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Income Taxes | 12 Months Ended
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Dec. 31, 2017
Income Taxes | Note 13—Income Taxes The Company does not file a consolidated return with its foreign subsidiaries. The Company files federal and state returns and its foreign subsidiaries file returns in their respective jurisdiction. For the years ended 2015, 2016 and 2017, the provision for income taxes, which included federal, state and foreign income taxes, was an expense of $3.4 million, $4.1 million, and $1.6 million reflecting effective tax provision rates of 12.9%, 76.8%, and (2.0%) respectively. For the years ended 2015 and 2016, provision for income taxes includes federal, state and foreign income taxes at effective tax rates of 12.9% and 76.8%. Exclusive of discrete items, the effective tax provision rate would be 9.5% in 2015 and 79.2% in 2016. The increase in the effective rate absent discrete items was primarily due to the foreign deemed dividend. The rate exclusive of discrete items can be materially impacted by the proportion of Hong Kong earnings to consolidated earnings. The 2017 tax expense of $1.6 million included a discrete tax benefit of $0.1 million primarily comprised of the US federal transition tax, return to provision and uncertain tax position adjustments. Absent these discrete tax expenses, the Company’s effective tax rate for 2017 was (2.8%), primarily due to various state taxes and taxes on foreign income. For years ended 2016 and 2017, the Company had net deferred tax liabilities of approximately $2.0 million and $0.8 million, respectively, primarily related to foreign jurisdictions. Provision for income taxes reflected in the accompanying consolidated statements of operations are comprised of the following (in thousands):
|  | 2015 |  |  | 2016 |  |  | 2017 |
Federal |  | $ | — |  |  | $ | 1,549 |  |  | $ | 550 |
State and local |  |  | 708 |  |  |  | 652 |  |  |  | 51 |
Foreign |  |  | 3,044 |  |  |  | 1,637 |  |  |  | 2,256 |
Total Current |  |  | 3,752 |  |  |  | 3,838 |  |  |  | 2,857 |
APIC |  |  | — |  |  |  | 548 |  |  |  | — |
Deferred |  |  | (329 | ) |  |  | (259 | ) |  |  | (1,251 | )
Total |  | $ | 3,423 |  |  | $ | 4,127 |  |  | $ | 1,606 |
The components of deferred tax assets/(liabilities) are as follows (in thousands):
|  | 2016 |  |  | 2017 |
Net deferred tax assets/(liabilities): |  |  |  |  |  |
Reserve for sales allowances and possible losses |  | $ | 801 |  |  | $ | 611 |
Accrued expenses |  |  | 1,739 |  |  |  | 1,375 |
Prepaid royalties |  |  | 16,806 |  |  |  | 13,631 |
Accrued royalties |  |  | 2,638 |  |  |  | 1,864 |
Inventory |  |  | 3,506 |  |  |  | 6,146 |
State income taxes |  |  | 98 |  |  |  | 26 |
Property and equipment |  |  | 4,997 |  |  |  | 4,257 |
Original issue discount interest |  |  | (6,945 | ) |  |  | (2,131 | )
Goodwill and intangibles |  |  | 29,378 |  |  |  | 15,782 |
Share based compensation |  |  | 1,607 |  |  |  | 578 |
Undistributed foreign earnings |  |  | (48,731 | ) |  |  | (2,524 | )
Federal and state net operating loss carryforwards |  |  | 22,755 |  |  |  | 14,091 |
Credit carryforwards |  |  | 21,097 |  |  |  | 35,195 |
Other |  |  | (2,495 | ) |  |  | 22 |
Gross |  |  | 47,251 |  |  |  | 88,923 |
Valuation allowance |  |  | (49,285 | ) |  |  | (89,706 | )
Total net deferred tax liabilities |  | $ | (2,034 | ) |  | $ | (783 | )
The U.S. Tax Cuts and Jobs Act (the Act) was signed into law on December 22, 2017 and introduces significant changes to the Internal Revenue Code. Effective for tax years beginning after December 31, 2017, the Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings and related-party payments, which are referred to as the global intangible low-taxed income and the base erosion and anti-abuse tax, respectively. In addition, the Act includes a one-time transition tax as of December 31, 2017 on accumulated foreign subsidiary earnings that were previously tax deferred. Due to the timing of the enactment and the complexity involved in applying the provisions of the Act, the SEC issued guidance on December 22, 2017 to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Act. In accordance with this guidance, we have made reasonable estimates below of the effects of the Act and recorded provisional amounts in our financial statements as of December 31, 2017. For the items for which we determined a reasonable estimate, we recognized a provisional amount of $34.3 million, which is included as a component of income tax expense from continuing operations and partially reduced by fully-valued tax attribute carryforwards. As we collect and prepare necessary data, and interpret the Act and any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes and effective tax rate in the period in which the adjustments are made. The accounting for the tax effects of the Act will be completed in 2018. Provisional amounts for the following