13. Income Taxes

Effective Income Tax Rate

We recorded income tax expense of $3.2 million, or 37.8% of income before income taxes, for the three month period ended July 31, 2016, compared to income tax expense of $2.7 million, or 36.5% of income before income taxes, for the three month period ended August 2, 2015. Our effective income tax rates for the three month periods ended July 31, 2016, and August 2, 2015, were based upon the estimated effective income tax rate applicable for the full year after giving effect to any significant items related specifically to interim periods. The effective income tax rate can be affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and foreign sources versus annual projections and changes in foreign currency exchange rates in relation to the U.S. dollar.

The following schedule summarizes the factors that are attributable to the difference between income tax expense at the federal income tax rate and the effective income tax rate reflected in the consolidated financial statements:

	2017			2016
federal income tax rate		34.0	%		34.0	%
U.S state income tax expense		1.4			0.8
tax effects of Chinese foreign exchange gains		1.1			0.4
increase in liability for uncertain tax positions		0.5			0.3
other		0.8			1.0
		37.8	%		36.5	%

Deferred Income Taxes

Valuation Allowance

In accordance with ASC Topic 740, we evaluate our deferred income taxes to determine if a valuation allowance is required. ASC Topic 740 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more-likely-than-not” standard, with significant weight being given to evidence that can be objectively verified. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, taking into account the effects of local tax law. Based on our assessment at July 31, 2016, we recorded a partial valuation allowance of $625,000, of which $539,000 pertained to certain U.S. state net operating loss carryforwards and credits and $86,000 pertained to loss carryfowards associated with our Culp Europe operation located in Poland. Based on our assessment at August 2, 2015, we recorded a partial valuation allowance of $926,000, of which $561,000 pertained to certain U.S. state net operating loss carryforwards and credits and $365,000 pertained to loss carryfowards associated with our Culp Europe operation located in Poland. Based on our assessment at May 1, 2016, we recorded a partial valuation allowance of $590,000, of which $518,000 pertained to certain U.S. state net operating loss carryforwards and credits and $72,000 pertained to loss carryfowards associated with our Culp Europe operation located in Poland.

No valuation allowance was recorded against our net deferred tax assets associated with our operations located in China and Canada at July 31, 2016, August 2, 2015, and May 1, 2016, respectively.

The recorded valuation allowance of $625,000 at July 31, 2016, has no effect on our operations, loan covenant compliance, or the possible realization of certain U.S. state net operating loss carryforwards and credits and our loss carryforwards associated with our Culp Europe operation located in Poland. If it is determined that it is more-likely-than-not that we will realize any of these deferred tax assets, an income tax benefit will be recognized at that time.

Undistributed Earnings

In accordance with ASC Topic 740, we assess whether the undistributed earnings from our foreign subsidiaries will be reinvested indefinitely or eventually distributed to our U.S. parent company. ASC Topic 740 requires that a deferred tax liability should be recorded for undistributed earnings from foreign subsidiaries that will not be reinvested indefinitely. Based on our assessment as of July 31, 2016, it is our intention not to permanently invest our undistributed earnings from our foreign subsidiaries. Also, we assess the recognition of U.S. foreign income tax credits associated with foreign withholding and income tax payments and whether it is more-likely-than-not that our foreign income tax credits will not be realized. If it is determined that any foreign income tax credits need to be recognized or it is more-likely-than-not our foreign income tax credits will not be realized, an adjustment to our provision for income taxes will be recognized at that time.

At July 31, 2016, we had accumulated earnings and profits from our foreign subsidiaries totaling $134.7 million. At the same date, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $431,000, which included U.S. income and foreign withholding taxes totaling $39.8 million, offset by U.S. foreign income tax credits of $39.4 million.

At August 2, 2015, we had accumulated earnings and profits from our foreign subsidiaries totaling $88.6 million. At the same date, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $2.0 million, which included U.S. income and foreign withholding taxes totaling $33.8 million, offset by U.S. foreign income tax credits of $31.8 million.

At May 1, 2016, we had accumulated earnings and profits from our foreign subsidiaries totaling $129.6 million. At the same date, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $604,000, which included U.S. income and foreign withholding taxes totaling $38.5 million, offset by U.S. foreign income tax credits of $37.9 million.

Overall

At July 31, 2016, our non-current deferred tax asset of $1.9 million represents $1.4 million and $561,000 from our operations located in the U.S. and China, respectively. At August 2, 2015, our non-current deferred tax asset of $4.4 million represents $3.5 million and $914,000 from our operations located in the U.S. and China, respectively. At May 1, 2016, our non-current deferred tax asset of $2.3 million represents $1.7 million and $572,000 from our operations located in the U.S. and China, respectively.

Our non-current deferred tax liability balances of $1.5 million, $1.1 million, and $1.5 million at July 31, 2016, August 2, 2015, and May 1, 2016, respectively, pertain to our operations located in Canada.

Uncertainty In Income Taxes

At July 31, 2016, we had a $15.0 million total gross unrecognized tax benefit, of which $3.8 million represents the amount of gross unrecognized tax benefits that, if recognized, would favorably affect the income tax rate in future periods. At August 2, 2015, we had a $14.2 million total gross unrecognized tax benefit, of which $3.6 million represents the amount of gross unrecognized tax benefits that, if recognized, would favorably affect the income tax rate in future periods. At May 1, 2016, we had a $14.9 million total gross unrecognized tax benefit, of which $3.8 million represents the amount of gross unrecognized tax benefits that, if recognized, would favorably affect the income tax rate in future periods.

At July 31, 2016, we had a $15.0 million total gross unrecognized tax benefit, of which $11.2 million and $3.8 million were classified as non-current deferred income taxes and income taxes payable – long-term, respectively, in the accompanying consolidated balance sheets. At August 2, 2015, we had a $14.2 million total gross unrecognized tax benefit, of which $10.6 million and $3.6 million were classified as non-current deferred income taxes and income taxes payable – long-term, respectively, in the accompanying consolidated balance sheets. At May 1, 2016, we had $14.9 million of total gross unrecognized tax benefit, of which $11.1 million and $3.8 million were classified as non-current deferred income taxes and income taxes payable – long-term, respectively, in the accompanying consolidated balance sheets.

We estimate that the amount of gross unrecognized tax benefits will increase by approximately $868,000 for fiscal 2017. This increase primarily relates to double taxation under applicable tax treaties with foreign tax jurisdictions.