2. INCOME TAXES

Income tax expense (benefit) for the years ended December 31, 2016 and 2015 consists of the following:


	2016		2015

Current:
Federal	$	(72,000)	$	62,000
State		7,000		10,000
		(65,000)		72,000
Deferred - Federal		61,000		18,000
	$	(4,000)	$	90,000

The expected provision for income taxes, computed by applying the U.S. federal income tax rate of 34% in 2016 and 2015 to income (loss) before taxes, is reconciled to income tax expense as follows:


	2016		2015

Expected provision for federal income taxes	$	(23,000)	$	77,000
State income taxes, net of federal benefit		7,000		7,000
Domestic manufacturers deduction		-		(6,000)
Non-deductible meals, entertainment, and life insurance		27,000		29,000
Research and development credit		(32,000)		(30,000)
Change in valuation allowance		15,000		15,000
Other		2,000		(2,000)
	$	(4,000)	$	90,000

Net deferred tax liabilities consist of the following as of December 31, 2016 and 2015:


	2016		2015

Deferred tax liabilities:
Accrued vacation	$	32,000	$	26,000
Inventories reserve		66,000		126,000
Allowance for doubtful accounts		4,000		5,000
Allowance for sales returns		15,000		37,000
Research and development credit carryforward		77,000		45,000
Accrued self-insured medical		3,000		1,000
Property and equipment		(499,000)		(494,000)
Intangible assets		(92,000)		(86,000)
Net operating loss		3,000		-
Other		5,000		-
Valuation allowance		(60,000)		(45,000)
Net deferred tax liabilities	$	(446,000)	$	(385,000)

At December 31, 2016, the Company generated a federal credit carryforward for increasing research and development costs of $17,000 which expires in 2036. The Company does not have any federal net operating loss carryforwards due to current carryback potential to previous tax years. The Company generated state net operating loss carryforwards in 2016 of $729,000 which begin expiring in 2026. The Company had state credit carryforwards for increasing research and development costs as of December 31, 2016 and 2015 of $60,000 and $45,000, respectively.

The valuation allowance balance of $60,000 and $45,000 at December 31, 2016 and 2015, respectively relates entirely to Minnesota research and development credit carryforwards that the Company does not expect to utilize and begin to expire in 2028. The change in the valuation allowance was $15,000 in 2016 and 2015, respectively.

It has been the Company’s policy to recognize interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2016 and 2015, there was no liability for unrecognized tax benefits.

The Company is subject to federal and state taxation. The material jurisdictions that are subject to examination by tax authorities primarily include Minnesota and the United States, for tax years 2013, 2014, 2015, and 2016.