NOTE 6 - Income Taxes

The provision for income taxes is comprised of the following (in thousands):


	For the Years Ended
	June 30,
	2020		2019
Current income taxes:
Federal	$	1,715	$	310
State		404		141
		2,119		451
Deferred income tax provision		165		771
Provision for income taxes	$	2,284	$	1,222

A reconciliation of the U.S. Federal statutory income tax rate to our actual effective tax rate on earnings before income taxes is as follows for the years ended June 30, (dollars in thousands):


	2020				2019
			% of				% of
			Pre-tax				Pre-tax
	Amount		Income		Amount		Income
Tax at Federal statutory rate	$	2,269	21.0	%	$	2,822	21.0	%

Increases (decreases) in taxes resulting from:
Meals and entertainment		44	0.4	%		49	0.3	%
State income taxes, net of Federal income tax benefit		112	1.0	%		103	0.8	%
Foreign source income not subject to tax		(1,213)	(11.2)	%		(1,219)	(9.1)	%
R&D Credit		(523)	(4.8)	%		(408)	(3.0)	%
Transition tax		0	0.0	%		0	0.0	%
Foreign withholding tax		0	0.0	%		0	0.0	%
Release of accrued tax reserves		0	0.0	%		(151)	(1.1)	%
Uncertain Tax Positions		775	7.1	%		0	0.0	%
IRS examination settlements		832	7.7	%		12	0.1	%
Other, net		(12)	(0.1)	%		14	0.1	%
Effective tax rate	$	2,284	21.1	%	$	1,222	9.1	%

Deferred tax assets and deferred tax liabilities at June 30, 2020 and 2019 are as follows (in thousands):


	Deferred Tax Assets (Liabilities)
	2020		2019
Accounts receivable	$	40	$	17
Inventories		374		246
Accrued liabilities		262		250
Stock based compensation expense		96		36
Intangibles		(300)		(502)
R&D credit		0		378
Property, plant and equipment		(484)		(407)
Revenue reserves		308		319
Other deferred tax liabilities		(408)		(409)
		(112)		(72)
Valuation allowance		—		—
Net deferred tax liabilities	$	(112)	$	(72)

The Company has identified the United States and New York State as its major tax jurisdictions. Fiscal year 2017 is currently under audit by the Internal Revenue Service ("IRS"). Fiscal year 2018 and forward years are still open for examination. In addition, the Company has a wholly-owned subsidiary which operates in a Free Zone in the Dominican Republic (“DR”) and is exempt from DR income tax.

The Company was audited by the IRS for the fiscal year 2016. In July 2019, the Company received Form 4549-A, Income Tax Examination Changes from the IRS proposing an adjustment to income for the fiscal 2016 tax year regarding deemed dividends based on its interpretation of Internal Revenue Code ("IRC") Section 956 arising from the intercompany balances on the books of the Company. In August 2019, the Company filed a formal protest with the IRS requesting an opportunity to appeal the examination findings to the Appeals Office. During fiscal year 2020, the Company settled the issue at Appeals. There is a provision recorded for the federal and state impact of $762,000 and $70,000, respectively.

The Company is currently under audit for the fiscal year 2017. The IRS has raised the IRC Section 956 issue that was settled during the fiscal year 2016 audit. The Company strongly believes that the position of the IRS with regard to this matter is inconsistent with the provisions of IRC Section 956 and that the Company is willing to go to court, if necessary to argue its position. During fiscal year 2020, the Company’s Provision for income taxes included a provision for the incremental tax liability of $657,000 and interest of $66,000 was recorded for the 2017 and 2018 fiscal years.

The provision for income taxes represents Federal, foreign, and state and local income taxes. The effective rate differs from statutory rates due to the effect of tax rates in foreign jurisdictions, state and local income taxes, tax benefit of R&D credits, certain nondeductible expenses, uncertain tax positions, audit settlements and global intangible low-taxed income ("GILTI").

On December 22, 2017, the U.S. government passed the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act is comprehensive tax legislation effective January 1, 2018 that implements complex changes to the U.S. tax code including, but not limited to, the reduction of the corporate tax rate from 35% to 21% and includes provisions to tax GILTI. We are subject to the GILTI provisions beginning with the fiscal year ended June 30, 2019. The Tax Act also imposed a one-time transition tax on its unremitted foreign earnings. ASC 740 requires filers to record the effects of tax law changes in the period enacted. However, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”), that permits filers to record provisional amounts during a measurement period ending no later than one year from the date of the Act’s enactment. As of March 31, 2019, the Company finalized its accounting for the income tax effects of the Tax Act and no additional expense was recorded since the final transition tax expense was equal to the $381,000 provisional expense reported in the fiscal year ended June 30, 2018. The net section 965 tax liability was $338,000, which is payable over 8 years.

During the year ending June 30, 2020 the Company increased its reserve for uncertain income tax positions by $824,000. The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense and accrued income taxes. As of June 30, 2020, the Company had accrued interest totaling $83,000 and $866,000 of unrecognized net tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in any future period. The Company does not expect that its unrecognized tax benefits will significantly change within the next twelve months. The Company claims R&D tax credits on eligible research and development expenditures. The R&D tax credits are recognized as a reduction to income tax expense.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):


	Tax		Interest		Total
Balance of gross unrecognized tax benefits as of July 1, 2018	$	221	$	—	$	221
Decrease to unrecognized tax benefits resulting from the release of R&D credits due to the IRS audit		(151)				(151)
Increases to unrecognized tax benefits resulting from the generation of additional R&D credits		55		—		55

Balance of gross unrecognized tax benefits as of June 30, 2019	$	125	$	—	$	125

Increase to unrecognized tax benefits resulting from deemed dividends for investments in US property		682		83		765

Increases to unrecognized tax benefits resulting from the generation of additional R&D credits		59		—		59

Balance of gross unrecognized tax benefits as of June 30, 2020	$	866	$	83	$	949

The Company plans to permanently reinvest a substantial portion of its foreign earnings and as such has not provided withholding tax on the permanently reinvested earnings. The Company has accrued $408,000 for withholding taxes on undistributed earnings that are not permanently reinvested. As of June 30, 2020 the Company had approximately $42.5 million of undistributed earnings of foreign subsidiaries.