15. Income Taxes

12 Months Ended

Dec. 31, 2013

Notes to Financial Statements

15. Income Taxes

The Company files a consolidated U.S. federal income tax return that includes all wholly-owned subsidiaries. State tax returns are filed on a consolidated or separate basis depending on applicable laws. The Company records adjustments related to prior years’ taxes during the period when they are identified, generally when the tax returns are filed.   The effect of these adjustments on the current and prior periods (during which the differences originated) is evaluated based upon quantitative and qualitative factors and are considered in relation to the financial statements taken as a whole for the respective periods. The Company has evaluated this year’s amounts in relation to the current and prior reporting periods and determined that a restatement of those prior reporting periods is not appropriate.

The provision for income taxes is comprised of the following:

Years ended December 31,	2013			2012
Current federal income tax expense	$	1,473,370		$	641,857
Current state income tax expense		14,952			(225	)
Deferred federal and state income tax expense		(724,053	)		(338,723	)
Provision for income taxes	$	764,269		$	302,909

A reconciliation of the federal statutory rate to our effective tax rate is as follows:

Years ended December 31,	2013					2012
Computed expected tax expense	$	944,040		34.0	%	$	363,669		34.0
State taxes, net of Federal benefit		(48,411	)	(1.8	)		(44,687	)	(4.2	)
State valuation allowance		85,821		3.1			104,325		9.8
Permanent differences
Dividends received deduction		(91,163	)	(3.3	)		(64,274	)	(6.0	)
Non-taxable investment income		(43,905	)	(1.5	)		(68,667	)	(6.4	)
Stock-based compensation expense		-		-			16,414		1.5
Other permanent differences		25,709		0.9			25,956		2.4
Prior year tax matters		(52,145	)	(1.9	)		(46,906	)	(4.4	)
Other		(55,677	)	(2.0	)		17,079		1.6
Total tax	$	764,269		27.5	%	$	302,909		28.3

Deferred tax assets and liabilities are determined using the enacted tax rates applicable to the period the temporary differences are expected to be recovered. Accordingly, the current period income tax provision can be affected by the enactment of new tax rates. The net deferred income taxes on the balance sheet reflect temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and income tax purposes, tax effected at a various rates depending on whether the temporary differences are subject to federal taxes, state taxes, or both. Significant components of the Company’s deferred tax assets and liabilities are as follows:

	December 31,			December 31,
	2013			2012
Deferred tax asset:
Net operating loss carryovers (1)	$	246,476		$	264,648
Claims reserve discount		445,384			313,544
Unearned premium		1,000,372			811,413
Deferred ceding commission revenue		2,374,616			1,658,190
Other		17,087			10,921
Total deferred tax assets		4,083,935			3,058,716
Deferred tax liability:
Investment in KICO (2)		1,169,000			1,169,000
Deferred acquisition costs		2,332,489			1,893,759
Intangibles		921,143			1,082,886
Depreciation and amortization		197,223			152,576
Reinsurance recoverable		-			20,400
Net unrealized appreciation of securities - available for sale		157,167			527,376
Investment income		-			-
Total deferred tax liabilities		4,777,022			4,845,997
Net deferred income tax liability	$	(693,087	)	$	(1,787,281	)

(1) The deferred tax assets from net operating loss carryovers are as follows:

	December 31,			December 31,
Type of NOL	2013			2012			Expiration
State only (A)	$	459,989		$	380,810		December 31, 2032
Valuation allowance		(240,713	)		(146,762	)
State only, net of valuation allowance		219,276			234,048
Amount subject to Annual Limitation, federal only (B)		27,200			30,600		December 31, 2019
Total deferred tax asset from net operating loss carryovers	$	246,476		$	264,648

(A) Kingstone generates operating losses for state purposes and has prior year net operating loss carryovers available. The state net operating loss carryover as of December 31, 2013 and December 31, 2012 was approximately $5,482,000 and $4,588,000, respectively. KICO, the Company’s insurance underwriting subsidiary, is not subject to state income taxes. KICO’s state tax obligations are paid through a gross premiums tax, which is included in the consolidated statements of income and comprehensive income within other underwriting expenses. A valuation allowance has been recorded due to the uncertainty of generating enough state taxable income to utilize 100% of the available state net operating loss carryovers over their remaining lives, which expire between 2027 and 2033.

(B) The Company has an NOL of $60,000 that is subject to Internal Revenue Code Section 382, which places a limitation on the utilization of the federal net operating loss to approximately $10,000 per year (“Annual Limitation”) as a result of a greater than 50% ownership change of the Company in 1999. The losses subject to the Annual Limitation will be available for future years, expiring through December 31, 2019.

(2) Deferred tax liability - investment in KICO

On July 1, 2009, the Company completed the acquisition of 100% of the issued and outstanding common stock of KICO (formerly known as Commercial Mutual Insurance Company (“CMIC”)) pursuant to the conversion of CMIC from an advance premium cooperative to a stock property and casualty insurance company. Pursuant to the plan of conversion, the Company acquired a 100% equity interest in KICO, in consideration for the exchange of $3,750,000 principal amount of surplus notes of CMIC. In addition, the Company forgave all accrued and unpaid interest on the surplus notes as of the date of conversion. As of the date of acquisition, unpaid accrued interest on the surplus notes along with the accretion of the discount on the original purchase of the surplus notes totaled $2,921,319 (together “Untaxed Interest”). As of the date of acquisition, the deferred tax liability on the Untaxed Interest was $1,169,000. Under GAAP guidance for business combinations, a temporary difference with an indefinite life exists when the parent has a lower carrying value of its subsidiary for income tax purposes. The Company is required to maintain its deferred tax liability of $1,169,000 related to this temporary difference until the stock of KICO is sold, or the assets of KICO are sold or KICO and the parent are merged.

The table below reconciles the changes in net deferred income tax liability to the deferred income tax provision for the year ended December 31, 2013:

Change in net deferred income tax liabilities	$	(1,094,194	)
Deferred tax expense allocated to other comprehensive income		(370,141	)
Deferred income tax provision	$	(724,053	)

In assessing the valuation of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. No valuation allowance against deferred tax assets has been established, except for NOL limitations, as the Company believes it is more likely than not the deferred tax assets will be realized based on the historical taxable income of KICO, or by offset to deferred tax liabilities.

The Company had no material unrecognized tax benefit and no adjustments to liabilities or operations were required. There were no interest or penalties related to income taxes that have been accrued or recognized as of and for the years ended December 31, 2013 and 2012. If any had been recognized these would be reported in income tax expense.

IRS Tax Audit

The Company’s federal income tax return for the year ended December 31, 2009 was examined by the Internal Revenue Service and was accepted as filed. The tax returns for years ended December 31, 2010 through 2012 are subject to examination, generally for three years after filing.

In March 2014, the Company received a notice that its Federal income tax return for the years ended December 31, 2011 and 2012 has been selected for examination by the Internal Revenue Service. The audit has not yet commenced. The final results of this audit are unknown, although management believes the outcome of this examination will not have a material effect on these financial statements though the actual outcome may differ from this belief.