Income Taxes

5 Months Ended

Jun. 30, 2011

Income Taxes [Abstract]

Income Taxes

(6) Income Taxes

     The Company recorded an income tax benefit to its Successor Company for the three months ended June 30, 2011 of $22.8 million, an income tax benefit to its Successor Company for the 157 day period ended June 30, 2011 of $38.2 million and an income tax expense to its Predecessor Company for the 24 day period ended January 24, 2011 of $279.9 million, respectively. The Company recorded an income tax benefit of $10.2 million and $6.7 million for the three and six months ended June 30, 2010, respectively.

     For the three months ended June 30, 2011, the Successor Company’s effective tax benefit rate on $49.9 million of pre-tax loss was 45.7%. The rate differs from the 35% federal statutory rate primarily due to a prior period adjustment. Without the prior period adjustment the effective tax rate would have been 38.9%.

     For the 157 day period ended June 30, 2011, the Successor Company’s effective tax benefit rate on $89.7 million of pre-tax loss was 42.6%. The rate differs from the 35% federal statutory rate primarily due to a prior period adjustment.

     For the 24 day period ended January 24, 2011, the Predecessor Company’s effective tax rate on $866.8 million of pre-tax income was 32.3%. The rate differs from the 35% federal statutory rate primarily due to the release of the valuation allowance and other miscellaneous reorganization adjustments.

     The effective tax rate for the three months ended June 30, 2010 was a 15.9% benefit. The effective tax rate was impacted by non-deductible restructuring charges and post-petition interest, as well as a significant increase in the Company’s valuation allowance for deferred tax assets due to its inability, by rule, to rely on future earnings to offset its NOLs during the Chapter 11 Cases.

     The effective tax rate for the six months ended June 30, 2010 was a 4.6% benefit. The effective tax rate was impacted by a one-time, non-cash income tax charge of $6.8 million during the first quarter of 2010, as a result of the enactment of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, both of which became law in March 2010 (collectively, the “Health Care Act”). The effective tax rate for the six months ended June 30, 2010 was also impacted by non-deductible restructuring charges and post-petition interest. In addition, tax benefits from the reported loss during the period were partially offset by an increase in the valuation allowance on the Company’s deferred tax assets.

     At June 30, 2011, the Company had federal and state NOL carryforwards of $199.0 million that will expire from 2019 to 2031. At June 30, 2011, the Company had no alternative minimum tax credits. Legacy FairPoint completed an initial public offering on February 8, 2005, which resulted in an “ownership change” within the meaning of the U.S. Federal income tax laws addressing NOL carryforwards, alternative minimum tax credits, and other similar tax attributes. The Merger and the Company’s emergence from the Chapter 11 Cases also resulted in ownership changes. As a result of these ownership changes, there are specific limitations on the Company’s ability to use its NOL carryfowards and other tax attributes. It is the Company’s belief that it can use the NOLs even with these restrictions in place.

     During the 24 days ended January 24, 2011 the Company excluded from taxable income $1,045.4 million of income from the discharge of indebtedness as defined under Internal Revenue Code (“IRC”) Section 108. There was no income from the discharge of indebtedness for the three months ended June 30, 2011 and the 157 days ended June 30, 2011. IRC Section 108 excludes from taxable income the amount of indebtedness discharged under a Chapter 11 case. IRC Section 108 also requires a reduction of tax attributes equal to the amount of excluded taxable income to be made on the first day of the tax year following the emergence from bankruptcy. We have not finalized our assessment of the tax effects of the bankruptcy emergence and this estimate, as well as the Plan’s effect on all tax attributes, is subject to revision, which could be significant.

     In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management determines its estimates of future taxable income based upon the scheduled reversal of deferred tax liabilities, projected future taxable income exclusive of reversing temporary differences, and tax planning strategies. The Company establishes valuation allowances for deferred tax assets when it is estimated to be more likely than not that the tax assets will not be realized.

     At June 30, 2011 and December 31, 2010, the Company established a valuation allowance of $29.3 million and $105.6 million, respectively, against its deferred tax assets.

     The Income Taxes Topic of the ASC requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The unrecognized tax benefits under the Income Taxes Topic of the ASC are similar to the income tax reserves reflected prior to adoption under SFAS No. 5, Accounting for Contingencies, whereby reserves were established for probable loss contingencies that could be reasonably estimated, with the reduction as a result of the termination of the Tax Sharing Agreements with Verizon. The Company’s unrecognized tax benefits totaled $1.0 million as of June 30, 2011 and $5.4 million as of December 31, 2010. Of the $1.0 million of unrecognized tax benefits at June 30, 2011, the entire $1.0 million would impact the Company’s effective rate, if recognized. The unrecognized tax benefits relate to tax reserves recorded in a business combination. Furthermore, the Company does not anticipate any significant increase or decrease to the unrecognized tax benefits within the next twelve months.

     The Company recognizes any interest and penalties accrued related to unrecognized tax benefits in income tax expense. For the three months ended June 30, 2011, the 157 days ended June 30, 2011, the 24 days ended January 24, 2011 and the three and six months ended June 30, 2010, the Company did not make any payment of interest and penalties. The Company had $1.0 million (after-tax) for the payment of interest and penalties accrued in the condensed consolidated balance sheet at December 31, 2010. There was nothing accrued in the condensed consolidated balance sheet for the payment of interest and penalties at June 30, 2011.

     The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and with various state and local governments. The Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years prior to 2004.