Note 8—Income Taxes

The components of income before income taxes are as follows:


	Years Ended January 31,
	2012		2011
Domestic	$	2,485,615	$	1,772,680
Foreign		1,746,878		1,010,934

	$	4,232,493	$	2,783,614

The components of the provision for income taxes are as follows:


	Years Ended January 31,
	2012			2011
Current:
Federal	$	707,637		$	699,622
State		84,579			170,930
Foreign		516,312			(14,321	)

		1,308,528			856,231

Deferred:
Federal		(216,322	)		(191,938	)
State		(15,056	)		(27,024	)
Foreign		23,652			84,576

		(207,726	)		(134,386	)

	$	1,100,802		$	721,845

The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate (34%) to income before income taxes due to the following:


	Years Ended January 31,
	2012			2011
Income tax provision at statutory rate	$	1,439,048		$	946,428
State taxes, net of federal tax effect		77,330			201,992
Officers life insurance		(93,100	)		12,466
Change in valuation allowance		34,990			65,202
Change in reserves related to ASC 740 liability		60,957			(241,098	)
Meals and entertainment		41,063			59,580
Domestic product deduction		(78,135	)		(44,162	)
Share-based compensation		53,656			76,162
Tax-exempt income		(26,949	)		(21,983	)
Prior year tax filing true up adjustment		(156,615	)		(143,014	)
R&D credits		(175,059	)		(108,093	)
Other, net		(76,384	)		(81,635	)

	$	1,100,802		$	721,845

The components of deferred income tax expense arise from various temporary differences and relate to items included in the statement of operations. The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and liabilities are as follows:


	January 31,
	2012			2011
Deferred Tax Assets:
Inventory Reserves	$	1,692,247		$	1,507,591
Stock-Based Compensation		380,221			360,883
R&D Credits		279,938			244,948
Vacation Accrual		355,046			400,343
Deferred Service Contract Revenue		239,503			300,844
Reserve for Doubtful Accounts		150,555			190,578
Other		806,987			554,397

		3,904,497			3,559,584
Deferred Tax Liabilities:
Accumulated Tax Depreciation in Excess of Book Depreciation		911,255			980,925
Deferred Tax Gain on Sale of Real Estate		1,235,098			1,235,098
Intangibles/Amortization		465,906			420,182
Currency Translation Adjustment		155,392			157,572
Other		132,434			4,111

		2,900,085			2,797,888

Subtotal		1,004,412			761,696
Valuation Allowance		(279,938	)		(244,948	)

Net Deferred Tax Assets	$	724,474		$	516,748

At January 31, 2012, we have state net operating loss carryforwards of $417,000, which can be used to offset future tax liabilities and expire at various dates beginning in fiscal 2015. At January 31, 2012 we have state research and development credit carryforwards of approximately $424,000, which can be used to offset future tax liabilities and expire at various dates beginning in fiscal 2012.

The valuation allowance at January 31, 2012 relates to certain state research and development tax credit carryforwards which are expected to expire unused. The change in the valuation allowance is approximately $35,000 and represents a reserve against the additional state research and development credits generated during the current year net of federal benefit.

The Company reasonably believes that it is possible that some unrecognized tax benefits, accrued interest and penalties could decrease income tax expense in the next year due to either the review of previously filed tax returns or the expiration of certain statutes of limitation. The Company estimates the reversal of the unrecognized tax benefit to be approximately $241,000, excluding interest and penalties. A reconciliation of unrecognized tax benefits, excluding interest and penalties follows:


	2012			2011
Balance at February 1	$	726,661		$	875,225
Increases in prior period tax positions		30,839			26,788
Increases in current period tax positions		78,571			72,140
Reductions related to lapse of statute of limitations		(56,528	)		(247,492	)

Balance at January 31	$	779,543		$	726,661

If the $779,543 is recognized, $443,337 would decrease the effective tax rate in the period in which each of the benefits is recognized and the remainder would be offset by a reversal of deferred tax assets.

During fiscal 2012 and 2011 the Company recognized $32,839 and $60,127, respectively, of potential interest and penalties, which are included as a component of income tax expense in the accompanying statement of operations. At January 31, 2012 and 2011, the Company had accrued potential interest and penalties of $453,000 and $420,000, respectively.

The Company and its subsidiaries file income tax returns in U.S. federal jurisdictions, various state jurisdictions, and various foreign jurisdictions. The Company is no longer subject to U.S. federal examinations prior to 2008.

At January 31, 2012, the Company has indefinitely reinvested $2,632,000 of the cumulative undistributed earnings of its foreign subsidiary in Germany, all of which would be subject to U.S. taxes if repatriated to the U.S. Through January 31, 2012, the Company has not provided deferred income taxes on the undistributed earnings of this subsidiary because such earnings are considered to be indefinitely reinvested. Non-U.S. income taxes are, however, provided on these undistributed earnings.