11. Income Taxes

We consider all income sources, including other comprehensive income, in determining the amount of tax expense allocated to continuing operations.

The components of income tax expense are as follows (in thousands):

 

		Year Ended
		December 31,				January 2,				January 3,
		2016				2016				2015
Current:
Federal		$	4,602			$	8,861			$	6,346
State			921				443				—
			5,523				9,304				6,346
Deferred:
Federal			5,371				4,893				2,379
State			906				1,100				950
			6,277				5,993				3,329
Income tax expense		$	11,800			$	15,297			$	9,675

 

The aggregate amount of income taxes included in the consolidated statements of operations and consolidated statements of shareholders’ equity are as follows (in thousands):

 

		Year Ended
		December 31,				January 2,				January 3,
		2016				2016				2015
Consolidated statements of income:
Income tax expense relating to continuing operations		$	11,800			$	15,297			$	9,675
Consolidated statements of shareholders’ equity:
Reversal of intraperiod tax allocation		$	—			$	(1,595	)		$	—
Income tax expense relating to derivative financial instruments		$	—			$	50			$	431
Income tax benefit relating to share-based compensation		$	(1,872	)		$	(3,840	)		$	(6,064	)

The reversal of intra-period income tax allocation of $1.6 million in the year ended January 2, 2016, represents income tax expense previously classified within accumulated other comprehensive losses, relating to the intra-period income taxes on our effective aluminum hedges, which we reversed in the second quarter of 2015 as the result of the culmination of our remaining cash flow hedges.

 

A reconciliation of the statutory federal income tax rate to our effective rate is provided below:

 

		Year Ended
		December 31,				January 2,				January 3,
		2016				2016				2015
Statutory federal income tax rate			35.0	%			35.0	%			35.0	%
State income taxes, net of federal income tax benefit			3.8	%			3.8	%			3.8	%
Reversal of intraperiod tax allocation			—				4.1	%			—
Research activities credits			(2.8	)%			—				—
Domestic manufacturing deduction			(1.8	)%			(2.2	)%			(2.1	)%
Florida jobs creation incentive credits			(0.6	)%			(2.0	)%			—
Non-deductible acquisition costs			—				—				0.6	%
Change in valuation allowance on deferred tax assets			(0.2	)%			0.3	%			—
Non-deductible expenses			0.2	%			0.2	%			—
Other			(0.4	)%			0.2	%			(0.2	)%
			33.2	%			39.4	%			37.1	%

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our net deferred tax liability are as follows:

 

		December 31,				January 2,
		2016				2016
		(in thousands)
Deferred tax assets:
State and federal net operating loss carryforwards		$	2,000			$	4,735
Stock-based compensation expense			2,646				2,735
Accrued warranty			2,149				1,643
Obsolete inventory and UNICAP adjustment			503				607
Other deferrals and accruals, net			899				682
Allowance for doubtful accounts			195				152
Acquisition costs			537				261
Total deferred tax assets			8,929				10,815
Deferred tax liabilities:
Trade names and other intangible assets, net			(26,007	)			(26,631	)
Property, plant and equipment			(10,492	)			(9,202	)
Goodwill			(3,193	)			(619	)
Deferred financing costs			(1,241	)			(131	)
Prepaid expenses			(167	)			(126	)
Total deferred tax liabilities			(41,100	)			(36,709	)
Total deferred tax liabilities, net		$	(32,171	)		$	(25,894	)

Regarding tax goodwill, the amount of goodwill deductible for tax purposes was $63.8 million at the time of the 2004 PGT acquisition, which was fully amortized in the year ended January 2, 2016.

We acquired goodwill deductible for tax purposes in the CGI acquisition as the transaction was treated as an acquisition of stock for tax purposes. At the date of the acquisition, the amount of goodwill deductible for tax purposes from the CGI acquisition was $9.3 million. At the time of the acquisition, this goodwill was the same amount for both book and tax purposes and, therefore, no deferred tax asset or liability was recognized. As we amortize this goodwill for tax purposes over its remaining life, which was approximately 7.4 years at the time of the acquisition, we will recognize a deferred tax liability. The unamortized amount of this goodwill was $6.5 million and $7.7 million at December 31, 2016, and January 2, 2016, respectively.

 

We have goodwill deductible for tax purposes in the WinDoor acquisition as the transaction was treated as an acquisition of stock treated as a step-up acquisition of assets and assumption of liabilities pursuant to our election under section 338(h)(10) of the Internal Revenue Code. We expect to be able to deduct goodwill for tax purposes of $38.9 million from the WinDoor transaction. The unamortized amount of this goodwill was $36.5 million at December 31, 2016.

Also, acquisition costs totaling $0.9 million included in selling, general, and administrative expenses on the consolidated statement of operations for the year ended December 31, 2016, and relating to legal expenses, representations and warranties insurance, diligence, and accounting services, are being deferred and amortized for tax purposes over the same period as tax deductible goodwill. See Note 4, “Acquisitions – WinDoor, Inc.”.

We have goodwill deductible for tax purposes in the USI acquisition as the transaction was treated as an acquisition of assets and assumption of liabilities for both book and tax purposes. We expect to be able to deduct goodwill for tax purposes of $0.6 million from the USI transaction. See Note 4, “Acquisitions – US Impact Systems, Inc.”. The unamortized amount of this goodwill was $0.6 million at December 31, 2016

We estimate that we have $1.2 million of tax affected federal net operating loss carryforwards, composed entirely of net operating loss carryforwards acquired in the CGI acquisition, and $0.8 million of state operating loss carryforwards, as of December 31, 2016, expiring at various dates through 2027. Use of the net operating loss carryforwards acquired in the CGI acquisition is subject to annual limitations for federal tax purposes. However, we believe they will be fully utilized prior to expiration.

As the result of tax deductible compensation expense in excess of stock-based compensation expense recorded for book purposes relating to the exercise of stock options, concurrent with the full utilization of all of our regular net operating loss carry-forwards during 2013, for the years ended December 31, 2016, January 2, 2016, and January 2, 2015, we recognized $1.9 million, $3.8 million, and $6.1 million, respectively, of excess tax benefits (ETBs) in additional paid-in capital. Our policy with regard to providing for income tax expense when ETBs are utilized is to follow the “with-and-without” approach as described in ASC 740-20 and ASC 718 and include in the measurement the indirect effects of the excess tax deduction.

At January 2, 2016, we provided for a valuation allowance against net operating losses of approximately $0.2 million we have to carryforward in North Carolina as we concluded it is not more likely than not that we will realize the full benefit of the net operating losses before expiration. During the year ended December 31, 2016, we reduced this valuation allowance by approximately $0.1 million to reflect an increase in our estimate of net operating losses we will be able to realize in North Carolina. For financial reporting purposes, we classified this valuation allowance as a reduction of state and federal net operating loss carryforwards in the above table. We had no valuation allowance on deferred tax assets at January 3, 2015, as management’s assessment of our ability to realize our deferred tax assets is that it is more likely than not that we will generate sufficient future taxable income to realize all of our deferred tax assets.

The tax years 2011 to 2016 remain open for examination by the IRS due to the statute of limitations and net operating losses utilized in prior tax years.