11. Income Taxes

The benefit (provision) for income taxes on the loss from continuing operations before income taxes and equity in net income of affiliates consists of the following (in thousands):


		Year Ended December 31,
		2012		2011		2010
Current:
U.S. Federal	$	55,928	$	(1,212)	$	(691)
State and local		59,390		305		(2,390)
Total current		115,318		(907)		(3,081)
Deferred:
U.S. Federal		(3,325)		(32,670)		270,470
State and local		(18,678)		(7,798)		57,756
Total deferred		(22,003)		(40,468)		328,226
Total income tax benefit (provision)	$	93,315	$	(41,375)	$	325,145

Our current tax benefit (provision) includes a decrease (increase) to our liability for UTPs for (in thousands):


		Year Ended December 31,
		2012		2011		2010
Decrease to unrecognized tax benefits	$	61,470	$	2,198	$	1,187
Interest expense		27,672		(4,880)		(5,493)
Penalties		21,175		627		557
Total	$	110,317	$	(2,055)	$	(3,749)

During 2012, the statute of limitations for assessment of additional tax expired with regard to certain UTPs related to Old Loral and several of our federal and state income tax returns filed for 2007 and 2008 which resulted in a $61.0 million reduction to our unrecognized tax benefits and an $86.7 million benefit to our income tax provision from continuing operations (a current tax benefit of $112.9 million, which included the reversal of applicable interest and penalties previously accrued, offset by a deferred tax provision of $26.2 million). Also during 2012, in order to minimize our cash tax liability from the Sale, we enhanced our extraterritorial income exclusion provided by former section 114 of the Internal Revenue Code and recorded an additional tax benefit of $11.2 million. Without the Sale, we would not have remeasured the extraterritorial income exclusion because it would have provided only a minimal cash tax benefit.

For 2011, the deferred income tax provision of $40.5 million related primarily to our equity in net income of Telesat after having reversed our valuation allowance in the fourth quarter of 2010.

For 2010, the deferred income tax benefit of $328.2 million related primarily to the reversal of a significant portion of our valuation allowance during the fourth quarter after having determined that based on all available evidence, it was more likely than not that we would realize the benefit from a significant portion of our deferred tax assets in the future.

In addition to the benefit (provision) for income taxes presented above, we also recorded the following items (in thousands):


		Year Ended December 31,
		2012		2011		2010
Tax provision on income from discontinued operations	$	(10,157)	$	(47,770)	$	(16,523)
Tax provision on Sale of discontinued operations		(267,451)		—		—
Excess tax benefit from stock option exercises recorded to paid-in-capital⁽ⁱ⁾		16,919		1,198		412
Deferred tax (provision) benefit for adjustments in other comprehensive loss (See Note 4)		(22,612)		39,416		22,300

⁽ⁱ⁾The Company uses the with-and-without approach of determining when excess tax benefits from equity compensation have been realized.

The benefit (provision) for income taxes differs from the amount computed by applying the statutory U.S. Federal income tax rate on the loss from continuing operations before income taxes and equity in net income of affiliates because of the effect of the following items (in thousands):


		Year Ended December 31,
		2012		2011		2010
Tax benefit at U.S. Statutory Rate of 35%	$	9,524	$	4,321	$	8,114
Permanent adjustments which change statutory amounts:
State and local income taxes, net of federal income tax		34,605		(2,802)		(28,788)
Equity in net income of affiliates		(12,019)		(37,215)		(29,969)
Extraterritorial income exclusion		11,200		—		—
Provision for unrecognized tax benefits		46,542		(1,137)		1,476
Nondeductible expenses		(603)		(1,906)		(639)
Change in valuation allowance		2,311		684		375,367
Other, net		1,755		(3,320)		(416)
Total income tax benefit (provision)	$	93,315	$	(41,375)	$	325,145

The following table summarizes the activity related to our unrecognized tax benefits (in thousands):


		Year Ended December 31,
		2012		2011		2010
Balance at January 1	$	115,293	$	132,211	$	120,124
Increases related to prior year tax positions		453		1,220		339
Decreases related to prior year tax positions		(27)		(24,745)		(1,933)
Decreases as a result of statute expirations		(61,021)		(1,629)		(1,886)
Decreases as a result of tax settlements		(8,184)		(7,606)		(5,207)
Increases related to current year tax positions		29,566		15,842		20,774
Balance at December 31	$	76,080	$	115,293	$	132,211

With few exceptions, the Company is no longer subject to U.S. federal, state or local income tax examinations by tax authorities for years prior to 2007. Earlier years related to certain foreign jurisdictions remain subject to examination. Various state and foreign income tax returns are currently under examination. However, to the extent allowed by law, the tax authorities may have the right to examine prior periods where net operating losses were generated and carried forward, and make adjustments up to the amount of the net operating loss carryforward. While we intend to contest any future tax assessments for uncertain tax positions, no assurance can be provided that we would ultimately prevail. During the next twelve months, the statute of limitations for assessment of additional tax will expire with regard to certain UTPs related to our federal income tax returns filed for 2009 and state income tax returns filed for 2007 and 2008, potentially resulting in a $1.6 million reduction to our unrecognized tax benefits. Pursuant to the Purchase Agreement for the Sale, we are obligated to indemnify SS/L for taxes related to periods prior to the closing of the transaction.

