NOTE 10 — Income Taxes

The provision for income taxes consisted of the following for the fiscal periods identified below (in thousands):


	Fiscal 2015		Fiscal 2014		Fiscal 2013
Current:
Federal tax expense (benefit)	$	—	$	(248)	$	107
State tax expense (benefit)		172		283		(112)
Current tax expense (benefit)		172		35		(5)
Deferred tax expense (benefit)		37,543		(37,937)		—
Income tax provision (benefit)	$	37,715	$	(37,902)	$	(5)

The following presents a reconciliation of income tax computed at the U.S. statutory rate to the effective income tax rate for the fiscal periods ended:


	January 30, 2016		January 31, 2015		February 1, 2014
Federal income tax at statutory rate	35.0	%	35.0	%	35.0	%
State income tax, net of federal benefit	3.1		4.6		0.4
Change in valuation allowance	(373.0)		(447.6)		(33.7)
Reserve for unrecognized tax benefits	(0.4)		0.6		(2.4)
Tax credits	4.8		—		—
Other	(1.0)		(3.4)		0.6
Effective income tax rate	(331.5)	%	(410.8)	%	(0.1)	%

Deferred income taxes are provided for temporary differences between the basis of assets and liabilities for financial reporting purposes and income tax purposes. Deferred tax assets and liabilities as of January 31, 2015, were classified as current and noncurrent on the basis of the classification of the related asset or liability for financial reporting. In November 2015, the FASB issued ASU 2015-17 “Income Taxes.” ASU 2015-17 requires that deferred income tax liabilities and assets be classified as non-current in a statement of financial position. The Company elected early adoption of this guidance for the fiscal year ended January 30, 2016, on a prospective basis. The adoption of this ASU allows the Company to simplify its presentation of deferred income tax liabilities and assets. Prior periods were not retrospectively adjusted.

Significant components of the Company's deferred income tax assets and liabilities are as follows (in thousands):


	January 30, 2016		January 31, 2015
Deferred tax assets:
Accrued Friendship Rewards loyalty liability	$	1,202	$	1,180
Accrued gift card liability		464		298
Merchandise inventories		1,557		1,291
Deferred rent and deferred lease incentives		7,991		6,426
Stock-based compensation expense		2,535		2,152
Net operating loss carryforwards		29,854		24,875
Contribution carryforwards		207		159
Tax credit carryforwards		1,276		706
Depreciation and amortization		—		46
Other accrued liabilities		1,440		1,257
Total deferred tax assets		46,526		38,390
Less: Valuation allowance		(42,021)		(28)
Deferred tax assets, net of valuation allowance		4,505		38,362
Deferred tax liabilities:
Depreciation and amortization		(3,504)		—
Other		(608)		(424)
Total deferred tax liabilities		(4,112)		(424)
Net deferred tax assets	$	393	$	37,938

Deferred income tax assets represent potential future income tax benefits. Realization of these assets is ultimately dependent upon future taxable income. ASC 740 Income Taxes requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some or all of the recorded deferred tax assets will not be realized in a future period. Forming a conclusion that a valuation allowance is not needed is difficult when negative evidence such as cumulative losses exists. As a result of management's evaluation in fiscal 2011, a non-cash provision of $10.6 million was recognized to establish a valuation allowance against deferred tax assets as there was insufficient positive evidence to overcome the negative evidence related to the Company's cumulative losses. In the fourth quarter of fiscal 2014, the Company released the vast majority of the valuation allowance based on two consecutive years of profitability, three years of cumulative positive earnings achieved in the fourth quarter of fiscal 2014 and the Company’s forecast of continued profitability in fiscal 2015. A small valuation allowance was retained for state net operating loss carryforwards that may expire before they are utilized. The release of the valuation allowance resulted in a $41.3 million benefit to the income tax provision in fiscal 2014.

Management continued to monitor the realizability of the deferred tax assets in fiscal 2015. The release of the valuation allowance in fiscal 2014 assumed the Company would continue to generate future profits. The fiscal 2015 loss had an impact on the expected amount of the 36 month cumulative loss. Although management’s evaluation considered the effects of improved sales trends that may result in future taxable income, estimates such as these are inherently subjective. Without significant positive evidence to overcome the weight of possible future cumulative losses, the Company established a valuation allowance against its deferred tax assets in the fourth quarter of fiscal 2015. A non-cash provision of $37.5 million was recognized to establish the valuation allowance. A small deferred tax asset was allowed related to certain state tax benefits.

As of January 30, 2016, the Company has federal and state net operating loss carryforwards which will reduce future taxable income. Approximately $29.8 million in net federal tax benefits are available from these federal loss carryforwards of approximately $85.0 million, and an additional $1.3 million is available in net tax credit carryforwards. Included in the federal net operating loss is approximately $5.3 million of loss generated by deductions related to equity-based compensation, the tax effect of which will be recorded to additional paid in capital when utilized. The state loss carryforwards will result in net state tax benefits of approximately $2.1 million. The federal net operating loss carryovers will expire in October 2032 and beyond. The Company has analyzed equity ownership changes and determined its net operating losses will not be limited under IRC Section 382. The state net operating loss carryforwards will expire in November 2016 and beyond. Additionally, the Company has charitable contribution carryforwards that will expire in 2016 and beyond.

A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows (in thousands):


Balance at February 2, 2013	$	993
Additions based on tax positions related to the current year		152
Reductions for tax positions of previous years		(152)
Reductions for tax positions of previous years due to lapse of applicable statute of limitations		(236)
Balance at February 1, 2014		757
Additions based on tax positions related to the current year		180
Additions for tax positions of previous years		24
Reductions for tax positions of previous years due to lapse of applicable statute of limitations		(85)
Balance at January 31, 2015		876
Additions based on tax positions related to the current year		329
Additions for tax positions of previous years		16
Reductions for tax positions of previous years		(70)
Reductions for tax positions of previous years due to lapse of applicable statute of limitations		(42)
Balance at January 30, 2016	$	1,109

The Company's liability for unrecognized tax benefits is recorded within other non-current liabilities. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate as of January 30, 2016 and January 31, 2015 were $0.6 million and $0.6 million, respectively.

Interest and penalties related to unrecognized tax benefits of approximately $64 thousand, $53 thousand and $47 thousand were recognized as components of income tax expense in fiscal 2015, fiscal 2014 and fiscal 2013, respectively. At January 30, 2016 and January 31, 2015, approximately $0.2 million and $0.2 million, respectively, were accrued for the potential payment of interest and penalties.

The Company and its subsidiaries are subject to U.S. federal income taxes and the income tax obligations of various state and local jurisdictions. In April 2015, the Company settled the IRS examination of the fiscal 2011 tax year. The settlement was related to certain issues which the Company had previously reflected net of tax within deferred tax assets. The settlement did not result in any cash payments nor any impact to tax expense. The Company is currently under exam by the IRS for fiscal 2013. Periods after the fiscal 2012 transition period remain subject to examination by the Internal Revenue Service. With few exceptions, the Company is not subject to state income tax examination by tax authorities for taxable years prior to fiscal 2011. As of January 30, 2016, the Company had no other ongoing audits in various jurisdictions and does not expect the liability for unrecognized tax benefits to significantly increase or decrease in the next twelve months.