income tax effects of the Tax Act have been recorded as of December 31, 2017 and are subject to change during 2018. The Act requires the Company to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. Given that the transition tax analysis requires significant data from our foreign subsidiaries that is not regularly collected or analyzed, we recorded a provisional amount for the one-time transitional tax liability for our foreign subsidiaries of approximately $35.1 million, which does not entirely impact income tax expense for 2017 since the Company has reflected the transition tax liability as a partial reduction to existing fully-valued tax attribute carryforwards. Additional work is necessary for a more detailed analysis of the Company’s deferred tax assets and liabilities and its historical foreign earnings as well as potential correlative adjustments. Any subsequent adjustment to the amount will be recorded in the quarter of 2018 when the analysis is complete, but is not anticipated to significantly impact tax expense due to the existence of the aforementioned fully-valued tax attribute carryforwards. The Act reduces the U.S. statutory tax rate from 35% to 21% for tax years after December 31, 2017. Accordingly, we have re-measured our deferred taxes as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. The provisional amount related to the re-measurement was which was fully offset by a concurrent change in the valuation allowance, resulting in no tax expense impact. Although the tax rate reduction is known, we have not collected the necessary data to complete our analysis of the effect of the Act on the underlying deferred taxes and as such, the amounts recorded as of December 31, 2017 are provisional. The Act repeals the Alternative Minimum Tax (AMT) for tax years beginning after 2017. However, AMT credits are fully refundable by tax years beginning after 2021. We have $0.8 million of deferred tax assets related to the AMT credit carryforwards. Given that these credits are now fully realizable, we have released the corresponding valuation allowance against these deferred tax assets and recognized the income tax benefit. We will continue to classify AMT credits along with our other deferred tax assets. The Act includes new anti-deferral, anti-base erosion, and base broadening provisions. Given the complexity of these provisions, we are still evaluating the effects and impact of these provisions. Provision for income taxes varies from the U.S. federal statutory rate. The following reconciliation shows the significant differences in the tax at statutory and effective rates:
|  | 2015 |  | 2016 |  | 2017
Federal income tax expense |  |  | 35.0 | % |  |  | 35.0 | % |  |  | 35.0 | %
State income tax expense, net of federal tax effect |  |  | 1.0 |  |  |  | (3.6 | ) |  |  | 5.0 |
Effect of differences in U.S. and foreign statutory rates |  |  | (9.4 | ) |  |  | (53.7 | ) |  |  | 1.9 |
Uncertain tax positions |  |  | 0.3 |  |  |  | 3.4 |  |  |  | ― |
Earn-out adjustments |  |  | (7.4 | ) |  |  | ― |  |  |  | ― |
Provision to return |  |  | 12.2 |  |  |  | 4.5 |  |  |  | (0.7) |
Non-deductible expenses |  |  | 1.1 |  |  |  | 8.9 |  |  |  | (48.0) |
Other |  |  | 0.5 |  |  |  | 0.6 |  |  |  | (0.2) |
Foreign deemed dividend |  |  | 1.7 |  |  |  | 262.2 |  |  |  | ― |
Foreign tax credit |  |  | (0.5 | ) |  |  | (126.1 | ) |  |  | 20.3 |
Undistributed foreign earnings |  |  | ― |  |  |  | 906.5 |  |  |  | 57.3 |
Effect of change in federal statutory rate |  |  | ― |  |  |  | ― |  |  |  | (23.0) |
Valuation allowance |  |  | (21.6 | ) |  |  | (960.9 | ) |  |  | (49.6 | )
|  |  | 12.9 | % |  |  | 76.8 | % |  |  | (2.0) | %
Deferred taxes result from temporary differences between tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. The temporary differences result from costs required to be capitalized for tax purposes by the U.S. Internal Revenue Code (“IRC”), and certain items accrued for financial reporting purposes in the year incurred but not deductible for tax purposes until paid. The Company has established a valuation allowance on net deferred tax assets in the United States since, in the opinion of management, it is not more likely than not that the U.S. net deferred tax assets will be realized. The components of income (loss) before provision for income taxes are as follows (in thousands):
|  | 2015 |  |  | 2016 |  |  | 2017 |
Domestic |  | $ | 11,692 |  |  | $ | (7,760 | ) |  | $ | (85,288 | )
Foreign |  |  | 14,901 |  |  |  | 13,136 |  |  |  | 3,866 |
|  | $ | 26,593 |  |  | $ | 5,376 |  |  | $ | (81,422 | )
