INCOME TAXES

Earnings from continuing operations before income tax expense was as follows for fiscal years 2014, 2013 and 2012:



	2014		2013		2012
United States	$	2,939	$	14,144	$	22,870
Outside the United States	1,065		1,165		1,587
Earnings from continuing operations before income tax expense	$	4,004	$	15,309	$	24,457

Following is a summary of the (benefit) provision for income taxes (in thousands):



	2014			2013		2012
Current:
Federal	$	(1,125	)	$	3,536	$	5,324
State	31			195		473
Foreign	296			412		79
Current taxes (benefit)	(798		)	4,143		5,876
Deferred:
Federal	1,200			194		3,202
State	511			2,937		197
Foreign	1,143			198		463
Deferred taxes	2,854			3,329		3,862
Income tax expense	$	2,056		$	7,472	$	9,738

Following is a summary of the difference between the effective income tax rate and the statutory federal income tax rate:



	2014		2013		2012
Statutory federal tax rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal tax benefit	5.6		4.4		1.9
Non-deductible permanent items	1.4		(0.3	)	1.6
Change in valuation allowance	47.5		9.3		—
Uncertain tax positions	(23.7	)	(0.5	)	(0.1	)
Impact of foreign operations	(3.7	)	2.6		1.2
Prior period true-up adjustments	(10.2	)	(2.3	)	0.8
Other	(0.6	)	0.6		(0.6	)
Effective tax rate	51.3	%	48.8	%	39.8	%

Deferred tax assets and liabilities are recognized for the differences between the bases of the related assets and liabilities for financial reporting and income tax purposes, and are calculated using enacted tax rates in effect for the year the differences are expected to reverse. Following is a summary of the tax effects of temporary differences that give rise to significant components of deferred tax assets and liabilities (in thousands):



	2014			2013
Assets:
Accrued payroll and benefits	$	6,652		$	6,523
Capitalized inventory costs	118			145
Accrued expenses	3,068			3,092
Intangible assets	2,005			2,686
Net operating losses and tax credits	8,755			7,107
Deferred rent	4,852			4,385
Vendor allowances	2,344			—
Other	2,592			2,440
Total deferred income tax assets	30,386			26,378
Valuation allowance	(6,807		)	(3,884		)
Deferred income taxes, net of valuation allowance	23,579			22,494
Liabilities:
Prepaid expenses	(2,474		)	(1,999		)
Property and equipment	(12,579		)	(8,018		)
Federal effect of state and foreign deferred items	(1,672		)	(2,398		)
Other liabilities	(1,024		)	(961		)
Total deferred tax liabilities	(17,749		)	(13,376		)
Net deferred income tax assets	$	5,830		$	9,118

Net deferred tax assets included in the accompanying consolidated balance sheet are as follows (in thousands):



	2014			2013
Current deferred income tax assets	$	5,585		$	5,012
Non-current deferred income tax assets	3,993			5,684
Non-current deferred income tax liabilities	(3,748		)	(1,578		)
Net deferred tax assets	$	5,830		$	9,118

At year-end 2014, the Company had $14.7 million of state income tax net loss carryforwards that expire between 2021 and 2034. The Company also had foreign net loss carryforwards of $2.7 million that expire between 2017 and 2034. In addition, the Company had California state enterprise zone credits of $5.4 million available for use in the tax years 2015 through 2024, and South Carolina tax credits of $1.3 million, which are available for use for tax years 2015 through 2018. These carryforwards are available to offset future taxable income. As of January 3, 2015 and December 28, 2013, non-current deferred tax liability was included in the Deferred rent and other line item on the Company's consolidated balance sheet.

A valuation allowance must be provided if it is more likely than not that some portion or all of the deferred tax assets will not be realized, based upon consideration of all positive and negative evidence. Sources of evidence include, among other things, a history of pretax earnings or losses, expectations of future results, tax planning opportunities, and appropriate tax law.

Since the Company has a significant net operating loss carryforward in South Carolina, realization of a benefit from state tax credits is not more likely than not. Therefore a full valuation allowance remains in place until such time as the Company determines it is able to either benefit from the credits or they expire. The Company has determined that it is not more likely than not that the Company will be able to realize the tax benefit for a portion of the California Enterprise Zone credits before they expire in 2024. Therefore, the valuation allowance against these credits was increased by $1.1 million to $2.8 million for credits no longer under reserve as an unrecognized tax benefit subsequent to settlement of a California franchise tax audit. This valuation allowance will remain in place until such time as the Company determines it is able to either benefit from the credits, or they expire.

On September 25, 2014, management presented and the Board of Directors approved the Company’s strategic plan which included a plan to exit all of its Canadian stores as the leases expired and a withdrawal from the country. The Company's exit will have accounting, tax and legal implications. This triggered the Company’s evaluation of its ability to utilize its Canadian net deferred tax assets and to place a valuation allowance of $0.8 million gross against these assets. The Company will continue to evaluate these deferred tax assets on a quarterly basis.

Following is a summary of the change in valuation allowance (in thousands):



	2014		2013			2012
Valuation allowance—beginning of year	$	3,884	$	1,692		$	1,692
Valuation allowance increases	2,923		2,552			—
Valuation allowance reductions	—		(360		)	—
Valuation allowance—end of year	$	6,807	$	3,884		$	1,692

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states and cities, and Puerto Rico and Canada. The Company has substantially settled all federal income tax matters through 2010, state and local jurisdictions through 2009 and foreign jurisdictions through 2007. The Company could be subject to audits in these jurisdictions for the subsequent years.

Unrecognized tax benefits activity for the fiscal years ending is summarized below (in thousands):



	2014			2013			2012
Unrecognized tax benefit—beginning of year	$	2,476		$	2,553		$	2,623
Additions based on tax positions related to the current year	167			32			—
Additions for tax positions of prior years	218			22			—
Reductions for tax positions of prior years	—			—			(36		)
Settlements	(1,463		)	(65		)	—
Lapse of statutes of limitations	(305		)	(66		)	(34		)
Unrecognized tax benefit—end of year	$	1,093		$	2,476		$	2,553

Included in the balance of unrecognized tax benefits at January 3, 2015 and December 28, 2013 are $0.5 million and $0.6 million, respectively, of tax benefits that, if recognized, would affect the Company’s effective tax rate.

During the year, the Company released $1.5 million in uncertain tax positions related to the California Enterprise Zone tax credits through settlement of an audit. The rate effect of the release was largely offset by increase in the valuation allowance against the tax credits. In addition, the Company released $0.3 million of uncertain tax positions related to federal and state liabilities which expired under statute of limitations. Current year additions of $0.2 million relate to West Marine Puerto Rico (“WMPR”) for amounts deducted from current year taxable income for intercompany charges. Prior year additions of $0.2 million relate to WMPR for amounts deducted for intercompany charges on the 2013 tax return.

The Company recognizes accrued interest and penalties (not included in the table above) as a component of income tax expense. For each of the years ended January 3, 2015 and December 28, 2013, the Company recognized less than $0.1 million in interest and penalties. The accrued interest balance at January 3, 2015 and December 28, 2013 was $0.4 million and $0.3 million, respectively, and accrued penalties balance was $0.1 million and less than $0.1 million, respectively.