Note 9 - Income Taxes

The components of income tax expense (benefit) are as follows:

(in thousands)	Year Ended December 31, 2012			Year Ended December 31, 2011


Federal - current	$	18,930		$	-
State - current		15,911			48
Total current		34,841			48

Federal - deferred		38,167			-
Change in valuation allowance		(38,167	)		-
Total deferred		-			-

Total income tax expense	$	34,841		$	48

AMBASE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

The components of pretax income/loss and the difference between income taxes computed at the statutory federal rate of 35% in 2012 and 2011, and the provision for income taxes are as follows:

(in thousands)	Year Ended December 31, 2012			Year Ended December 31, 2011

Income (loss) before income taxes	$	180,770		$	(1,845	)

Tax expense (benefit) :
Tax at statutory federal rate	$	63,270		$	646
Permanent items		(6,173	)		-
State income taxes		15,911			48
Accounting loss benefit not recognized		-			(646	)
Change in valuation allowance		(38,167	)		-

Income tax expense (benefit)	$	34,841		$	48

A reconciliation of the United States federal statutory rate to the Company's effective income tax rate is as follows:

	Year Ended December 31, 2012				Year Ended December 31, 2011
Tax at statutory federal rate		35.0		%		35.0		%
State income taxes		8.8				2.6
Accounting loss benefit not recognized		-				(35.0	)
Change in valuation allowance		(21.1	)			-
Permanent differences, tax credits and other adjustments		(3.4	)			-
Effective income tax rate		19.3		%		2.6		%

The Company recorded a reserve for uncertain tax positions in the amount of $34,157,000 and $0 as of December 31, 2012 and December 31, 2011. It is unclear as to whether any significant changes in unrecognized income tax benefits are currently expected to occur over the next year. Interest and/or penalties related to underpayments of income taxes, if applicable, would be included in interest expense and operating expenses, respectively. The accompanying financial statements do not include any amounts for any such interest and/or penalties.

The Company's federal income tax returns for the years subsequent to 1992 have not been reviewed by the Internal Revenue Service ("IRS") or state authorities, except for tax year 2007, which was reviewed by the IRS and has been concluded. The Company has not been notified of any other potential tax audits by any federal, state or local tax authorities. As such, the Company believes the statutes of limitations for the assessment of additional federal and state tax liabilities are generally closed for tax years prior to 2009.

AMBASE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

As part of the Company's 2012 federal income tax ("FIT") return as filed (subject to IRS audit adjustment/review), as prepared by the Company's outside tax advisors, the Company recognized a $152 million worthless stock deduction for the Company's investment tax basis in Carteret in the computation of the Company's 2012 taxable income. The Company further reduced its 2012 federal taxable income through the utilization of $25 million of its previously available federal tax net operating loss ("NOL") carryforward deductions in the computation of the Company's 2012 federal tax liability. The federal NOL carryforwards were required to be utilized in tax year 2012 as a result of the IRC regulations which require NOLs to be utilized in the first year in which the Company has taxable income; otherwise, use of the NOL carryforwards would be lost. The worthless stock deduction was required to be recognized in the year of worthlessness, i.e. 2012.

As part of the Settlement Agreement in the Supervisory Goodwill legal proceedings, (as approved by the Court of Federal Claims), the Company is entitled to a tax gross-up in an amount to be determined if and when any federal taxes should be imposed on the Settlement Amount. Based on the Company's 2012 FIT return, (subject to IRS audit adjustment/review), in March 2013 the Company paid approximately $501,000 of federal income taxes attributable to Alternative Minimum Tax ("AMT") rate calculations. Pursuant to the Settlement Agreement, the Company is planning to seek a tax gross-up from the United States for the $501,000, plus applicable tax consequences relative to the reimbursement of this amount. The Company is also: (i) planning to seek a tax gross-up for any additional federal tax which could be owed as a result of additional taxes which may be imposed by the IRS upon tax return review or otherwise; and (ii) reserving the right to seek the economic value for deductions utilized against the Settlement Award. Pursuant to the Settlement Agreement Rule 60(b) of the Rules of the Court of Federal Claims will govern the process for receiving a tax gross-up. At the current time, the Company has initiated discussions with the DOJ and the IRS in an effort to resolve the gross-up issues without additional court proceedings. Based on the Company's March 2013 payment of the 2012 federal tax amount, the Company recorded a receivable of $501,000 to reflect a portion of the tax gross-up reimbursement the Company will be seeking pursuant to the Settlement Agreement, which was recognized as other income in the Company's Consolidated Statement of Operations. For additional information, see Note 10 – Legal Proceedings.

