2. INCOME TAXES

Income tax expense for the years ended December 31, 2012 and 2011 consists of the following:

	2012		2011
Current:
Federal	$	319,000	$	162,000
State	2,000		3,000
	321,000		165,000
Deferred	30,000		180,000
	$	351,000	$	345,000

The expected provision for income taxes, computed by applying the U.S. federal income tax rate of 35% in 2012 and 2011 to income before taxes, is reconciled to income tax expense as follows:

	2012			2011

Expected provision for federal income taxes	$	365,700		$	365,100
State income taxes, net of federal benefit	(400		)	2,200
Domestic manufacturers deduction	(31,800		)	(18,600		)
Non-deductible meals, entertainment, and life insurance	20,800			20,700
Research and development credit	—			(15,900		)
Other	(3,300		)	(8,500		)
	$	351,000		$	345,000

Net deferred tax liabilities consist of the following as of December 31, 2012 and 2011:

	2012			2011

Deferred tax assets:
Accrued vacation	$	25,000		$	23,000
Inventories	101,000			107,000
Allowance for doubtful accounts	5,000			8,000
Allowance for sales returns	11,000			10,000
Capital loss carryforward	323,000			323,000
Less valuation allowance	(323,000		)	(323,000		)
	142,000			148,000
Deferred tax liabilities:
Property and equipment and other assets	(324,000		)	(305,000		)
Prepaid expenses	—			(4,000		)
Intangible assets	(42,000		)	(33,000		)
Net deferred tax liabilities	$	(224,000	)	$	(194,000	)

The deferred tax amounts described above have been included in the accompanying balance sheet as of December 31, 2012 and 2011 as follows:

	2012			2011

Current assets	$	142,000		$	144,000
Noncurrent liabilities	(366,000		)	(338,000		)

	$	(224,000	)	$	(194,000	)

At December 31, 2012 and 2011, the Company established a valuation allowance against its deferred tax asset related to the Company’s $919,000 loss on its investment in non-marketable equity securities since it is more likely that the deferred tax asset will not be realized. The deferred tax asset and valuation allowance at December 31, 2012 and December 31, 2011 was $323,000. As of December 31, 2012 the capital loss can be carried forward two years and must be offset by a capital gain.

It has been the Company’s policy to recognize interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2012 and 2011, there was no liability for unrecognized tax benefits.

The Company is subject to federal and state taxation. The material jurisdictions that are subject to examination by tax authorities primarily include Minnesota and the United States, for tax years 2009, 2010, 2011 and 2012.