Our liability for UTPs decreased from $139.9 million at December 31, 2011 to $80.7 million at December 31, 2012 and is included in long-term liabilities in the consolidated balance sheets. At December 31, 2012, we have accrued $2.6 million and $9.5 million for the potential payment of tax-related interest and penalties, respectively. If our positions are sustained by the taxing authorities, approximately $36.1 million of the tax benefits will reduce the Company’s income tax provision from continuing operations. Other than as described above, there were no significant changes to our unrecognized tax benefits during the year ended December 31, 2012, and we do not anticipate any other significant increases or decreases to our unrecognized tax benefits during the next twelve months.

In connection with the acquisition of our ownership interest in Telesat, Loral retained the benefit of tax recoveries related to the transferred assets and indemnified Telesat for Loral Skynet tax liabilities relating to periods preceding 2007. The unrecognized tax benefits related to the Loral Skynet subsidiaries were transferred to Telesat subject to the contractual tax indemnification provided by Loral. Loral’s net receivable at December 31, 2012 for the probable outcome of these matters is not material. (see Note 19)

At December 31, 2012, we had federal NOL carryforwards of $290.4 million, state NOL carryforwards, primarily California, of $73.4 million, and federal research credits of $1.2 million which expire from 2016 to 2024, as well as federal and state AMT credit carryforwards of approximately $2.7 million that may be carried forward indefinitely.

The reorganization of the Company on the Effective Date constituted an ownership change under section 382 of the Internal Revenue Code. Accordingly, use of our tax attributes, such as NOLs and tax credits generated prior to the ownership change, are subject to an annual limitation of approximately $32.6 million, subject to increase or decrease based on certain factors. Our annual limitation was increased significantly each year through 2010, the last year allowed for the recognition of additional benefits from our “net unrealized built-in gains” (i.e., the excess of fair market value over tax basis for our assets) as of the Effective Date.

We assess the recoverability of our NOLs and other deferred tax assets and based upon this analysis, record a valuation allowance to the extent recoverability does not satisfy the “more likely than not” recognition criteria. We continue to maintain our valuation allowance until sufficient positive evidence exists to support full or partial reversal. As of December 31, 2012, we had a valuation allowance totaling $7.1 million against our deferred tax assets for certain tax credit and loss carryovers due to the limited carryforward periods. During 2012, the valuation allowance decreased by $3.8 million, of which $2.3 million was recorded as a benefit to continuing operations and $1.5 million was recorded as a benefit to discontinued operations in our statement of operations. Subsequent to the Sale, to the extent that profitability from operations is not sufficient to realize the benefit from our remaining net deferred tax assets, we would generate sufficient taxable income from the appreciated value of our Telesat investment, which currently has a nominal tax basis, in order to prevent federal net operating losses from expiring and realize the benefit of our all remaining net deferred tax assets.

During 2011, the valuation allowance decreased by $0.3 million, of which $0.7 million was recorded as a benefit to continuing operations and $0.4 million was recorded as a provision to discontinued operations in our statement of operations.

During the fourth quarter of 2010, we determined, based on all available evidence, that it was more likely than not that we would realize the benefit from a significant portion of our deferred tax assets in the future and no longer required a full valuation allowance. We based this conclusion on cumulative profits generated in prior periods, as well as our expectation that future operations would generate sufficient taxable income to realize the tax benefit from certain deferred tax assets. Accordingly, during 2010, our valuation allowance decreased from $414.0 million to $11.2 million. Of the $402.8 million change, $375.4 million was recorded as a benefit to continuing operations (of which $335.3 million was recorded as a deferred income tax benefit during the fourth quarter of 2010) and $27.4 million was recorded as a benefit to discontinued operations in our statement of operations.

The significant components of the net deferred income tax assets are (in thousands):


		December 31,
		2012		2011
Deferred tax assets:
Postretirement benefits other than pensions	$	432	$	26,685
Inventoried costs		—		20,165
Net operating loss and tax credit carryforwards		131,359		139,070
Compensation and benefits		3,766		24,984
Deferred research & development costs		—		3,269
Income recognition on long-term contracts		—		22,402
Indemnification liabilities		7,440		—
Investments in and advances to affiliates		—		6,175
Property, plant and equipment		996		—
Other, net		4,022		5,850
Federal benefit of uncertain tax positions		9,931		29,576
Pension costs		15,746		93,948
Total deferred tax assets before valuation allowance		173,692		372,124
Less valuation allowance		(7,108)		(10,887)
Net deferred tax assets		166,584		361,237
Deferred tax liabilities:
Gain from installment sale		(38,818)		—
Property, plant and equipment		—		(27,515)
Intangible assets		—		(3,289)
Investments in and advances to affiliates		(9,883)		—
Total deferred tax liabilities		(48,701)		(30,804)
Net deferred tax assets	$	117,883	$	330,433

Classification on consolidated balance sheets:
Current deferred tax assets	$	4,165	$	67,070
Long-term deferred tax assets		117,381		263,363
Long-term liabilities		(3,663)		—
Total deferred tax assets	$	117,883	$	330,433