Pursuant to the accounting principles with regard to recognition of uncertain tax positions, (ASC 740-10, Accounting for Income Taxes), as of December 31, 2012, the Company was required to record an aggregate tax reserve of approximately $34,157,000; ($18.4 million for federal), to reflect the net tax effect for potential tax audit and uncertainty that the $152 million Carteret worthless stock tax deduction, (which did meet the uncertain tax position recognition test), could be disallowed in whole or in part by the tax authorities.

The Company believes that if any additional federal tax is owed as a result of any adjustments, these potential amounts would be reimbursable to the Company pursuant to the tax gross-up provision of the Settlement Agreement. As a result the Company recorded an indemnification asset of $18.4 million to reflect the net amount of the federal uncertain tax position reserve recognized, as noted above, which was recognized as other income in the Company's Consolidated Statement of Operations. The calculation of the net federal uncertain tax position reserve amount factors in the assumed use of the Company's remaining NOL carryforwards totaling $24.1 million and use of the Company's AMT Tax Credits of $21.0 million.

State income tax amounts for 2012 and 2011 are primarily attributable to a provision for a minimum tax on capital imposed by the state jurisdictions. In 2012, the Company reduced its state taxable income with the $152 million Carteret worthless stock deduction and through the utilization of $25 million of previously available state NOL carryforward deductions in the computation of the Company's 2012 state tax liability. Based on the state tax returns as filed the Company has approximately $1.9 million of NOL carryforward deductions remaining available for future use, which expire beginning in 2030. As noted herein above, pursuant to the accounting principles with regard to the recognition of uncertain tax positions, a portion of the uncertain tax position reserve as of December 31, 2012, is attributable to state taxes on the Settlement Amount which are not reimbursable to the Company as part of the Settlement Agreement.

AMBASE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

The Company has calculated a net deferred tax asset arising primarily from the tax effect of the federal NOL carryforwards and the AMT Credits noted above.

The net deferred tax asset is as follows:

	December 31, 2012		December 31, 2011
Net deferred tax asset	$	-	$	38,000,000
Valuation allowance		-		(38,000,000	)
Net deferred tax asset recognized	$	-	$	-

The net deferred tax asset amounts noted above do not include any tax effects of the NOL's generated from the Company's investment in Carteret. A valuation allowance has been established for the entire net deferred tax asset in 2011, as management, at the current time, has no basis to conclude that realization is more likely than not.

As a result of the Office of Thrift Supervision's December 4, 1992 placement of Carteret Savings Bank, F.A. in receivership, under the management of the Resolution Trust Corporation ("RTC")/Federal Deposit Insurance Corporation ("FDIC"), and then proposed Treasury Reg. §1.597-4(g), the Company had previously filed its 1992 and subsequent federal income tax returns with Carteret disaffiliated from the Company's consolidated federal income tax return. Based upon the impact of Treasury Reg. §1.597-4(g), which was issued in final form on December 20, 1995, a continuing review of the Company's tax basis in Carteret, and the impact of prior year tax return adjustments on the Company's 1992 federal income tax return as filed, the Company originally decided not to make an election pursuant to final Treasury Reg. §1.597-4(g) to disaffiliate Carteret from the Company's consolidated federal income tax return effective as of December 4, 1992 (the "Election Decision"). Based on the lack of availability of Carteret and Carteret FSB information from December 1992 forward, the resolution of the Supervisory Goodwill legal proceedings and the Settlement Agreement, the Company filed its 2012 income tax returns with Carteret/Carteret FSB deconsolidated from the Company operations from December 1992 forward.

The Company has made numerous requests to the RTC/FDIC for tax information pertaining to Carteret and the resulting successor institution, Carteret Federal Savings Bank ("Carteret FSB"); however, that information has not been received. Because the Carteret and Carteret FSB tax information has not been received, the Company is unable to determine with certainty the amount of or the years in which any NOL's may ultimately be generated; if the NOL carryforwards/carrybacks will be utilized in prior federal income tax return years; or the final expiration dates of any of the NOL carryforwards/carrybacks ultimately generated relating to the Election Decision noted herein.

