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Income Taxes
9 Months Ended
Jul. 31, 2014
Income Tax Disclosure [Abstract]  
Income Taxes
8. Income Taxes
To determine our income tax expense for interim periods, consistent with accounting standards, we apply the estimated annual effective income tax rate to year-to-date results except when this method does not result in a reliable estimate of year-to-date income tax expense. For the three- and nine-month periods ended July 31, 2013, we used the discrete or cut-off method, which allows for the use of a year-to-date effective income tax rate that is more applicable to our results. This approach is appropriate where a small change in estimated income could produce a large change in the estimated annual effective tax rate. Our estimated annual effective tax rates from continuing operations for the nine months ended July 31, 2014 and 2013, were 38.2% and a benefit of 36.5%, respectively. The increase in the 2014 effective rate is attributable to the change in the tax status of our facility in the United Kingdom (UK). On November 1, 2013, the assets of our UK branch were contributed to a newly formed wholly-owned UK subsidiary. This change resulted in a U.S. taxable charge and was booked as a discrete item in the first quarter.
We evaluate the likelihood of realization of our deferred tax assets by considering both positive and negative evidence. We believe there is no need for a valuation allowance of the federal net operating losses. However, if we record three years of cumulative losses, after adjusting for non-recurring items, we may be required to increase our valuation allowance to the full extent of our net deferred tax assets of $32.2 million. We will continue to evaluate our position throughout the year. We maintain a valuation allowance for certain state net operating losses which totaled $2.5 million at July 31, 2014.
Our unrecognized tax benefit (UTB) is related to the 2008 spin-off of Quanex from its former parent and certain state tax items regarding the interpretation of tax laws and regulations. The total UTB at October 31, 2013 was $13.2 million. Of this amount, $5.4 million was recorded as a liability for uncertain tax positions and $7.8 million was recorded as deferred income taxes (non-current assets) on the accompanying condensed consolidated balance sheet. During the nine months ended July 31, 2014, we reduced the liability for uncertain tax positions related to the spin-off by $1.9 million due to the lapse in the statute of limitations, which resulted in a non-cash increase in retained earnings of $1.6 million and a decrease in income tax expense of $0.3 million. At July 31, 2014, $4.6 million is recorded as a liability for uncertain tax positions and $6.8 million is recorded in deferred income taxes. The total UTB at July 31, 2014 is $11.4 million, which includes $10.7 million for which the disallowance of such items would not affect the annual effective tax rate.
Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. The final outcome of the future tax consequences of legal proceedings, if any, as well as the outcome of competent authority proceedings, changes in regulatory tax laws, or interpretation of those tax laws could impact our financial statements. We are subject to the effect of these matters occurring in various jurisdictions. We believe it is reasonably possible that a decrease of approximately $1.8 million in the UTB may be recognized within the next twelve months as a result of the lapse in the statute of limitations.
Our federal income tax returns for the tax years ended October 31, 2011 and 2012 are currently under examination by the Internal Revenue Service.