Income Taxes

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act made broad and complex changes to the U.S. tax code including, but not limited to, reducing the U.S. federal corporate tax rate from 35 percent to 21 percent for tax years beginning in 2018 and requiring companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred. The Tax Act established certain new provisions which are applicable to us including (1) creating a new provision designed to tax global intangible low-tax income ("GILTI"); (2) establishing a deduction for foreign derived intangible income ("FDII"); (3) repealing the domestic production activity deduction; and (4) establishing new limitations on certain executive compensation.

During the year ended December 31, 2017, we recorded additional net tax expense of $7.6 million for the impact of the Tax Act using the current available information and technical guidance on the interpretations of the Tax Act. As permitted by SEC Staff Accounting Bulletin 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, we recorded provisional estimates and have subsequently finalized our accounting analysis based on the guidance, interpretations, and data available as of December 31, 2018. We recorded additional tax expense of $0.3 million during the three months ended December 31, 2018 upon finalization of our accounting analysis.

Income before income taxes included the following components for the years ended December 31 (in thousands):



	2018		2017		2016
United States	$	25,751	$	14,978	$	38,414
Foreign	2,353		783		(6,917		)
Total	$	28,104	$	15,761	$	31,497

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



	2018			2017			2016
Current:
Federal	$	4,900		$	6,039		$	16,346
State	1,377			1,263			1,534
Foreign	228			656			1,050
Total current	6,505			7,958			18,930
Deferred:
Federal	(8,382		)	4,539			(4,145		)
State	(364		)	(1,631		)	(977		)
Foreign	(3		)	(78		)	(45		)
Total deferred	(8,749		)	2,830			(5,167		)
Tax impact of unrecorded tax benefits liability	1,143			(234		)	437
Provision for income taxes (Income tax benefit)	$	(1,101	)	$	10,554		$	14,200

A reconciliation of our effective income tax rate to the federal statutory rate follows for the years ended December 31 (in thousands):



	2018			2017			2016
Federal income tax at the statutory rate	$	5,902		$	5,518		$	11,024
State income taxes, net of federal benefit	(215		)	339			889
Difference between statutory and foreign tax rates	7			(560		)	1,521
Permanent differences ⁽¹⁾	725			300			(457		)
Executive compensation limitation	1,167			—			—
Research and development	(6,908		)	(2,380		)	(1,928		)
Return to provision adjustment	1,780			23			327
Change in liability for unrecognized tax benefits	1,768			7			700
Excess stock-based compensation benefit ⁽²⁾	(8,907		)	(1,819		)	(77		)
Change in valuation allowance	1,984			1,949			1,779
Tax effects of intercompany transactions	1,004			(277		)	630
Adjustments to deferred tax assets, net resulting from enactment of new tax law⁽³⁾	—			7,601			—
Other	592			(147		)	(208		)
Provision for income taxes (Income tax benefit)	$	(1,101	)	$	10,554		$	14,200
Effective tax rate	(3.9		)%	66.9		%	45.1		%


⁽¹⁾	Permanent differences include certain expenses that are not deductible for tax purposes including meals and entertainment, certain transaction costs, lobbying fees, and unfavorable income as a result of GILTI offset by favorable items including the domestic production activities deduction, for tax years 2017 and 2016, and a deduction for FDII for 2018.

⁽²⁾

For the years ended December 31, 2018 and 2017, the provision for income taxes included $8.9 million and $1.8 million, respectively, of benefits resulting from excess stock-based compensation that were recorded as a decrease in the provision for income taxes. For the year ended December 31, 2016, we included $1.4 million of benefits resulting from excess stock-based compensation that were recorded as increases to additional paid-in capital in the consolidated statement of changes in stockholders' equity.


⁽³⁾	The adjustment to deferred tax assets of $7.6 million was a result of the impact of changes in the U.S. federal effective tax rate, as well as a reduction of the stock-based compensation deferred tax asset due to expected permanent limitations on its deductibility for certain key executives under the Tax Act.

