10. Income Taxes

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


	2013			2012
Deferred income tax assets:
Net operating loss carryforward	$	513		$	47
Deferred warranty revenue		2,837			1,759
Inventory reserve		389			906
Non-qualified and non-employee stock option expense		3,518			3,682
Capitalized research and development		6,588			8,191
Alternative minimum tax carryforward		1,466			1,406
Research and development tax credit carryforward		3,165			2,936
Deferred legal settlement		1,294			723
IRC section 481(a) adjustment—tangible property		1,316			—
Reserves, accruals, and other		2,066			2,156

Total deferred income tax assets		23,152			21,806

Deferred income tax liabilities:
Depreciation		(2,136	)		(662	)
Amortization		(236	)		(142	)

Total deferred income tax liabilities		(2,372	)		(804	)

Net deferred income tax assets	$	20,780		$	21,002

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


	2013		2012
Current deferred tax assets, net	$	7,101	$	9,396
Long-term deferred tax assets, net		13,679		11,606

Total	$	20,780	$	21,002

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 $0.4 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 $2.8 million, which expire at various dates between 2018 and 2028, and California R&D credit carry forwards for financial reporting purposes of $0.3 million which do not expire. The Company has a minimum tax credit carryover of $1.5 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 2013 and 2012, the Company recognized benefits of $6.8 million and $4.7 million, respectively, for the reduction of federal and state taxes payable, which was recorded as a credit to additional paid-in capital. At December 31, 2013 and 2012, the Company had income tax receivable of $2.3 million and $0.8 million, respectively.

Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and our effective tax rate in the future. The American Taxpayer Relief Act of 2012 (the “Act”) was signed into law on January 2, 2013. Because a change in tax law is accounted for in the period of enactment, certain provisions of the Act benefitting the Company’s 2012 federal taxes, including the R&D credit, were not recognized in the Company’s 2012 financial results and instead are reflected in the Company’s 2013 financial results. A benefit of approximately $55,000 was accounted for in the tax provision for the year ended December 31, 2013.

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, 2013, the Company continues to demonstrate three-year cumulative pre-tax income in the U.S. federal and Arizona tax jurisdictions, and based on that and other available evidence, management has concluded that it is more likely than not that the Company’s deferred tax assets will be realized.

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


	2013			2012			2011
Current:
Federal	$	7,963		$	4,605		$	133
State		987			666			59

Total current		8,950			5,271			192

Deferred:
Federal		764			3,168			(3,253	)
State		(143	)		(1,485	)		771

Total deferred		621			1,683			(2,482	)

Tax provision (benefit) recorded as an increase (decrease) in liability for unrecorded tax benefits		219			920			(299	)

Provision (benefit) for income taxes	$	9,790		$	7,874		$	(2,589	)

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, 2013, 2012 and 2011 is as follows:


	2013			2012			2011
Federal income tax at the statutory rate	$	9,812		$	7,914		$	(3,370	)
State income taxes, net of federal benefit		1,283			969			(357	)
Permanent differences (i)		(96	)		156			231
Research and development		(386	)		(327	)		(230	)
Return to provision adjustment (ii)		(361	)		(270	)		(458	)
Change in liability for unrecognized tax benefits		219			921			(299	)
Incentive stock option detriment/(benefit)		(538	)		174			449
Change in valuation allowance		—			(1,429	)		1,429
Other		(143	)		(234	)		16

Povision (benefit) for income taxes	$	9,790		$	7,874		$	(2,589	)

Effective tax rate		34.9	%		34.8	%		26.9	%

(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 2011 return to provision adjustment was driven by higher than estimated 2010 R&D tax credits, which increased the net tax benefit and therefore, reduced the effective tax rate. 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 $9.8 million in tax credits for federal, Arizona and California income tax purposes related to the 2003 through 2013 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 $3.0 million as of December 31, 2013. In addition, management accrued approximately $0.1 million for estimated uncertain tax positions related to certain state income tax liabilities. As of December 31, 2013, management does not expect the amount of the unrecognized tax benefit liability to increase or decrease significantly within the next 12 months. Should the unrecognized tax benefit of $3.1 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, 2013 and 2012, respectively, the Company had accrued interest of $12,000 and $0.

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


	2013		2012		2011
Balance, beginning of period	$	2,903	$	1,982	$	2,282
Increase in previous year tax positions		57		659		—
Increase in current year tax positions		144		151		83
Increase (decrease) related to adjustment of previous estimates of activity		6		111		(383	)

Balance, end of period	$	3,110	$	2,903	$	1,982

Federal income tax returns for 2004 through 2012 remain open to examination by the U.S. Internal Revenue Service (the “IRS”), while state and local income tax returns for 2004 through 2012 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 2010 through 2012 also remain open to examination. The Company has not been notified by any major state tax jurisdiction that it will be subject to examination.

On September 13, 2013, the U.S. Treasury Department released final income tax regulations on the deduction and capitalization of expenditures related to tangible property. These final regulations apply to tax years beginning on or after January 1, 2014. Several of the provisions within the regulations will require a tax accounting method change to be filed with the IRS, resulting in a cumulative effect adjustment. To account for the adoption of these regulations and other related items, tangible property-related, long-term deferred tax liabilities increased by $1.3 million, with the offsetting increase to current deferred income tax assets.