INCOME TAXES

Overview

For the year ended December 31, 2013, the Company recorded a benefit for income taxes from continuing operations of $3,305,000 compared to a benefit of $2,027,000 in 2012 and a provision of $162,000 in 2011. The provision (benefit) for income taxes of continuing operations is composed of the following components:



	Year Ended December 31,
	2013			2012			2011
Current provision (benefit) :
Federal	$	(61,000	)	$	(349,000	)	$	55,000
State	23,000			13,000			171,000
	(38,000		)	(336,000		)	226,000
Deferred provision (benefit):
Federal	(3,467,000		)	(1,450,000		)	(76,000		)
State	200,000			(241,000		)	12,000
	(3,267,000		)	(1,691,000		)	(64,000		)
Provision (benefit) for income taxes of continuing operations
	$	(3,305,000	)	$	(2,027,000	)	$	162,000

A reconciliation of taxes computed at statutory income tax rates on income (loss) from continuing operations is as follows:



	Year Ended December 31,
	2013			2012			2011
Provision (benefit) for federal income taxes at statutory rates	$	(2,986,000	)	$	(1,967,000	)	$	277,000
Provision (benefit) for state income taxes, net of federal benefit	(147,000		)	(175,000		)	128,000
Resolution with tax authorities	—			—			(79,000		)
Valuation allowance changes affecting the provision for income taxes	448,000			(7,000		)	(8,000		)
Employment tax credits	(1,124,000		)	(130,000		)	(1,000,000		)
Nondeductible expenses	334,000			254,000			437,000
Stock based compensation expense	9,000			13,000			410,000
Other	161,000			(15,000		)	(3,000		)
Provision (benefit) for income taxes of continuing operations	$	(3,305,000	)	$	(2,027,000	)	$	162,000

Deferred Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets are reduced by a valuation allowance if, based upon the weight of available evidence, it is more likely than not that we will realize only some portion of the deferred tax assets. The net deferred tax assets and liabilities, at the respective income tax rates, are as follows:



	December 31,
	2013			2012
Current deferred tax assets:
Credit carryforwards	$	—		$	251,000
Net operating loss and other carryforwards	643,000			352,000
Allowance for doubtful accounts	1,788,000			1,447,000
Accrued liabilities	5,126,000			4,236,000
	7,557,000			6,286,000
Less valuation allowance	(377,000		)	(242,000		)
	7,180,000			6,044,000
Current deferred tax liabilities:
Prepaid expenses	(601,000		)	(739,000		)
	$	6,579,000		$	5,305,000



	December 31,
	2013			2012
Noncurrent deferred tax assets:
Net operating loss and other carryforwards	$	3,389,000		$	1,365,000
Credit carryforwards	2,210,000			964,000
Deferred lease costs	289,000			356,000
Depreciation	(634,000		)	(2,036,000		)
Tax goodwill and intangibles	(879,000		)	(739,000		)
Stock-based compensation	882,000			1,238,000
Accrued rent	4,219,000			4,538,000
Kansas acquisition costs	125,000			—
Impairment of long-lived assets	472,000			659,000
Interest rate swap	349,000			564,000
Noncurrent self-insurance liabilities	6,422,000			6,062,000
	16,844,000			12,971,000
Less valuation allowance	(932,000		)	(619,000		)
	$	15,912,000		$	12,352,000

Deferred Tax Valuation Allowance

The assessment of the amount of value assigned to our deferred tax assets under the applicable accounting standards is highly judgmental. We are required to consider all available positive and negative evidence in evaluating the likelihood that we will be able to realize the benefit of our deferred tax assets in the future. Such evidence includes scheduled reversals of deferred tax assets and liabilities, projected future taxable income, tax-planning strategies, and the results of recent operations. Since this evaluation requires consideration of historical and future events, there is significant judgment involved, and our conclusion could be materially different should certain of our expectations not transpire.

When assessing all available evidence, we consider the weight of the evidence, both positive and negative, based on the objectivity of the underlying evidence and the extent to which it can be verified. For the three-year period ended December 31, 2013, the Company has a cumulative pre-tax loss from continuing operations of $13,884,000, of which $8,782,000 is attributable to the year ended December 31, 2013. Additionally, the Company recognized governmental and regulatory changes have put downward revenue pressure on the long-term care industry as a piece of negative evidence in our analysis. As a result of this negative evidence, the Company performed a thorough assessment of the available positive and negative evidence in order to ascertain whether it is more-likely-than-not that in future periods the Company will generate sufficient pre-tax income to utilize all of our federal deferred tax assets and our net operating loss and other carryforwards and credits. State deferred tax assets are considered for valuation separately and on a state-by-state basis.