The Company uses a recognition threshold and measurement process for recording in the consolidated financial statements uncertain tax positions (“UTP”) taken or expected to be taken in a tax return. $1.1 million of the liability for UTP related to state taxes and audit examination in Hong Kong was de-recognized in 2017. Additionally, approximately $66,300 of UTP related to state taxes was recognized in 2017. During 2016, approximately $49,700 of additional UTP was recognized. Current interest on uncertain income tax liabilities is recognized as interest expense and penalties are recognized in selling, general and administrative expenses in the consolidated statement of operations. During 2015, the Company did not recognize any current year interest expense relating to UTPs. During 2016, the Company recognized $67,900 of current interest expense relating to UTPs. During 2017, the Company did not recognize any current year interest expense relating to UTPs. The following table provides further information of UTPs that would affect the effective tax rate, if recognized, as of December 31, 2017 (in millions):
Balance, January 1, 2015 |  | $ | 2.5 |
Current year additions |  |  | 1.8 |
Current year reduction due to lapse of applicable statute of limitations |  |  | (2.1 | )
Balance, December 31, 2015 |  |  | 2.2 |
Current year additions |  |  | 0.1 |
Current year reduction due to lapse of applicable statute of limitations |  |  | — |
Balance, December 31, 2016 |  |  | 2.3 |
Current year additions |  |  | 0.1 |
Current year reduction due to audit settlement |  |  | (1.1 | )
Balance, December 31, 2017 |  | $ | 1.3 |
We do not expect our gross unrecognized tax benefits to significantly change within the next 12 months. Tax years 2014 through 2016 remain subject to examination in the United States. The tax years 2013 through 2016 are generally still subject to examination in the various states. The tax years 2011 through 2016 are still subject to examination in Hong Kong. In the normal course of business, the Company is audited by federal, state and foreign tax authorities. The U.S. Internal Revenue Service is currently examining the 2015 tax year. Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. The Company is required to establish a valuation allowance for the U.S. deferred tax assets and record a charge to income if Management determines, based upon available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets may not be realized. Based on our evaluation of all positive and negative evidence, as of December 31, 2017, a valuation allowance of $89.7 million has been recorded against the deferred tax assets that more likely than not will not be realized. For the year ended December 31, 2017, the valuation allowance increased by $40.4 million from $49.3 million at December 31, 2016 to $89.7 million at December 31, 2017. The net deferred tax liabilities of $2.0 million in 2016 represent the net deferred tax liabilities in the foreign jurisdiction, where the Company is in a cumulative income position. The net deferred tax liabilities of $0.8 million in 2017 represent the net deferred tax liabilities in the foreign jurisdiction, where the Company is in a cumulative income position, partially offset by the U.S. deferred tax assets related to the AMT credit carryforwards. At December 31, 2017, the Company had no remaining U.S. federal net operating loss carryforwards, or "NOLs", as they were fully utilized in 2017. At December 31, 2017, the Company's state NOLs were mainly from California. The majority of the approximately $164.4 million of California NOLs will begin to expire in 2031. At December 31, 2017, the Company had foreign tax credit carryforwards of approximately $34.1 million, which will begin to expire in 2022. At December 31, 2017, the Company had federal research and development tax credit carryforwards ("credit carryforwards") of approximately $0.2 million, which will begin to expire in 2029. At December 31, 2017, the Company had state research and development tax credits of approximately $0.1 million, which carry forward indefinitely. At December 31, 2017, the Company had AMT credit carryforwards of approximately $0.8 million, which carry forward indefinitely. Utilization of certain NOLs and research credit carryforwards may be subject to an annual limitation due to ownership change limitations set forth in Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, and comparable state income tax laws. Any future annual limitation may result in the expiration of NOLs and credit carryforwards before utilization. During the first quarter of 2017, the Company adopted ASU 2016-09, “Improvement to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for share-based payments, including treatment of excess tax benefits and forfeitures, as well as consideration of minimum statutory tax withholding requirements. This accounting standard did not have a material effect on the Company’s income tax provision in 2017.

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- Definition The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information. + References Reference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 740 -URI http://asc.fasb.org/topic&trid=2144680 + Details
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