Income Taxes

9 Months Ended

Jun. 30, 2012

Income Taxes

Income Taxes

8.Income Taxes

Headwaters’ estimated effective income tax rate for the fiscal year ending September 30, 2012, exclusive of discrete items, is currently expected to be approximately negative (12)%, which estimated rate was used to calculate income taxes for the June 2012 quarter and nine-month periods. Headwaters has also recognized approximately $1.5 million of net income tax benefit for discrete items that did not affect the calculation of the estimated effective income tax rate for the 2012 fiscal year. A majority of the benefit recognized for discrete items represented adjustments related to unrecognized income tax benefits. For the nine months ended June 30, 2011, Headwaters used an estimated effective income tax rate of negative (1)%, excluding approximately $3.2 million of income tax expense for discrete items.

Headwaters utilized its fiscal 2009 and prior year federal net operating losses (NOLs) by carrying those amounts back to prior years, receiving income tax refunds. NOLs and tax credit carryforwards for fiscal 2010 were offset by Headwaters’ existing deferred income tax liabilities resulting in a near $0 deferred tax position as of September 30, 2010. In fiscal 2011, Headwaters recorded a full valuation allowance on its net amortizable deferred tax assets, a situation that is also expected to continue throughout fiscal 2012. Accordingly, Headwaters does not expect to recognize any benefit for pre-tax losses and tax credits in fiscal 2012. A valuation allowance is required when there is significant uncertainty as to the realizability of deferred tax assets. Because the realization of Headwaters’ deferred tax assets is dependent upon future income in domestic and foreign jurisdictions that have generated losses, management determined that Headwaters does not meet the “more likely than not” threshold that NOLs, tax credits and deferred tax assets will be realized. Accordingly, a valuation allowance is required.

The estimated effective income tax rate for fiscal 2012 of negative (12)% is due primarily to the combination of not recognizing benefit for expected pre-tax losses and tax credits, but recognizing current state income taxes in certain state jurisdictions where Headwaters expects to generate taxable income. As of June 30, 2012, Headwaters’ NOL and capital loss carryforwards total approximately $70.9 million (tax effected). The U.S. and state NOLs and capital losses expire from 2012 to 2032. Substantially all of the non-U.S. NOLs do not expire. In addition, there are approximately $22.8 million of tax credit carryforwards as of June 30, 2012, which expire from 2014 to 2032.

The estimated effective tax rate for fiscal 2011 of negative (1)%, which was used to calculate income taxes for the 2011 periods, exclusive of discrete items, resulted from the same factors as the expected negative tax rate for 2012. The discrete items recorded during 2011 consisted primarily of changes in the valuation allowance and uncertain tax positions.

The calculation of tax liabilities involves uncertainties in the application of complex tax regulations in multiple tax jurisdictions. During 2012, Headwaters reached a tentative agreement with the IRS for the 2009 fiscal year examination, which, as of June 30, 2012, has not resulted in any material changes to earnings or tax-related liabilities. Headwaters currently has open tax years subject to examination by the IRS or other taxing authorities for the years 2009 through 2011. Headwaters recognizes potential liabilities for anticipated tax audit issues in the U.S. and state tax jurisdictions based on estimates of whether, and the extent to which, additional taxes and interest will be due. If events occur (or do not occur) as expected and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer required to be recorded in the consolidated financial statements. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. It is reasonably possible that approximately $1.5 million to $3.0 million of Headwaters’ unrecognized income tax benefits will be released within the next 12 months, depending on the timing of ongoing examinations, the expiration of statute of limitation time periods and other factors.