The Company also identified several pieces of objective positive evidence which were considered and weighed in the analysis performed regarding the valuation of deferred tax assets, including, but not limited to the degree to which nonrecurring expenses caused the last three year cumulative pre-tax loss, the expected accretive strategic acquisitions completed by us during 2012 and 2013, corporate and regional restructuring expected to reduce costs while maintaining revenue levels, our results from operations for the fourth quarter of 2013, the long-term expiration dates of a majority of the net operating losses and credits, our history of not having carryforwards or credits expire unutilized, and the completed divestiture of the facilities in Arkansas in 2013. The operations in the state of Arkansas demonstrated a trend of growing losses in recent years primarily as a result of disproportionate amount of professional liability expense relative to the revenue contributed.

In performing the analysis, the Company contemplated utilization of the deferred tax assets under multiple scenarios. After consideration of these factors, the Company determined that it was more likely than not that future taxable income would be sufficient to realize substantially all of the recorded value of the Company's deferred tax assets for federal income tax purposes.

Realization of the deferred tax assets is not assured and future events could result in a change in judgment. If future events result in a conclusion that realization is no longer more likely than not to occur, the Company would be required to establish a valuation allowance on the deferred tax assets at that time, which would result in a charge to income tax expense and a potentially material decrease in net income in the period in which the factors change our judgment.

At December 31, 2013, the Company had $15,148,000 of net operating losses, which expire at various dates beginning in 2019 and continue through 2033. The use of a portion of these loss carryforwards is limited by change in ownership provisions of the Federal tax code to a maximum of approximately $10,282,000. The Company has reduced the deferred tax asset and the corresponding valuation allowances for net operating loss deductions permanently lost as a result of the change in ownership provisions.

With respect to state deferred tax assets, the Company recorded an additional valuation allowance of approximately $448,000 in 2013, primarily related to existing deferred tax assets for the state of Arkansas that will not be utilized as a result of our exit from the state as explained in Note 4. In 2012 and 2011, the Company recorded a deferred tax benefit to reverse approximately $7,000 and $8,000, respectively, of the valuation allowance on state deferred tax assets. The changes in valuation allowance were based on the Company's assessment of the realization of certain individual tax assets. The Company has recorded a total valuation allowance of approximately $1,309,000 at December 31, 2013 to reduce the deferred tax assets by the amount management believes is more likely than not to not be realized through the turnaround of existing temporary differences, future earnings, or a combination thereof.

During 2011, the Company recorded an estimated $400,000 in employment tax credits under the Hiring Incentives to Restore Employment (HIRE) Act which provided a one-time tax credit. In addition, under the Work Opportunity Tax Credit ("WOTC") program the Company recorded $1,124,000, $130,000 and $600,000 in Work Opportunity Tax Credits during 2013, 2012 and 2011, respectively. In January 2013, the American Taxpayer Relief Act of 2012 (Act) was signed into law. The Act retroactively reinstated the federal Work Opportunity Tax Credit for qualifying costs paid during 2012. Pursuant to ASC 740-10-25-47 the effect of changes in the tax laws including retroactive changes are recognized in the period the law was enacted. As a result of the retroactive treatment, the Company claimed the WOTC on its 2012 tax return, and the benefit of the credit was recognized in the financial statements during 2013. The remaining WOTC credit carryforwards expire at various dates beginning in 2030 and continue through 2033.

Unrecognized Tax Benefits and Liabilities

The Company follows the FASB's guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns evaluating the need to recognize or unrecognize uncertain tax positions. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	2013		2012			2011
Balance at the beginning of the period	$	—	$	86,000		$	84,000
Changes in tax positions for prior years	—		(86,000		)	2,000
Balance at the end of the period	$	—	$	—		$	86,000

The Company records the liabilities associated with our unrecognized tax benefits in “other current liabilities” on the consolidated balance sheet. The net change in the amount of unrecognized tax benefits during the years ended December 31, 2012 and 2011 was related primarily to the adjustment of the estimated liability. Further, the Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the consolidated statements of operations.

As of December 31, 2013, the Company has no open or pending audits underway by regulatory authorities.