Income Taxes

Significant components of the Company’s deferred income tax assets and liabilities are as follows at December 31 (in thousands):



	2014			2013
Deferred income tax assets:
Net operating loss carryforward	$	343		$	513
Deferred warranty revenue	4,141			2,837
Inventory reserve	508			389
Non-qualified and non-employee stock option expense	3,094			3,518
Capitalized research and development	4,847			6,588
Alternative minimum tax carryforward	1,081			1,466
Research and development tax credit carryforward	2,139			3,165
Deferred legal settlement	—			1,294
IRC section 481(a) adjustment—tangible property	—			1,316
Reserves, accruals, and other	2,320			2,066
Total deferred income tax assets	18,473			23,152
Deferred income tax liabilities:
Depreciation	(1,674		)	(2,136		)
Amortization	(236		)	(236		)
Total deferred income tax liabilities	(1,910		)	(2,372		)
Net deferred income tax assets before valuation allowance	16,563			20,780
Valuation allowance	(500		)	—
Net deferred income tax assets	$	16,063		$	20,780

The Company’s net deferred tax assets are presented as follows on the accompanying consolidated balance sheets at December 31 (in thousands):



	2014		2013
Current deferred tax assets, net	$	5,186	$	7,101
Long-term deferred tax assets, net	10,877		13,679
Total	$	16,063	$	20,780

For the years ended December 31, 2014, 2013 and 2012 the provision for income taxes includes $8.0 million, $6.8 million and $4.7 million, respectively, of tax expense resulting from the fact that stock-based compensation tax benefits have been recorded as increases to additional paid-in capital on the consolidated statement of changes in stockholders’ equity.

The Company has deferred tax assets of $0.1 million related to state NOLs which expire at various dates between 2016 and 2031. The Company also has deferred tax assets of approximately $0.2 million related to federal NOLs which expire between 2031 and 2033, and are subject to limitation under IRC Section 382. The Company has Arizona R&D credit carry forwards for financial reporting purposes of $3.2 million, which expire at various dates between 2018 and 2028, and California R&D credit carry forwards for financial reporting purposes of $0.2 million which do not expire. The Company has a minimum tax credit carryover of $1.1 million which does not expire.

The Company recognizes the income tax benefits associated with certain stock compensation deductions only when such deductions produce a reduction to the Company’s actual tax liability. Accordingly, in 2014 and 2013, the Company recognized benefits of $8.0 million and $6.8 million, respectively, for the reduction of federal and state taxes payable, which was recorded as a credit to additional paid-in capital. At each of December 31, 2014 and 2013, the Company had income tax receivables of $1.3 million and $2.3 million, respectively.

In preparing the Company’s consolidated financial statements, management has assessed the likelihood that deferred income tax assets will be realized from future taxable income. In evaluating the ability to recover its deferred income tax assets, management considers all available evidence, positive and negative; including the Company’s operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. A valuation allowance is established if it is determined that it is more likely than not that some portion or all of the net deferred income tax assets will not be realized. Management exercises significant judgment in determining the Company’s provisions for income taxes, its deferred income tax assets and liabilities and its future taxable income for purposes of assessing its ability to utilize any future tax benefit from its deferred income tax assets.

Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgments that could become subject to audit by tax authorities in the ordinary course of business. As of each reporting date, management considers new evidence, both positive and negative, that could impact management’s view with regards to future realization of deferred tax assets. As of December 31, 2012, in part because in that year the Company achieved three years of cumulative pre-tax income in the U.S. federal and Arizona tax jurisdictions, management determined that sufficient positive evidence existed to conclude that it is more likely than not that additional deferred taxes related to Arizona R&D credits are realizable, and therefore, reversed in full the valuation allowance related to that item. As of December 31, 2014, the Company continues to demonstrate three-year cumulative pre-tax income in the U.S. federal and Arizona tax jurisdictions; however, the Arizona R&D Tax Credits start to expire in 2018 with a significant tranche with a gross value of $1.2 million expiring in 2019. Under the Company’s new tax structure, it appears that long term investments which impact short term profits will likely result in some of the R&D credits expiring before they are utilized. Therefore, management has concluded that it is more likely than not that a portion of the Company’s deferred tax assets will not be realized.

