INCOME TAXES

Earnings from continuing operations before income tax expense was as follows for 2016, 2015 and 2014 (in thousands):



	2016		2015			2014
United States	$	10,907	$	7,346		$	2,939
Outside the United States	697		(52		)	1,065
Earnings from continuing operations before income tax expense	$	11,604	$	7,294		$	4,004

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



	2016			2015			2014
Current:
Federal	$	1,789		$	1,754		$	(1,125	)
State	529			(316		)	31
Foreign	544			368			296
Current taxes (benefit)	2,862			1,806			(798		)
Deferred:
Federal	1,784			672			1,200
State	542			117			511
Foreign	(119		)	179			1,143
Deferred taxes	2,207			968			2,854
Income tax expense	$	5,069		$	2,774		$	2,056

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



	2016		2015		2014
Statutory federal tax rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal tax benefit	4.4		4.5		5.6
Non-deductible permanent items	(0.5	)	(0.5	)	1.4
Change in valuation allowance	0.5		0.7		47.5
Uncertain tax positions	1.3		(1.6	)	(23.7	)
Impact of foreign operations	3.7		0.9		(3.7	)
Prior period true-up adjustments	(0.8	)	(1.0	)	(10.2	)
Other	0.1		—		(0.6	)
Effective tax rate	43.7	%	38.0	%	51.3	%

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):



	2016			2015
Assets:
Accrued payroll and benefits	$	5,828		$	6,431
Capitalized inventory costs	118			139
Accrued expenses	3,448			3,145
Intangible assets	664			1,333
Net operating losses and tax credits	7,733			8,210
Deferred rent	4,653			4,844
Vendor allowances	2,847			2,453
Other	2,608			2,583
Total deferred income tax assets	27,899			29,138
Valuation allowance	(6,024		)	(6,209		)
Deferred income taxes, net of valuation allowance	21,875			22,929
Liabilities:
Prepaid expenses	(1,899		)	(2,007		)
Property and equipment	(15,999		)	(14,257		)
Federal effect of state and foreign deferred items	(1,346		)	(1,512		)
Other liabilities	(1,032		)	(1,101		)
Total deferred tax liabilities	(20,276		)	(18,877		)
Net deferred income tax assets	$	1,599		$	4,052

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



	2016			2015
Non-current deferred income tax assets	$	3,862		$	4,321
Non-current deferred income tax liabilities	(2,263		)	(269		)
Net deferred tax assets	$	1,599		$	4,052

At year-end 2016, the Company had $11.6 million of state income tax net loss carryforwards that expire between 2022 and 2034. The Company also had foreign net loss carryforwards in the amount of $2.9 million that expire between 2028 and 2035. In addition, the Company had California state Enterprise Zone credits of $5.3 million available for use in the tax years 2016 through 2024, and South Carolina tax credits of $0.6 million available for use for tax years 2016 through 2018. These carryforwards are available to offset future taxable income.

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 against these credits until such time as the Company determines it is able to either benefit from the credits or they expire. The Company has also 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 Company maintains a valuation allowance against these state tax credits in the amount of $4.1 million. This valuation allowance will also remain in place until such time as the Company determines it is able to either benefit from the credits or they expire.

For 2016, the Company maintained a full valuation allowance of $1.4 million against its Canadian deferred tax assets. The Company expects to close its remaining two stores in Canada during 2017.

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



	2016			2015			2014
Valuation allowance—beginning of year	$	6,209		$	6,807		$	3,884
Valuation allowance increases	—			143			2,923
Valuation allowance reductions	(185		)	(741		)	—
Valuation allowance—end of year	$	6,024		$	6,209		$	6,807

West Marine 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 2012, state and local jurisdictions through 2011 and foreign jurisdictions through 2008. The Company could be subject to audits in these jurisdictions for subsequent years.

Unrecognized tax benefits activity is summarized below (in thousands):



	2016			2015			2014
Unrecognized tax benefit—beginning of year	$	862		$	1,093		$	2,476
Additions based on tax positions related to the current year	—			50			167
Additions for tax positions of prior years	—			31			218
Settlements	—			(22		)	(1,463		)
Lapse of statutes of limitations	(27		)	(290		)	(305		)
Unrecognized tax benefit—end of year	$	835		$	862		$	1,093

Included in the balance of unrecognized tax benefits at December 31, 2016 and January 2, 2016 are $0.4 million of tax benefits for each year that, if recognized, would affect the Company’s effective tax rate.

The Company recognizes accrued interest and penalties (not included in the table above) as a component of income tax expense. For the year ended December 31, 2016, the Company recognized an expense of $0.2 million related to accrued state and foreign interest. For each of the years ended January 2, 2016 and January 3, 2015, the Company recognized a benefit of less than $0.1 million in accrued interest. For all years ended December 31, 2016, January 2, 2016 and January 3, 2015, the Company recognized less than $0.1 million in penalties. The accrued interest balance at December 31, 2016 and January 2, 2016 was $0.6 million and $0.3 million, respectively, and the accrued penalties balance at the end of both years was $0.1 million.