NOTE 6 - Income Taxes

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


	For the Years Ended
	June 30,
	2019		2018
Current income taxes:
Federal	$	310	$	567
State		141		37
		451		604
Deferred income tax provision		771		80
Provision for income taxes	$	1,222	$	684

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):


	2019				2018
			% of				% of
			Pre-tax				Pre-tax
	Amount		Income		Amount		Income
Tax at Federal statutory rate	$	2,822	21.0	%	$	2,296	27.6	%

Increases (decreases) in taxes resulting from:
Meals and entertainment		49	0.3	%		56	0.6	%
State income taxes, net of Federal income tax benefit		103	0.8	%		29	0.3	%
Foreign source income not subject to tax		(1,219)	(9.1)	%		(1,895)	(22.7)	%
R&D Credit		(408)	(3.0)	%		(314)	(3.8)	%
Transition tax		0	0.0	%		381	4.6	%
Foreign withholding tax		0	0.0	%		256	3.1	%
Release of accrued tax reserves		(151)	(1.1)	%		0	0	%
U.S. Federal Tax rate reduction		0	0.0	%		(136)	(1.6)	%
Audit Settlements		12	0.1	%		0	0	%
Other, net		14	0.1	%		11	0.1	%
Effective tax rate	$	1,222	9.1	%	$	684	8.2	%

Deferred tax assets and deferred tax liabilities at June 30, 2019 and 2018 are as follows (in thousands):


	Deferred Tax Assets (Liabilities)
	2019		2018
Accounts receivable	$	17	$	17
Inventories		246		437
Accrued liabilities		250		233
Stock based compensation expense		36		15
Intangibles		(502)		(324)
R&D credit		378		781
Property, plant and equipment		(407)		(339)
Revenue reserves		319		0
Other deferred tax liabilities		(409)		(256)
		(72)		564
Valuation allowance		—		—
Net deferred tax liabilities	$	(72)	$	564

The Company has identified the United States and New York State as its major tax jurisdictions. Fiscal 2016 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 Internal Revenue Service ("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 under Internal Revenue Code ("IRC") Section 956 arising from the intercompany balances on the books of the Company. The incremental tax liability associated with the income adjustment proposed by the IRS would be approximately $1.8 million, excluding any interest and penalties. In August 2019 the Company filed a formal protest with the IRS requesting an opportunity to appeal the examination findings to the Appeals Office. The Company believes that the position of the IRS with regard to this matter is inconsistent with the provisions of IRC Section 956 and management believes that the Company will prevail, and that the tax originally paid in fiscal 2016 is correct, as such no additional reserve for this tax uncertainty has been recognized. However, there can be no assurance that this matter will ultimately be resolved in the Company's favor.

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 , release of uncertain tax positions for R &D tax credits 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 effective for 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 $442,000, which is payable over 8 years.

During the year ending June 30, 2019 the Company decreased its reserve for uncertain income tax positions by $96,000. 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, 2019, the Company had accrued interest totaling $0 and $125,000 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, 2017	$	183	$	—	$	183

Increases to unrecognized tax benefits resulting from the generation of additional R&D credits		38		—		38

Balance of gross unrecognized tax benefits as of June 30, 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

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, 2019 the Company had approximately $31.3 million of undistributed earnings of foreign subsidiaries.