THE HACKETT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. Income Taxes

The Company files federal income tax returns, as well as multiple state, local and foreign jurisdiction tax returns. A number of years may elapse before an uncertain tax position is audited and finally resolved. While it is often difficult to predict the final outcome or the timing of resolution on any particular uncertain tax position, the Company believes that its reserves for income taxes reflect the most probable outcome. The Company adjusts these reserves, as well as the related interest, in light of changing facts and circumstances. The resolution of a matter would be recognized as an adjustment to the provision for income taxes and the effective tax rate in the period of resolution. The Company is no longer subject to examinations of its federal income tax returns by the Internal Revenue Service for years through 2013 and all significant state, local and foreign matters have been concluded for years through 2013. In the first quarter of 2017, the IRS commenced an examination of the Company’s U.S. income tax return for fiscal year 2014, which is still in progress.

The components of income before income taxes are as follows (in thousands):

	Year Ended
	December 29,		December 30,		January 1,
	2017		2016		2016
Domestic	$	22,038	$	28,611	$	16,249
Foreign		8,200		5,555		5,267
Income before income taxes	$	30,238	$	34,166	$	21,516

9. Income Taxes (continued)

The components of income tax expense (benefit) are as follows (in thousands):

	Year Ended
	December 29,			December 30,		January 1,
	2017			2016		2016
Current tax expense
Federal	$	3,231		$	8,969	$	2,042
State		445			1,065		463
Foreign		989			252		224
		4,665			10,286		2,729
Deferred tax expense (benefit)
Federal		(2,915	)		789		3,566
State		209			667		529
Foreign		925			883		883
		(1,781	)		2,339		4,978
Income tax expense	$	2,884		$	12,625	$	7,707

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

	Year Ended
	December 29,				December 30,				January 1,
	2017				2016				2016
U.S statutory income tax expense rate		35.0		%		35.0		%		35.0		%
State income taxes, net of federal income tax expense		1.4				3.3				3.0
Valuation reduction		(0.2	)			(0.7	)			(0.8	)
Tax reform impact on deferred taxes		(13.4	)			—				—
Meals and entertainment		0.9				0.8				1.2
Foreign rate differential		(3.7	)			(1.8	)			(3.1	)
Shared based compensation		(11.4	)			—				—
Foreign exchange loss		0.3				0.1				(0.2	)
Other, net		0.6				0.2				0.7
Effective tax rate		9.5		%		36.9		%		35.8		%

The components of the net deferred income tax asset (liability) are as follows (in thousands):

	Year Ended
	December 29,			December 30,
	2017			2016
Deferred income tax assets:
Allowance for doubtful accounts	$	582		$	978
Net operating loss and tax credits carryforward		2,311			2,182
Accrued expenses and other liabilities		4,257			4,089
		7,150			7,249
Valuation allowance		(984	)		(1,042	)
		6,166			6,207
Deferred income tax liabilities:
Depreciation		(4,787	)		(5,484	)
Tax over book amortization on goodwill and intangibles		(7,437	)		(10,789	)
Other items		(182	)		(150	)
		(12,406	)		(16,423	)
Net deferred income tax liability	$	(6,240	)	$	(10,216	)

9. Income Taxes (continued)

The 2017 Tax Cuts and Jobs Act (the “2017 Tax Act”) was signed into law on December 22, 2017. The 2017 Tax Act made a significant number of changes to existing U.S. Internal Revenue Code, including a permanent reduction of the U.S. corporate income tax rate from 35% to 21% for tax years beginning after December 31, 2017, and it also provides for a one-time transition tax on certain unremitted foreign earnings (the “Transition Tax”). As a result, the Company recorded a provisional income tax benefit of $4.0 million related to the re-measurement of deferred tax assets and liabilities resulting from the reduction of the federal corporate tax rate. The Company has performed a preliminary analysis of its post-1986 earnings and profits of its foreign subsidiaries and has estimated an overall accumulated net deficit, therefore no amounts have been recorded relative to the Transition Tax. In accordance with Staff Accounting Bulletin (“SAB”) No. 118, the Company will finalize the deferred tax and Transition Tax calculations during the allowed measurement period in 2018.

The SEC staff issued Staff Accounting Bulletin ("SAB") No. 118 in December. The SAB provides guidance on accounting for the tax effects of the 2017 Tax Act where uncertainty exists, it provides a measurement period that should not extend beyond one year from the 2017 Tax Act enactment date for companies to complete the related accounting under U.S. GAAP. In accordance with this guidance, the company has recorded provisional amounts for those specific income tax effects of the 2017 Tax Act for which a reasonable estimate could be determined.

As of December 29, 2017, the Company had $1.9 million of U.S. state net operating loss carryforwards. Additionally, at December 29, 2017, the Company had $3.7 million of foreign net operating loss carryforwards, of which $0.5 million related to operations in France and $0.8 million related to operations in Australia. A significant amount of the foreign net operating losses may be carried forward indefinitely.

The liability method of accounting for deferred income taxes requires a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. In determining the need for valuation allowances the Company considers evidence such as history of losses and general economic conditions. At December 29, 2017 and December 30, 2016, the Company had a valuation allowance of $1.0 million for both periods, to reduce deferred income tax assets primarily related to foreign and state net operating loss and tax credit carryforwards.

The undistributed earnings in foreign subsidiaries at December 31, 2017 was approximately $4.9 million. The company has historically reinvested its foreign earnings abroad indefinitely, and as a result no U.S. federal or state deferred income taxes have been provided on these earnings.

The 2017 Tax Act implements a territorial system, whereby certain foreign subsidiary earnings can be repatriated to the U.S with no federal tax. As a result, the company is still evaluating the impact of the 2017 Tax Act on its assertion to indefinitely reinvest the earnings from certain of its foreign jurisdictions and therefore continues to assert that such earnings will be indefinitely reinvested.

Penalties and tax-related interest expense are reported as a component of income tax expense. For the years ended December 29, 2017 and December 30, 2016, the total amount of accrued income tax-related interest and penalties was $256 thousand and $ 228 thousand, respectively.

The Company prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures.

The following table sets forth the detail and activity of the ASC 740-10 liability during the years ended December 29, 2017 and December 30, 2016 (in thousands):

	Year Ended
	December 29,		December 30,
	2017		2016
Beginning balance	$	738	$	712
Additions based on tax positions		28		26
Reduction for prior year tax deductions		—		—
Ending balance	$	766	$	738

9. Income Taxes (continued)

As of December 29, 2017 and December 30, 2016, the ASC 740-10, “Accounting for Uncertainty in Income Taxes”, liability of $0.8 million and $0.7 million, respectively, was classified as a current liability and included in accrued expenses and other liabilities in the accompanying consolidated balance sheets.

The Company does not believe there will be any material changes in its unrecognized tax positions over the next twelve months. The reversal of ASC 740-10 tax liabilities as of December 29, 2017 and December 30, 2016 would have a favorable impact on the effective tax rate in future period.