Note 16 — Income Taxes

The components of the provision for income taxes are as follows:

	Year Ended
	January 31,		February 1,		February 2,
	2016		2015		2014
	(In thousands)

Current	$	2,786	$	2,427	$	2,790
Deferred		16,650		15,729		8,014
	$	19,436	$	18,156	$	10,804

A reconciliation of the tax provision computed at the statutory federal income tax rate and our provision for income taxes follows:

	Year Ended
	January 31,			February 1,			February 2,
	2016			2015			2014
	(In thousands)

Income taxes at statutory federal rate	$	18,142		$	16,875		$	15,771
State income taxes, net of federal income tax benefit		1,139			1,662			1,902
Reversal of valuation allowance on deferred income tax assets		(817	)		(150	)		(4,306	)
Benefit of foreign tax credits in excess of benefit previously recorded		(910	)		-			(4,481	)
Foreign taxes, principally withholding taxes		2,625			2,457			2,309
Credit for foreign income taxes		(2,625	)		(2,457	)		(2,309	)
Other changes in tax credit carryforwards		(27	)		-			118
Accruals for uncertain tax positions		40			-			359
Accruals for interest and penalties		66			15			3
Changes in estimated future blended state income tax rate		1,408			73			717
Other		395			(319	)		721
	$	19,436		$	18,156		$	10,804

We establish valuation allowances for deferred income tax assets in accordance with GAAP, which provides that such valuation allowances shall be established unless realization of the income tax benefits is more likely than not.

In the fourth quarter of fiscal 2016, after considering all relevant factors and objectively verifiable evidence having an impact on the likelihood of future realization of our deferred tax assets, we concluded that it was more likely than not that state income tax NOL carryovers deferred tax assets would be realized in future years in excess of amounts previously estimated. This reduction in the valuation allowance resulted from the increase in our estimate of annual pre-tax income to be earned in future periods from $45 million to $56.3 million. Accordingly, we reversed $817,000 of the valuation allowance on deferred tax assets, with an offsetting credit to the provision for income taxes. In addition, $267,000 of state NOL deferred tax assets expired unused during fiscal 2016 which had a valuation allowance related to them. This reduction in state NOL deferred tax assets required a corresponding reduction of the same amount in the valuation allowance with no net impact on tax expense. The total reduction of the valuation allowance for the fourth quarter of fiscal 2016 was $1,084,000.

Also in the fourth quarter of fiscal 2016, we concluded that foreign tax credit carryovers related to certain tax years, which we previously forecasted would be deducted from future taxable income, rather than being taken as a credit against future income taxes payable would ultimately be taken as a credit rather than as a deduction. The resulting increase in our estimate of the amount of tax benefits to be realized from the credit carryovers also was reflected as a credit to income tax expense in the fourth quarter of fiscal 2016 of $910,000.

The aggregate credit to income tax expense in the fourth quarter of fiscal 2016 from the reduction in our estimate of the necessary valuation allowance at January 31, 2016, and the increase in the aggregate amount of tax benefits expected to be realized from the foreign tax credit carryovers, was $1.7 million. All of both adjustments resulted from the increase in the fourth quarter of fiscal 2016 in our estimate of the amount of annual pretax income to be earned in future periods.

In fiscal 2014, as a result of an increase in our estimate of the amount of annual pretax income to be earned in future periods, we concluded that it was more likely than not that deferred tax assets would be realized in future years in excess of amounts previously estimated. Accordingly, we reversed $4.3 million of the valuation allowance on deferred tax assets, with an offsetting credit to the provision for income taxes. Also as a result of our change in estimate for future pretax income we concluded that certain foreign tax credits would be taken as credits instead of deductions and recorded a tax benefit of $4.5 million.

As of January 31, 2016 and February 1, 2015, we had approximately $2.9 million and $5.2 million, respectively, of foreign tax credits related to other tax years which we continued to forecast would be reflected as a deduction from future taxable income rather than as a credit against future taxes payable.

In the second quarter of fiscal 2016, the North Carolina state legislature announced it had surpassed its revenue estimates and these increased tax revenues triggered an automatic reduction to the state corporate income tax rate, which caused us to revalue our deferred income tax assets to reflect the lower corporate income tax rate. The net effect of the NC tax rate reduction and associated revaluation of our deferred tax assets resulted in a reduction in net deferred tax assets of $467,000; such amount was included in income tax expense for the second quarter of fiscal 2016. Because a portion of the deferred tax assets were already subject to a valuation allowance, the revaluation of the assets resulted in a reduction in the necessary valuation allowance of approximately $63,000, which is reflected in the $467,000 reduction in net deferred tax assets.

We recognize deferred income tax assets and liabilities based upon our expectation of the future tax consequences of temporary differences between the income tax and financial reporting bases of assets and liabilities. Deferred tax liabilities generally represent tax expense recognized for which payment has been deferred, or expenses which have been deducted in our tax returns but which have not yet been recognized as an expense in the financial statements. Deferred tax assets generally represent tax deductions or credits that will be reflected in future tax returns for which we have already recorded a tax benefit in the consolidated financial statements.