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



	2018			2017
Deferred income tax assets:
Net operating loss carryforward	$	2,347		$	3,691
Deferred revenue	13,304			9,442
Deferred compensation	858			1,109
Inventory reserve	1,294			702
Non-qualified and non-employee stock option expense	3,758			3,704
Capitalized research and development	—			485
Amortization	412			—
Research and development tax credit carryforward	5,193			3,817
Reserves, accruals, and other	3,094			1,921
Total deferred income tax assets	30,260			24,871
Deferred income tax liabilities:
Depreciation	(2,195		)	(2,027		)
Amortization	(57		)	(1,398		)
Other	(1,232		)	(256		)
Total deferred income tax liabilities	(3,484		)	(3,681		)
Net deferred income tax assets before valuation allowance	26,776			21,190
Valuation allowance	(7,429		)	(5,435		)
Net deferred income tax assets	$	19,347		$	15,755

We have $2.5 million of state net operating losses (“NOLs”) which expire at various dates between 2029 and 2036. We also have a federal NOL of $1.5 million which expires in 2036, and is subject to limitation under Internal Revenue Code (“IRC”) Section 382. We have $0.1 million of federal R&D credits, which expire in 2024 and 2027, and are also subject to limitation under IRC Section 382. We have $9.7 million of Arizona R&D credits carrying forward, which expire at various dates between 2019 and 2033. In the U.K., Canada, and Germany, we have $8.9 million, $1.4 million, and $0.1 million of NOLs, respectively, which expire at various dates or may be carried forward indefinitely.

In preparing our 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 our 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 our provisions for income taxes, our deferred income tax assets and liabilities, and our future taxable income for purposes of assessing our ability to utilize any future tax benefit from our deferred income tax assets.

As of December 31, 2018, we continue to demonstrate positive income in the U.S. federal and state tax jurisdictions; however, we have Arizona R&D tax credits expiring unutilized each year. Therefore, management has concluded that it is more likely than not that our Arizona R&D deferred tax asset will not be realized.

As of December 31, 2018, we have cumulative pre-tax losses in Australia, the U.K., and Canada, which limits the ability to consider other subjective evidence, such as projections for future growth. On the basis of this evaluation, a full valuation allowance has been recorded for these jurisdictions. The amount of the deferred tax asset considered realizable; however, could be adjusted in future periods if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as projections for growth.

We consider the undistributed earnings of certain non-U.S. subsidiaries to be indefinitely reinvested outside of the United States on the basis of estimates that future domestic cash generation will be sufficient to meet future domestic cash needs and our specific plans for reinvestment of those subsidiary earnings. We project that our foreign earnings will be utilized offshore for working capital and future foreign growth. The determination of the unrecognized deferred tax liability on those undistributed earnings is not practicable due to our legal entity structure and the complexity of U.S. and local country tax laws. If we decide to repatriate the undistributed foreign earnings, we will need to recognize the income tax effects in the period we change our assertion on indefinite reinvestment.

We complete R&D tax credit studies for each year that an R&D tax credit is claimed for federal, Arizona, and California income tax purposes. 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 $5.2 million as of December 31, 2018. In addition, management accrued approximately $0.1 million for estimated uncertain tax positions related to certain federal income tax liabilities. Should the unrecognized tax benefit of $5.3 million be recognized, our effective tax rate would be favorably impacted.

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



	2018			2017			2016
Balance, beginning of period	$	4,243		$	4,050		$	3,396
Increase in previous year tax positions	213			379			206
Increase in current year tax positions	1,982			587			448
Decrease due to lapse of statutes of limitations	(380		)	(773		)	—
Balance, end of period	$	6,058		$	4,243		$	4,050

Federal income tax returns for 2015 through 2017 remain open to examination by the U.S. Internal Revenue Service (the “IRS”), while state and local income tax returns for 2014 through 2017 also generally remain open to examination by state taxing authorities. The 2004 through 2013 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 2014 through 2017. The foreign tax returns for 2014 through 2017 also generally remain open to examination. Our U.S. federal income tax return for fiscal year 2016 is currently under audit by the Internal Revenue Service.

We recognize interest and penalties related to unrecognized tax benefits within the provision (benefit) for income tax expense line in the accompanying consolidated statements of operations and comprehensive income. As of December 31, 2018 and 2017, we had accrued interest of $0.1 million.