Note 6. Income Taxes

The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered, and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is “more likely than not” that some or all of the deferred tax assets will not be realized. Management has determined that other than deferred tax assets associated with certain state net operating losses and capital losses, net deferred tax assets will more likely than not be utilized. Therefore, a valuation allowance has been established against only those assets related to state net operating losses and capital losses.

During the three and six months ended February 28, 2018, the Company recorded an income tax provision of $571,000 and $1,317,000, respectively resulting in an effective tax rate of 30.2% and 34.4%, respectively. For the three and six months ended February 28, 2017, the Company recorded income tax provision of $459,000 and $861,000, respectively, resulting in an effective tax rate of 38.0% and 37.9%, respectively. The current period effective tax rate differs from the current statutory rate of 21% primarily due to the three and six months ended February 28, 2018 and 2017 extending into both calendar years 2017 and 2018, creating a blended tax rate. The difference is also contributed to the valuation allowance against certain deferred tax assets, state income tax expenses and permanent book to tax differences.

Accounting for uncertainty in income taxes prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. For the three and six months ended February 28, 2018, the Company did not have a liability for unrecognized tax benefit. The Company has elected to classify interest and penalties as a component of its income tax provision. For the three and six months ended February 28, 2018, the Company did not have a liability for penalties or interest. The Company does not expect any changes to its unrecognized tax benefit for the next twelve months that would materially impact its consolidated financial statements.

On December 22, 2017, the Tax Cuts and Jobs Act (the “Act”) was enacted. The Act reduces the US federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign sourced earnings. At February 28, 2018, we have not completed our accounting for the tax effects of enactment of the Act; however, in certain cases, as described below, we have made a reasonable estimate of the effects on our existing deferred tax balances. We have not been able to make a reasonable estimate for the one-time transition tax. and continue to account for those items based on our existing accounting under ASC 740, “Income Taxes”. For the items for which we were able to determine a reasonable estimate, we recognized a provisional amount of $141,591, which is included as a component of income tax expense from continuing operations.

Prior to the reporting period in which the Act was enacted, the Company did not recognize a deferred tax liability related to unremitted foreign earnings because it overcame the presumption of the repatriation of foreign earnings. Upon enactment, the Act imposes a tax on certain foreign earnings and profits at various tax rates. Based on the Company’s facts and circumstances, it was not able to determine a reasonable estimate of the tax liability for this item for the reporting period in which the Act was enacted by the time the financial statements for that reporting period were issued; that is, the Company did not have the necessary information available, prepared, or analyzed to develop a reasonable estimate of the tax liability for this item (or evaluate how the Act would impact the Company’s existing accounting position to indefinitely reinvest unremitted foreign earnings). As a result, the Company did not include a provisional amount for this item in its financial statements that were issued during the reporting period in which the Act was enacted, but would do so in its future financial statements issued for subsequent reporting periods, beginning with the first reporting period falling within the measurement period by which the necessary information became available, prepared, or analyzed in order to develop the reasonable estimate and ending with the first reporting period within the measurement period in which the Company was able to obtain, prepare, and analyze the necessary information to complete the accounting under ASC 740.