11. Income Taxes

Income Tax Expense

Income before income taxes consists of the following (in thousands):


	2014		2013		2012
Domestic	$	8,350	$	23,004	$	11,686
Foreign		353		288		366
Income before income taxes	$	8,703	$	23,292	$	12,052

Income tax expense consists of the following (in thousands):


	2014		2013		2012
Current:
Federal	$	898	$	6,304	$	2,778
State		211		396		180
Foreign		99		96		98
		1,208		6,796		3,056
Deferred:
Federal		127		1,142		1,274
State		46		(818)		(227)
Foreign		--		--		3
		173		324		1,050
Income tax expense	$	1,381	$	7,120	$	4,106

The Company’s income tax expense in 2014, 2013, and 2012 included the Company’s federal, state, and foreign tax obligations. The Company’s effective income tax rate was approximately 16%, 31%, and 34% for the years ended December 31, 2014, 2013, and 2012, respectively. The Company’s income tax rate for the twelve months ended December 31, 2014 was favorably affected by the reduction in uncertain tax positions, nontaxable gains recorded as change in stock basis of subsidiary, and favorable deductions taken on the Company’s 2013 federal tax return, which was filed in 2014. The Company’s income tax rate for the twelve months ended December 31, 2013 was favorably affected by adjustments to valuation allowances on certain of the Company’s state net operating loss carryforwards, based on revised estimates of utilization of these carryforwards, and by the 2012 research and development tax credit, which was enacted in January 2013 and, therefore, reduced the Company’s tax expense during 2013. The Company’s income tax rates for the twelve months ended December 31, 2012 were favorably affected by adjustments to valuation allowances on certain of the Company’s state net operating loss carryforwards, based on revised estimates of utilization of these carryforwards, and unfavorably affected by the tax treatment of certain acquisition related expenses due to the acquisition of Hemosphere and by the research and development tax credit, which had not been enacted during the 2012 tax year.

The income tax expense amounts differ from the amounts computed by applying the U.S. federal statutory income tax rate of 34% for the year ended December 31, 2014 and 35% for the years ended December 31, 2013 and 2012 to pretax income as a result of the following (in thousands):


	2014		2013		2012
Tax expense at statutory rate	$	2,959	$	8,152	$	4,220
Increase (reduction) in income taxes resulting from:
State income taxes, net of federal benefit		220		183		296
Non-deductible entertainment expenses		218		207		188
State valuation allowance adjustment		83		(760)		(427)
Foreign income taxes		69		96		(199)
Equity compensation		63		(29)		32
Non-deductible transaction costs		--		--		151
Net change in uncertain tax positions		(781)		104		(15)
Non-deductible change in stock basis of subsidiary		(641)		--		--
Domestic production activities deduction		(486)		(402)		(407)
Research and development credit		(221)		(392)		--
Other		(102)		(39)		267
	$	1,381	$	7,120	$	4,106

Deferred Taxes

The Company generates deferred tax assets primarily as a result of write-downs of inventory and deferred preservation costs; accruals for product and tissue processing liability claims; investment and asset impairments; and, in prior periods, due to operating losses. The Company acquired significant deferred tax assets, primarily net operating loss carryforwards, from its acquisitions of Hemosphere and Cardiogenesis in the second quarters of 2012 and 2011, respectively.

The tax effects of temporary differences which give rise to deferred tax assets and liabilities at December 31 are as follows (in thousands):


	2014		2013
Deferred tax assets:
Allowance for bad debts	$	853	$	131
Inventory and deferred preservation costs write-downs		873		1,077
Investment in equity securities		1,913		1,959
Property		2,934		2,737
Intangible assets		400		422
Accrued expenses		3,864		3,766
Loss carryforwards		14,141		15,689
Credit carryforwards		635		241
Stock compensation		2,367		2,409
Other		1,402		1,108
Less valuation allowance		(2,145)		(1,532)
Total deferred tax assets		27,237		28,007

Deferred tax liabilities:
Prepaid items		(420)		(451)
Intangible assets		(4,652)		(5,289)
Other		(296)		(220)
Total deferred tax liabilities		(5,368)		(5,960)

Total net deferred tax assets	$	21,869	$	22,047

As of December 31, 2014 the Company maintained a total of $2.1 million in valuation allowances against deferred tax assets, related to state net operating loss carryforwards, and a net deferred tax asset of $21.9 million. As of December 31, 2013 the Company maintained a total of $1.5 million in valuation allowances against deferred tax assets, related to state net operating loss carryforwards, and a net deferred tax asset of $22.0 million.

As of December 31, 2014 the Company had approximately $11.0 million tax-effected federal net operating loss carryforwards related to the acquisitions of Cardiogenesis and Hemosphere that will begin to expire in 2017, $3.1 million of tax-effected state net operating loss carryforwards that began to expire in 2014, $459,000 in research and development tax credit carryforwards that will begin to expire in 2022, and $158,000 in credits from the state of Texas that will fully expire by 2027.

Uncertain Tax Positions

A reconciliation of the beginning and ending balances of the Company’s uncertain tax position liability, excluding interest and penalties, is as follows (in thousands):


	2014		2013		2012
Beginning balance	$	2,100	$	2,004	$	1,788
Increases related to current year tax positions		92		281		231
Decreases related to prior year tax positions		(265)		(185)		(15)
Decreases due to the lapsing of statutes of limitations		(490)		--		--
Ending balance	$	1,437	$	2,100	$	2,004

A reconciliation of the beginning and ending balances of the Company’s liability for interest and penalties on uncertain tax positions is as follows (in thousands):


	2014		2013		2012
Beginning balance	$	422	$	489	$	418
Accrual of interest and penalties		91		66		79
Decreases related to prior year tax positions		(147)		(133)		(8)
Ending balance	$	366	$	422	$	489

As of December 31, 2014 the Company’s uncertain tax liability, including interest and penalties of $1.8 million, was recorded as a reduction to deferred tax assets of $108,000 and a non-current liability of $1.7 million on the Company’s Consolidated Balance Sheets, which is expected to impact the Company’s tax rate when recognized. The Company believes it is reasonably possible that approximately $940,000 of its uncertain tax liability will be recognized in 2015 due to the lapsing of various federal and state statutes of limitations. As of December 31, 2013 the Company’s total uncertain tax liability, including interest and penalties of $2.5 million, was recorded as a non-current liability on the Company’s Consolidated Balance Sheets.

Other

The Company’s tax years 2011 through 2013 generally remain open to examination by the major taxing jurisdictions to which the Company is subject. However, certain returns from years prior to 2011, in which net operating losses and tax credits have arisen, are still open for examination by the tax authorities.