Note 12. Income Taxes

Consolidated income before provision for income taxes includes non-U.S. income of approximately $2.8 million, $6.5 million and $6.4 million for the years ended December 31, 2019, 2018 and 2017, respectively. We recorded a current tax provision of $562,000, $938,000 and $792,000 for the years ended December 31, 2019, 2018 and 2017, respectively. The components of the provision for income taxes are summarized below (in thousands):


	Year Ended December 31,
	2019		2018		2017
Current:
Federal	$	—	$	—	$	—
State		27		5		2
Foreign		535		933		790
Total current		562		938		792
Deferred:
Federal		—		—		—
State		—		—		—
Total deferred		—		—		—
Total provision for income taxes	$	562	$	938	$	792

A reconciliation of the effective income tax rates and the U.S. statutory federal income tax rate is summarized below:


	Year Ended December 31,
	2019		2018		2017
Statutory federal income tax rate	21.0	%	21.0	%	35.0	%
State income taxes, net of federal tax benefits	(2.1)		—		—
Valuation allowance	(173.0)		(2.6)		(139.5)
Rate change	—		—		100.8
Stock-based compensation	(21.8)		0.3		(10.4)
Foreign tax rate differential	137.7		(11.4)		(10.3)
Foreign tax incentives	32.2		(2.9)		(7.0)
Foreign income inclusion	—		2.6		55.6
Section 78 gross up	—		—		11.7
Foreign tax credit	—		—		(30.6)
Tax effect in equity method loss or gain from unconsolidated affiliates	(47.8)		3.2		2.9
Foreign-derived intangible income	—		(2.4)		—
Other	(1.0)		0.1		(0.9)
Effective tax rate	(54.8)	%	7.9	%	7.3	%

Deferred tax assets and liabilities are summarized below (in thousands):


	As of December 31,
	2019		2018
Deferred tax assets:
Net operating loss carryforwards	$	14,979	$	15,735
Accruals, reserves and other		3,011		2,100
Credit carryforwards		1,685		1,685
Operating lease liability		209		—
Gross deferred tax assets		19,884		19,520
Valuation allowance		(19,691)		(19,520)
Total deferred tax assets		193		—
Deferred tax liabilities:
Operating lease right-of-use assets		(193)		—
Total net deferred tax assets	$	—	$	—

As of December 31, 2019, we have federal net operating loss (“NOL”) carryforwards of approximately $58.3 million, which will expire beginning in 2022. In addition, we have federal tax credit carryforwards of approximately $1.7 million, which will expire beginning in 2027. We have utilized all state net operating losses, primarily in the state of California, as of December 31, 2019.

The deferred tax assets valuation allowance as of December 31, 2019 is attributed to U.S. federal, and state deferred tax assets, which result primarily from future deductible accruals, reserves, NOL carryforwards, and tax credit carryforwards. We believe that, based on a number of factors, the available objective evidence creates sufficient uncertainty regarding the realizability of the deferred tax assets such that a full valuation allowance has been recorded. These factors include our history of losses related to domestic operations, and the lack of carryback capacity to realize deferred tax assets. The valuation allowance increased by $0.2 million for the year ended December 31, 2019, whereas the valuation allowance decreased by $2.6 million and $46.3 million for the years ended December 31, 2018 and 2017, respectively.

The China Enterprise Income Tax Law (“EIT”) imposes a single uniform income tax rate of 25% on all Chinese enterprises. Our subsidiaries in China have qualified for a preferential 15% tax rate that is available for High and New Technology Enterprises (“HTE”). In order to retain the preferential tax rate, we must meet certain operating conditions, satisfy certain product requirements, meet certain headcount requirements and maintain certain levels of research expenditures. We realized benefits from this 10% reduction in tax rate of $211,000, $764,000 and $599,000 for 2019, 2018 and 2017, respectively. As of December 31, 2019, the favorable tax rate is still valid for the Company and it will stay the same for next year if there is no change of the business nature. The preferential tax rate that we enjoy could be modified or discontinued altogether at any time, which could materially and adversely affect our financial condition and results of operations.

Our subsidiaries in China also qualify for reduction in their taxable income in China for research and development (“R&D”) expenditures. Government pre-approval is required to claim R&D tax benefits. Any R&D claim is then submitted with the annual corporate income tax for the taxing authorities’ approval. Historically, we didn’t record such benefit until we received the tax refund from the Chinese government. Beginning in 2019, we record the tax benefit in the year it incurs the cost rather than in the year the tax benefit is received. This will better align the costs with the tax benefit. Our consolidated subsidiaries in China have enjoyed various tax holidays since 2000. Benefits under the tax holidays vary by jurisdiction.

Utilization of the NOL and R&D credit carryforwards may be subject to a substantial annual limitation due to ownership changes that might have occurred previously or that could occur in the future, as provided by Section 382 of the Internal Revenue Code of 1986 (“Section 382”), as well as similar state provisions. Ownership changes may limit the amount of NOL and tax credit carryforwards that can be utilized to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. If there is a change of control, utilization of our NOL or tax credit carryforwards would be subject to an annual limitation under Section 382. Any limitation may result in expiration of a portion of the NOL or research and development credit carryforwards before utilization. Subsequent ownership changes could further impact the limitation in future years. Until a Section 382 study is completed and any limitation known, no amounts are being presented as an uncertain tax position. A full valuation allowance has been provided against our NOL carryforwards and R&D credit carryforwards and, if an adjustment is required, this adjustment would be offset by an adjustment to the valuation allowance. Thus, there would be no net impact to the consolidated balance sheets or statements of operations if an adjustment were required.

During fiscal year 2019, 2018 and 2017, the amount of gross unrecognized tax benefits remains unchanged. The total amount of unrecognized tax benefits was $14.6 million as of December 31, 2019 and 2018. The Company recognizes interest and penalties related to uncertain tax positions as part of the provision for income taxes. To date, such interest and penalties have not been material.

We comply with the laws, regulations, and filing requirements of all jurisdictions in which we conduct business. We regularly engage in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions.

We file income tax returns in the U.S. federal, various states and foreign jurisdictions. Currently, there is no tax audit in any of the jurisdictions and we do not expect there will be any significant change to this.

A reconciliation of the beginning and ending amount of the gross unrecognized tax benefits is as follows (in thousands):


	Year Ended December 31,
	2019	2018	2017

Gross unrecognized tax benefits balance at beginning of the year	$ 14,557	$ 14,557	$ 14,557
Add:
Additions based on tax positions related to the current year	—	—	—
Additions for tax positions of prior years	—	—	—
Less:
Decrease related to lapse of statute of limitations	—	—	—
Gross unrecognized tax benefits balance at end of the year	$ 14,557	$ 14,557	$ 14,557

Excluding the effects of recorded valuation allowances for deferred tax assets, $14.6 million of the unrecognized tax benefit would favorably impact the effective tax rate in future periods if recognized.