The tax effects of temporary differences are as follows:

	January 31,			February 1,
	2016			2015
	(In thousands)
Deferred income tax assets:
Goodwill and reacquired franchise rights	$	-		$	1,325
Other intangible assets		1,463			1,505
Allowance for doubtful accounts		108			191
Other current assets		1,444			1,124
Property and equipment		5,997			6,202
Other non-current assets		1,600			2,777
Self-insurance accruals		3,545			3,434
Deferred revenue		3,425			2,608
Accrued compensation		3,932			5,154
Other current liabilities		911			998
Other non-current liabilities		3,505			3,488
Share-based compensation		8,375			8,489
Federal net operating loss carryforwards		19,619			34,709
Federal tax credit carryforwards		16,680			12,642
State net operating loss and credit carryforwards		6,788			8,938
Other		554			505
Gross deferred income tax assets		77,946			94,089
Valuation allowance on deferred income tax assets		(1,419	)		(2,566	)
Deferred income tax assets, net of valuation allowance		76,527			91,523
Deferred income tax liabilities - goodwill and reacquired franchise rights		(1,653	)		-
Net deferred income tax assets	$	74,874		$	91,523

The changes in the valuation allowance on deferred income tax assets are summarized as follows:

	Year Ended
	January 31,			February 1,			February 3,
	2016			2015			2014
	(In thousands)
Valuation allowance on deferred tax assets:
Balance at beginning of year	$	2,566		$	2,675		$	9,767
Reversal of valuation allowance credited to earnings		(817	)		(150	)		(4,306	)
Reduction of valuation allowance due to state NOL deferred tax assets expirations not affecting earnings		(267	)		-			-
Reclassification of valuation allowance against deferred tax assets not affecting earnings		-			-			(2,472	)
Reduction in valuation allowance related to enacted change in
North Carolina statutory income tax rate		(63	)		-			(314	)
Other		-			41			-
Balance at end of year	$	1,419		$	2,566		$	2,675

The valuation allowances of $1.4 million and $2.6 million as of January 31, 2016 and February 1, 2015, respectively, represent the portion of our deferred tax assets management estimated would not be realized in the future. Such assets are associated with state net operating loss carryforwards related to states in which the scope of our operations has decreased, which adversely affects our ability to realize the net operating loss carryforwards before the statute of limitations expire because we have little income earned in or apportioned to those states.

Realization of net deferred tax assets generally is dependent on generation of taxable income in future periods. While we believe our forecast of future taxable income is reasonable, actual results will inevitably vary from management's forecasts. Such variances could result in adjustments to the valuation allowance on deferred tax assets in future periods, and such adjustments could be material to the financial statements.

We have approximately $60 million of federal income tax loss carryforwards expiring in fiscal 2027 through 2031. In addition to this amount, we have approximately $64 million of income tax loss carryforwards resulting from tax deductions related to stock options and other equity awards to employees, the tax benefits of which, if subsequently realized, will be recorded as additions to common stock; the amount of such potential benefits is approximately $24 million. We also have state income tax loss carryforwards expiring in fiscal 2017 through 2035. We have $16.7 million of federal tax credit carryforwards expiring in fiscal 2020 through 2036, principally consisting of federal foreign tax credit carryforwards.

We are subject to U.S. federal income tax, as well as income tax in multiple U.S. state and local jurisdictions and a limited number of foreign jurisdictions. Our income tax returns periodically are examined by the Internal Revenue Service (the “IRS”) and by other tax authorities in various jurisdictions. We assess the likelihood of adverse outcomes resulting from these examinations in determining the provision for income taxes. Because of special rules applicable to companies which have incurred net operating losses that may be carried back to earlier years or forward to subsequent years, our income tax returns for fiscal 2002 and later years are subject to examination and adjustment notwithstanding the normal three year statute of limitations. With the exception of fiscal 2010, which was examined by the IRS without adjustment, the IRS has not examined our federal income tax returns for years subsequent to fiscal 2004. Our state income tax returns generally are subject to adjustment by state tax authorities for similar reasons over similar time periods.

Income tax payments, net of refunds, were $2.6 million, $2.5 million and $2.5 million in fiscal 2016, 2015 and 2014, respectively. The tax payments in all three fiscal years were comprised largely of foreign withholding taxes on amounts received from foreign franchisees.

The following table presents a reconciliation of the beginning and ending amounts of unrecognized tax benefits:

	Year Ended
	January 31,			February 1,			February 2,
	2016			2015			2014
	(In thousands)

Unrecognized tax benefits at beginning of year	$	1,965		$	1,952		$	1,327
Increases related to positions taken in the current year		70			108			105
Increases (decreases) related to positions taken in prior years		22			(21	)		702
Lapsing of statutes of limitations		(76	)		(74	)		(182	)
Unrecognized tax benefits at end of year	$	1,981		$	1,965		$	1,952

Approximately all of the aggregate $2.0 million of unrecognized income tax benefits at January 31, 2016, would, if recognized, be reflected as a reduction in income tax expense.

We do not expect any material change in fiscal 2017 in the amount of unrecognized tax benefits.

Our policy is to recognize interest and penalties related to income tax issues as components of income tax expense. Our balance sheet reflects approximately $379,000 and $313,000 of accrued interest and penalties as of January 31, 2016 and February 1, 2015, respectively. Our statement of income reflects $66,000 and $15,000 of interest and penalty expense for fiscal 2016 and 2015, respectively.