Note 9. Income Taxes

U.S. Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act ("Tax Act") was enacted. The Tax Act made significant changes to the U.S. Internal Revenue Code including a number of changes that impact the Company, most notably a reduction to the U.S. federal corporate tax rate from 35% to 21%, effective January 1, 2018, and an indefinite carryforward period for net operating losses generated in taxable years beginning after December 31, 2017. As a result, we will be able to use our hanging credit deferred tax liability as a source of taxable income to support the indefinite-lived net operating losses created by the future reversal of our temporary differences. Accordingly, we have re-measured our existing deferred tax assets and liabilities using the enacted tax rate, and adjusted the valuation allowance on our deferred taxes and recorded a decrease in deferred tax liabilities of $3.0 million, with a corresponding adjustment to deferred tax benefit for the same amount for the year ended December 31, 2017.

On December 22, 2017, Staff Accounting Bulletin No. 118, "Income Tax Accounting Implications of the Tax Cuts and Jobs Act" ("SAB 118") was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. The Company has re-measured its deferred tax assets and liabilities and adjusted the valuation allowance related to the hanging credit deferred tax liability and included these amounts in its consolidated financial statements for the year ended December 31, 2017. During 2018, we will continue to evaluate the impact of the Tax Act, which may impact our current conclusions. Any subsequent adjustment to these amounts will be recorded to current tax expense in 2018 in the quarter the analysis is completed.

The (benefit) provision for income taxes attributable to income from operations includes the following (in thousands):

	For the Years Ended December 31,
	2017			2016		2015
Current (benefit) provision
Federal	$	(86	)	$	114	$	(902	)
State		29			28		54
Total current		(57	)		142		(848	)

Deferred (benefit) provision
Federal		(2,622	)		155		4,333
State		(88	)		37		780
Total deferred		(2,710	)		192		5,113
Total provision (benefit)	$	(2,767	)	$	334	$	4,265

The provision for income taxes related to operations varies from the amount determined by applying the federal income tax statutory rate to the income or loss before income taxes, exclusive of net income attributable to non-controlling interest. The reconciliation of these differences is as follows:

	For the Years Ended December 31,
	2017	2016	2015
Computed expected income tax provision	34.0%	34.0%	34.0%
State income taxes, net of federal income tax benefit	0.9	0.8	2.1
Change in valuation allowance for deferred tax assets, exclusive of impact of Tax Act	(26.9)	(21.5)	(61.3)
Cumulative deferred adjustments	--	(0.3)	(0.1)
Provision to return adjustments	--	(0.4)	1.3
Other permanent differences	(1.3)	(1.8)	(1.1)
Dividend and accretion on preferred stock	(15.2)	(19.3)	(11.3)
FIN 48 liability	(0.9)	0.7	(0.8)
R&D credit	4.6	3.3	1.6
Impact of Tax Act	35.5	--	--
Other	1.5	(0.4)	(0.9)
	32.2%	(4.9)%	(36.5)%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2017 and 2016 are as follows (in thousands):

	December 31,
	2017			2016
Deferred tax assets:
Accounts receivable, principally due to allowance for doubtful accounts	$	108		$	161
Allowance for inventory obsolescence and amortization		818			778
Accrued liabilities not currently deductible		1,657			2,234
Accrued compensation		735			1,006
Deferred rent		5,134			7,682
Telos ID basis difference		65			--
Net operating loss carryforwards - federal		2,453			1,301
Net operating loss carryforwards - state		848			405
Federal tax credit		666			533
Total gross deferred tax assets		12,484			14,100
Less valuation allowance		(7,219	)		(10,499	)
Total deferred tax assets, net of valuation allowance		5,265			3,601
Deferred tax liabilities:
Amortization and depreciation		(2,127	)		(2,696	)
Unbilled accounts receivable, deferred for tax purposes		(1,282	)		(787	)
Goodwill basis adjustment and amortization		(2,597	)		(3,451	)
Telos ID basis difference		--			(58	)
Total deferred tax liabilities		(6,006	)		(6,992	)

Net deferred tax liabilities	$	(741	)	$	(3,391	)

The components of the valuation allowance are as follows (in thousands):

	Balance Beginning of Period		Additions		Recoveries			Balance End of Period

December 31, 2017	$	10,499	$	--	$	(3,280	)	$	7,219
December 31, 2016	$	9,027	$	1,472	$	--		$	10,499
December 31, 2015	$	1,868	$	7,159	$	--		$	9,027

We are required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based on available evidence, realization of deferred tax assets is dependent upon the generation of future taxable income. We considered projected future taxable income, tax planning strategies, and reversal of taxable temporary differences in making this assessment. As such, we have determined that a full valuation allowance is required as of December 31, 2017 and 2016. We were not able to use temporary taxable differences related to goodwill, as a source of future taxable income. As a result of a full valuation allowance against our deferred tax assets, a deferred tax liability (hanging credit) related to goodwill remains on our consolidated balance sheet at December 31, 2017 and 2016. Under the Tax Act, we will be able to use hanging credit deferred tax liabilities as a source of taxable income to support the indefinite-lived net operating losses created by the future reversal of our temporary differences. Accordingly, we have re-measured our existing deferred tax assets and liabilities using the enacted tax rate, and adjusted the valuation allowance on our deferred taxes and recorded a decrease in deferred tax liabilities of $3.0 million, with a corresponding adjustment to deferred tax benefit for the same amount for the year ended December 31, 2017.

At December 31, 2017, for federal income tax purposes there was approximately $11.7 million net operating loss available to be carried forward to offset future taxable income. These net operating loss carryforwards expire in 2037. In addition, there was approximately $60,000 of alternative minimum tax credit available to be carried forward indefinitely to reduce future regular tax liabilities until 2020, after which time it will be fully refundable in 2021, in accordance with the Tax Act.

Under the provisions of ASC 740-10, we determined that there were approximately $677,000 and $762,000 of unrecognized tax benefits, including $266,000 and $233,000 of related interest and penalties, required to be recorded in other liabilities as of December 31, 2017 and 2016, respectively. We believe that the total amounts of unrecognized tax benefits will not significantly increase or decrease within the next 12 months. The period for which tax years are open, 2014 to 2017, has not been extended beyond the applicable statute of limitations.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

	2017			2016			2015
Unrecognized tax benefits, beginning of period	$	762		$	803		$	708
Gross (decreases) increases—tax positions in prior period		(127	)		(66	)		92
Gross increases—tax positions in current period		77			46			38
Settlements		(35	)		(21	)		(35	)
Unrecognized tax benefits, end of period	$	677		$	762		$	803