Based on information received to date, and prior to the recognition of the 1992 tax losses reflected on the Company's 1992 amended federal income tax return, as further described herein, the Company estimated that as of December 1992 it had a remaining tax basis related to its investment in Carteret of approximately $152 million. Based on the Company's Election Decision, described herein, and the receipt of some of the requested information from the RTC/FDIC, the Company amended its 1992 consolidated federal income tax return to include the federal income tax effects of Carteret and Carteret FSB, (the "1992 Amended Return").

If the Company is successful in its appeal to the United States Court Appeals for the Second Circuit for the "Carryback Claims", the Company expects that the 1992 Amended Return will generate approximately $56 million of NOL's for tax year 1992, which the Company is seeking to carryback to prior tax years to produce refunds of tax previously paid. The 1992 Amended Return has not yet been accepted by the IRS. See "Carryback Claims," below for further information. As part of the 1992 Amended Return approximately $56 million (of the $152 million) of Carteret/Carteret FSB tax basis is expected to be converted into NOL's, in tax year 1992.

AMBASE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

If the Carteret worthless stock deduction is denied by the IRS, the Carteret/Carteret FSB tax basis of approximately $96 million remaining after recognition of the 1992 Amended Return, may be converted into NOL carryforwards/carrybacks as additional tax losses are incurred by Carteret/Carteret FSB and may be carried back or carried forward to other tax years; may be utilized in other tax years; or could begin to expire no earlier than the 2008 tax year based upon the year any NOL's are ultimately generated. The Company can give no assurances with regard to the 1992 Amended Return, subsequent year returns, or the final amount or expiration of NOL carryforwards/carrybacks ultimately generated, if any, from the Company's tax basis in Carteret/Carteret FSB. NOL's generated from the Company's tax basis in Carteret/Carteret FSB are in addition to the NOL carryforwards/carrybacks generated based on the Company's federal income tax returns as previously filed from 1993 forward, as further detailed above.

In March 2000, the Company filed with the IRS several carryback claims and amendments to previously filed carryback claims (the "Carryback Claims") seeking refunds from the IRS of alternative minimum tax and other federal income taxes paid by the Company in prior years plus applicable IRS interest, based on the filing of the 1992 Amended Return. The Company can give no assurances as to the final amount of refunds, if any, or when they might be received. The accompanying financial statements include no legal fees in connection with the Carryback Claims proceedings as these legal fees are payable pursuant to a contingent fee arrangement with the attorneys upon a final recovery received. For additional information, see Note 10 – Legal Proceedings.

The FDIC has previously filed a federal income tax return for Carteret FSB for 1995 (as well as other years), which indicates that Carteret FSB allegedly could owe a 1995 federal income tax liability of $32 million, which including interest and penalty thereon, is alleged to be in excess of $139 million. The FDIC has stated to the United States Court of Federal Claims ("Court of Claims") that the tax amounts are only estimates and are highly contingent. However, it is possible that the IRS may try to collect the alleged Carteret FSB federal income taxes from the Carteret FSB receivership.

The Company believes the Carteret FSB federal income tax returns filed by the FDIC were improperly filed and are neither accurate nor valid. Based on the information received to date, if the correct Carteret FSB federal income tax results were included with the Company's originally filed federal income tax returns, the Company, believes that no additional material federal income tax would be owed by the Company, although this cannot be assured because a contrary result is possible, given the uncertainty with various legal and factual assumptions underlying the Company's beliefs. This assessment included among other items a review of the Carteret FSB federal income tax returns as prepared by the FDIC and the correction of errors originally reported therein, the proper application of federal NOL carryforwards and carrybacks, and the adherence to statute of limitation provisions contained in the Internal Revenue Code, as amended.

As explained above, although the Company does not believe that Carteret FSB or the Company will have a material federal income tax liability related to Carteret FSB for tax year 1995 (or any other tax year), the Company can give no assurances of the final amounts, if any, of federal income taxes owed by the Carteret FSB receivership or by the Company as a result of the Carteret FSB receivership operations. Additionally, the Company believes that the Settlement Agreement, tax regulations and/or tax positions on the Company's tax returns as filed, would preclude additional tax owed resulting from the Carteret FSB receivership. The Company is pursuing the Carryback Claims, as further described above, which could have an impact on the analysis of the prior year tax information. The discussion of the Carteret FSB federal income tax results is intended to provide details as to the potential inter-relationship of the Carteret FSB federal income tax returns with the Company's federal income tax positions. It is not a reflection of any federal income tax liability of the Company arising from the Carteret receivership operations.