NOTE 13—INCOME TAXES

The following is a summary of the income tax expense (benefit) (in thousands):

	Year Ended
	January 28,			January 30,			January 31,
	2017			2016			2015
Current
Federal	$	751		$	55,676		$	45,611
State		2,410			9,112			9,235
Foreign		694			227			(596	)
Total current tax expense		3,855			65,015			54,250
Deferred
Federal		2,109			(5,691	)		3,895
State		(2,414	)		(648	)		(973	)
Foreign		(397	)		105			1
Total deferred tax expense (benefit)		(702	)		(6,234	)		2,923
Total income tax expense	$	3,153		$	58,781		$	57,173

A reconciliation of the federal statutory tax rate to the Company’s effective tax rate is as follows:

	Year Ended
	January 28,			January 30,			January 31,
	2017			2016			2015
Provision at federal statutory tax rate		35.0	%		35.0	%		35.0	%
State income taxes—net of federal tax impact		4.8			3.7			4.0
Donation of appreciated property		(8.7	)		—			—
Meals and entertainment		5.0			0.2			0.2
Aircraft expenses		3.3			0.1			—
Transaction costs		2.6			—			—
Other permanent items		2.8			0.1			0.1
Valuation allowance		0.9			—			—
Tax rate adjustments		(5.8	)		0.1			(0.4	)
Foreign income		(4.2	)		(0.1	)		(0.3	)
Net adjustments to tax accruals and other		1.2			0.1			—
Effective tax rate		36.9	%		39.2	%		38.6	%

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

	January 28,			January 30,
	2017			2016
Non-current deferred tax assets (liabilities)
Stock-based compensation	$	37,804		$	32,248
Inventory		37,198			29,430
Deferred lease credits		25,457			20,074
Accrued expense		18,024			18,964
Deferred revenue		1,887			1,800
Charitable contributions		1,877			—
U.S. impact of Canadian transfer pricing		1,404			1,420
Net operating loss carryforwards		1,044			214
Property and equipment		(32,396	)		(24,905	)
Prepaid expense and other		(28,387	)		(17,956	)
Trademarks and domain names		(28,345	)		(18,414	)
State tax benefit		(4,143	)		(3,052	)
Convertible senior notes		(3,867	)		(4,719	)
Other		1,669			1,793
Non-current deferred tax assets		29,226			36,897
Valuation allowance		(760	)		(158	)
Net non-current deferred tax assets	$	28,466		$	36,739

A reconciliation of the valuation allowance is as follows (in thousands):

	Year Ended
	January 28,		January 30,			January 31,
	2017		2016			2015
Balance at beginning of fiscal year	$	158	$	176		$	206
Net changes in deferred tax assets and liabilities		602		(18	)		(30	)
Balance at end of fiscal year	$	760	$	158		$	176

The Company has recorded deferred tax assets and liabilities based upon estimates of their realizable value, such estimates are based upon likely future tax consequences. In assessing the need for a valuation allowance, the Company considers both positive and negative evidence related to the likelihood of realization of the deferred tax assets. If, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be realized, the Company records a valuation allowance.

As of January 28, 2017, the Company no longer has a valuation allowance against its Shanghai net operating loss deferred tax assets as these losses have expired. The Company has a $0.8 million valuation allowance against its Waterworks U.K. operations net deferred tax assets as it believes that these assets will not be realized due to historical losses.

As of January 28, 2017, the Company had state net operating loss carryovers of $0.8 million and foreign net operating loss carryovers of $5.0 million. The state net operating loss carryovers will begin to expire in 2019, and the foreign net operating loss carryovers have an indefinite carryforward. Internal Revenue Code Section 382 and similar state rules place a limitation on the amount of taxable income which can be offset by net operating loss carryforwards after a change in ownership (generally greater than 50% change in ownership). The Company cannot give any assurances that it will not undergo an ownership change in the future resulting in further limitations on utilization of net operating losses.

A reconciliation of the exposures related to unrecognized tax benefits is as follows (in thousands):

	Year Ended
	January 28,		January 30,			January 31,
	2017		2016			2015
Balance at beginning of fiscal year	$	921	$	940		$	1,395
Gross increases (decreases)—prior period tax positions		53		(88	)		(122	)
Gross increases—current period tax positions		1,216		69			—
Lapses in statute of limitations		—		—			(333	)
Balance at end of fiscal year	$	2,190	$	921		$	940

As of January 28, 2017, the Company has $2.2 million of unrecognized tax benefits, of which $1.4 million would reduce income tax expense and the effective tax rate, if recognized. The remaining unrecognized tax benefits would offset other deferred tax assets, if recognized. As of January 28, 2017, the Company does not have any exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.

Adjustments required upon adoption of accounting for uncertainty in income taxes related to deferred tax asset accounts were offset by the related valuation allowance. Future changes to the Company’s assessment of the realizability of those deferred tax assets will impact the effective tax rate. The Company accounts for interest and penalties related to exposures as a component of income tax expense. The Company had interest accruals of $0.3 million and $0.2 million associated with exposures as of January 28, 2017, and January 30, 2016, respectively.

This Company is subject to tax in the United States, Canada, the U.K., Shanghai and Hong Kong. The Company could be subject to United States federal and state tax examinations for years 2002 forward. There are no United States tax examinations currently in progress. The Company may also be subject to audits in Canada for years 2009 and forward, and in the U.K. for years 2015 forward.