal deferred taxes	525			110			208
Other	67			130			113
Income tax provision	$	749		$	51		$	227

The tax effect of temporary differences that give rise to deferred income taxes are as follows, (in thousands):



	December 31,
	2013			2014
Deferred tax assets:
Net operating loss and tax credit carry forwards	$	93,128		$	88,656
Inventory reserve and uniform capitalization	1,474			1,705
Stock options and warrants	2,440			2,704
Allowance for bad debts and sales returns	171			880
Vacation accrual	261			146
Deferred rent	143			126
Deferred revenue	380			433
Warranty accrual	958			1,173
Depreciation and amortization	1,358			1,137
Other accruals and reserves	362			433
Accrued Bonus	873			418
Intangible assets	1,195			1,037
Total deferred tax assets	102,743			98,848
Deferred tax liabilities:
State taxes	(3,885		)	(3,696		)
Other	(548		)	(187		)
Total deferred income tax liabilities	(4,433		)	(3,883		)
Valuation allowance	(98,205		)	(94,873		)
Net deferred tax assets	$	105		$	92

As a result of certain realization requirements, the table of deferred tax assets and liabilities shown above does not include deferred tax assets for net operating losses as of December 31, 2014 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by $2.5 million if and when such excess tax benefits are recognized through current taxes payable. The Company uses FASB Accounting Standards Codification, or ASC, 740, Income Taxes, ordering when determining when excess tax benefits or shortfalls have been realized.

United States income and withholding taxes have not been recognized on the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration.

The following table summarizes the activity related to our unrecognized tax benefits (in thousands):



	Year Ended December 31,
	2012			2013			2014
Balance, January 1	$	5,025		$	5,726		$	5,771
Increase related to prior period positions	583			341			122
Increase related to current year tax positions	241			380			169
Reductions for tax positions of prior years	(123		)	(676		)	(395		)
Settlements	—			—			—
Balance, December 31	$	5,726		$	5,771		$	5,667

At December 31, 2012, 2013, and 2014 we had cumulative unrecognized tax benefits of approximately $5.7 million, $5.8 million, and $5.7 million, respectively, of which approximately $0.9 million, $0.8 million, and $0.6 million, respectively, are included in other long term liabilities that, if recognized, would affect the effective tax rate. The remaining $4.8 million, $5.0 million and $5.1 million of unrecognized tax benefits will have no impact on the effective tax rate due to the existence of net operating loss carryforwards and a full valuation allowance. Consistent with previous periods, penalties and tax related interest expense are reported as a component of income tax expense. As of December 31, 2012, and 2013, the total amount of accrued income tax related interest and penalties included in the consolidated balance sheet was less than $0.2 million and approximately $0.4 million, respectively. As of December 31, 2014, the total amount of accrued income tax related interest and penalties included in the consolidated balance sheet was approximately $0.5 million. We anticipate none of our unrecognized tax positions will be settled or reversed within the next 12 months.

Due to net operating losses and other tax attributes going forward, we are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending March 31, 2000 through December 31, 2014. With few exceptions, our state income tax returns are open to audit for the years ended December 31, 2010 through 2014.

We periodically evaluate the likelihood of the realization of deferred tax assets, and adjust the carrying amount of the deferred tax assets by the valuation allowance to the extent the future realization of the deferred tax assets is not judged to be more likely than not. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income or loss, the carryforward periods available to us for tax reporting purposes, and other relevant factors.

At December 31, 2014, based on the weight of available evidence, including cumulative losses in recent years and expectations regarding future taxable income, we determined that it was not more likely than not that our deferred tax assets would be realized and have a $94.9 million valuation allowance associated with our deferred tax assets.

As of December 31, 2014, we had federal net operating loss carryforwards of approximately $182.9 million which begin to expire in the tax year ending 2020, and state net operating loss carryforwards of approximately $101.7 million which begin to expire in the tax year ending 2015. We had foreign net operating loss carryforwards of $43.8 million, which have no expiration date. In addition, we had federal tax credit carryforwards of $4.9 million, of which approximately $0.4 million can be carried forward indefinitely to offset future tax liability, and the remaining $4.5 million begin to expire in the tax year ending 2018. We also had state tax credit carryforwards of $3.5 million, of which the entire $3.5 million has no expiration date.

As a result of our equity transactions, an ownership change, within the meaning of IRC Section 382, occurred on September 18, 2003. As a result, annual use of our federal net operating loss and credit carry forwards is limited to (i) the aggregate fair market value of Dot Hill immediately before the ownership change multiplied by (ii) the long-term tax-exempt rate (within the meaning of Section 382 (f) of the IRC) in effect at that time. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the IRC Section 382 limitation for those years.

As a result of our acquisition of Chaparral Network Storage, Inc., or Chaparral, a second ownership change, within the meaning of IRC Section 382, occurred on February 23, 2004. As a result, annual use of Chaparral’s federal net operating loss and credit carry forwards may be limited. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the Section 382 limitation for those years.

As a result of our acquisition of Cloverleaf, a third ownership change, within the meaning of IRC Section 382, occurred on January 26, 2010. As a result, annual use of Cloverleaf’s federal net operating loss and credit carry forwards may be limited. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the Section 382 limitation for those years.