Note 13: Income Taxes

During the year ended December 31, 2013, the Company recorded an income tax provision of $45.4 million, reflecting an effective rate of 37.6% of pretax income from continuing operations. The effective tax rate for the year ended December 31, 2013, primarily consisted of a provision for federal income taxes of 33.0% (which is net of a benefit for state taxes of 2.0%), a provision for state taxes of 5.8% and a net benefit of 1.2%, due to permanent book versus tax differences. During the year ended December 31, 2012, the Company recorded an income tax provision of $51.8 million, reflecting an effective rate of 39.7% of pretax income from continuing operations. The effective tax rate for the year ended December 31, 2012, primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a provision for state taxes of 6.6% and a net provision of 0.4%, due to permanent book versus tax differences, and international rate differentials.

The effective tax rates for the respective periods are shown below:


	Year Ended December 31,
	2013			2012
Federal provision		35.0	%		35.0	%
State provision		5.8	%		6.6	%
State benefit		(2.0	%)		(2.3	%)
Changes in state apportionment⁽¹⁾		(0.2	%)		0.0	%
Tax reserves⁽²⁾		0.0	%		0.1	%
International provision⁽³⁾		(2.2	%)		(0.4	%)
Permanent items⁽⁴⁾		2.4	%		0.5	%
Other		(1.2	%)		0.2	%

Effective rate		37.6	%		39.7	%

⁽¹⁾	Represents changes in state apportionment methodologies.

⁽²⁾	Represents reserves taken for certain tax position adopted by the Company.

⁽³⁾	Relates primarily to the lower tax rate on the income attributable to international operations.

⁽⁴⁾	Represents a provision for nondeductible items.

The pretax income consisted of the following (in thousands):


	Year Ended December 31,
	2013		2012		2011
Domestic	$	105,009	$	122,423	$	92,759
Foreign		15,859		7,902		5,910

	$	120,868	$	130,325	$	98,669

The provision for income taxes consisted of the following (in thousands):


	Year Ended December 31,
	2013			2012			2011
Current expense:
Federal	$	50,304		$	48,025		$	30,822
State		7,196			9,537			6,647
Foreign		4,052			2,765			2,407

		61,552			60,327			39,876
Deferred (benefit) expense:
Federal		(13,134	)		(6,801	)		(814	)
State		(2,369	)		(1,301	)		90
Foreign		(661	)		(471	)		(1,076	)

		(16,164	)		(8,573	)		(1,800	)

	$	45,388		$	51,754		$	38,076

The components of deferred tax assets and liabilities consisted of the following for the years presented (in thousands):


	December 31, 2013			December 31, 2012
Deferred tax assets:
State taxes	$	2,758		$	1,408
Stock-based compensation expense		7,250			8,888
Accrued expenses		5,015			2,957
Non-qualified plan		97			(136	)
Deferred revenue		38,529			—
Cash flow hedge instruments		1,588			1,037
State and international operating losses		6,490			51
Fixed asset basis—International		86			(26	)
Capitalized legal fees—International		1,609			—
Cumulative translation adjustment		1,509			—
Tax benefit of uncertain tax positions		4,237			—
Valuation allowance		(3,595	)		(13	)

		65,573			14,166

Deferred tax liabilities:
Deferred court costs		(15,445	)		(15,013	)
Difference in basis of amortizable assets		(12,200	)		(7,898	)
Difference in basis of depreciable assets		(6,834	)		(4,134	)
Differences in income recognition related to receivable portfolios		(20,773	)		5,723
Deferred debt cancellation income		(1,222	)		(1,222	)
Other		(2,289	)		142

		(58,763	)		(22,402	)

Net deferred tax asset (liability)	$	6,810		$	(8,236	)

The differences between the total income tax expense and the income tax expense computed using the applicable federal income tax rate of 35% per annum were as follows (in thousands):


	Year Ended December 31,
	2013			2012			2011
Computed “expected” Federal income tax expense	$	42,304		$	45,614		$	34,534
Increase (decrease) in income taxes resulting from:
State income taxes, net		3,138			5,551			4,200
Foreign non-taxed income, rate differential		(2,647	)		(481	)		(772	)
Other adjustments, net		2,593			1,070			114

	$	45,388		$	51,754		$	38,076

The Company has not provided for the United States income taxes or foreign withholding taxes on the undistributed earnings from continuing operations of its subsidiary operating outside of the United States. Undistributed earnings of the subsidiary for the year ended December 31, 2013, were approximately $5.6 million. Such undistributed earnings are considered permanently reinvested. If the earnings were to be distributed, it is estimated that taxes in the amount of approximately $2.2 million, before utilization of any foreign tax credits, would need to be reflected in the financial statements.

The Company’s subsidiary in Costa Rica is operating under a 100% tax holiday through December 31, 2018 and a 50% tax holiday for the subsequent four years. The impact of the tax holiday in Costa Rica for the year ended December 31, 2013 was immaterial.

A reconciliation of the beginning and ending amount of the Company’s unrecognized tax benefit is as follows (in thousands):


	Amount
Balance at December 31, 2012	$	1,784
Current year deletions relating to prior years		(712	)
Current year additions relating to prior years—acquisitions		70,201

Balance at December 31, 2013	$	71,273

As of December 31, 2013, the Company had a gross unrecognized tax benefit of $83.0 million primarily related to an uncertain tax position resulting from the AACC Merger due to AACC’s tax revenue recognition policy. This uncertain tax position, if recognized, would result in a net tax benefit of $13.5 million and would have a positive effect on the Company’s effective tax rate. During the year ended December 31, 2013, there was an increase in the gross unrecognized tax benefit of $79.4 million primarily as a result of the AACC Merger as discussed in Note 3, “Business Combinations.”

During 2013, the Company accrued interest of $1.4 million related to prior years’ uncertain tax positions. In total as of December 31, 2013, the Company recorded a liability for potential interest of $11.7 million. The interest accrual is recorded as part of the provision for income taxes.

The Company believes that it is reasonably possible that its $83.0 million gross unrecognized tax benefits will decrease within the next 12 months. The majority of the gross unrecognized tax benefits relate to uncertain tax positions associated with the acquisition of AACC. The event that may significantly reduce the unrecognized tax benefits is the completion of a federal tax audit of AACC. The unrecognized tax benefits are included in other liabilities on the Company’s consolidated statements of financial condition.

The Company files U.S. federal, state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2010 through 2013 tax years remain subject to examination by federal taxing authorities for Encore while tax years from 2008 forward remain open to adjustment for AACC. The 2008 through 2013 tax years generally remain subject to examination by state tax authorities, and the 2011 through 2013 tax years remain subject to examination by foreign tax authorities.

The Company’s UK subsidiary has a net operating loss carry forward in the amount of approximately $30.4 million, which can be carried forward indefinitely.