Significant components of the provision for income taxes are as follows for the years ended December 31 (in thousands):



	2014		2013			2012
Current:
Federal	$	7,793	$	7,963		$	4,605
State	800		987			666
Total current	8,593		8,950			5,271
Deferred:
Federal	2,656		764			3,168
State	942		(143		)	(1,485		)
Total deferred	3,598		621			1,683
Tax provision recorded as an increase in liability for unrecorded tax benefits	202		219			920
Provision for income taxes	$	12,393	$	9,790		$	7,874

The Company is subject to federal, state, local and foreign taxes; however, no separate calculation of the foreign provision for deferred tax assets was calculated for the periods presented due to the minimal amount of book income in the Company’s foreign subsidiary and the comparability of the foreign tax rate to the tax rate in the U.S. A reconciliation of the Company’s effective income tax rate to the federal statutory rate for the years ended December 31, 2014, 2013 and 2012 is as follows (in thousands):



	2014			2013			2012
Federal income tax at the statutory rate	$	11,236		$	9,812		$	7,914
State income taxes, net of federal benefit	1,433			1,283			969
Permanent differences ⁽ⁱ⁾	98			(96		)	156
Research and development	(452		)	(386		)	(327		)
Return to provision adjustment ⁽ⁱⁱ⁾	28			(361		)	(270		)
Change in liability for unrecognized tax benefits	202			219			921
Incentive stock option detriment/(benefit)	(616		)	(538		)	174
Change in valuation allowance	500			—			(1,429		)
Other	(36		)	(143		)	(234		)
Provision for income taxes	$	12,393		$	9,790		$	7,874
Effective tax rate	38.4		%	34.9		%	34.8		%


(i)	Permanent differences include certain expenses that are not deductible for tax purposes including lobbying fees as well as favorable items including the domestic production activities deduction


(ii)	The 2012 return to provision adjustment was driven by higher than estimated 2011 R&D tax credits which increased the net tax benefit and therefore, reduced the effective tax rate. The 2013 return to provision adjustment was driven by the domestic production activities deduction which decreased taxable income, and therefore, reduced the effective tax rate.

The Company has completed research and development tax credit studies which identified approximately $10.4 million in tax credits for federal, Arizona and California income tax purposes related to the 2003 through 2014 tax years. Management has made the determination that it is more likely than not that the full benefit of the R&D tax credit will not be sustained on examination and recorded a liability for unrecognized tax benefits of $3.1 million as of December 31, 2013. In addition, management accrued approximately $0.2 million for estimated uncertain tax positions related to certain state income tax liabilities. The Company is currently under an IRS audit for the tax year 2012. Depending on the outcome of the audit, the uncertain tax positions relating to 2012 may significantly change in the next 12 months. Should the unrecognized tax benefit of $3.3 million be recognized, the Company’s effective tax rate would be favorably impacted.

The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying Consolidated Statement of Operations. As of December 31, 2014 and 2013, respectively, the Company had accrued interest of $46,000 and $12,000.

The following table presents a roll forward of our liability for unrecognized tax benefits, exclusive of accrued interest, as of December 31 (in thousands):



	2014		2013		2012
Balance, beginning of period	$	3,110	$	2,903	$	1,982
Increase in previous year tax positions	—		57		659
Increase in current year tax positions	121		144		151
Increase (decrease) related to adjustment of previous estimates of activity	94		6		111
Balance, end of period	$	3,325	$	3,110	$	2,903

Federal income tax returns for 2004 through 2013 remain open to examination by the U.S. Internal Revenue Service (the “IRS”), while state and local income tax returns for 2004 through 2013 also remain open to examination. The 2004 through 2009 income tax returns are only open to the extent that net operating loss or other tax attributes carrying forward from those years were utilized in 2010 through 2013. The foreign tax returns for 2011 through 2013 also remain open to examination. The Company is currently under examination by the IRS for tax year 2012. As of December 31, 2014 the exam is still ongoing. No adjustments have been proposed to date. The Company has not been notified by any major state tax jurisdiction that it will be subject to examination.