7. Income Taxes

The components of the income tax expense (benefit) for the years ended December 31, consist of the following:

	(in thousands)
Current:	2012		2011			2010
Federal	$	-	$	-		$	158
State		196		204			247
Deferred:
Federal		-		(1,249	)		(5,545	)
State		7		(1,073	)		(431	)
Total expense (benefit)	$	203	$	(2,118	)	$	(5,571	)

State income tax is presented net of the related federal tax benefit or provision.

Frozen Food Express Industries, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

Reconciliation between the statutory tax rate and the effective tax rate for the years ended December 31, is as follows:

	(in thousands)
	2012			2011			2010
Income tax benefit at statutory federal rate	$	(5,199	)	$	(13,576	)	$	(6,125	)
Federal income tax effects of:
Non-deductible driver per-diem payments		397			438			752
Non-taxable life insurance transactions		(15	)		(75	)		(10	)
State income taxes and other		(167	)		(907	)		(188	)
Valuation allowance		5,187			12,002			-
Total expense (benefit)	$	203		$	(2,118	)	$	(5,571	)
Effective tax rate		(1.4	)%		5.5	%		31.8	%

For 2012, our effective tax rate was (1.4)%, as compared to 5.5% in 2011, and 31.8% in 2010. Our effective tax rate differs from federal and state statutory rates because of taxable and non-taxable components of our pre-tax income. Non-deductible items consist primarily of certain expenses incurred by our employee-drivers in the course of their duties. We believe that our assumptions and estimates are reasonable, although actual results may have a positive or negative material impact on the balances of deferred tax assets and liabilities, valuation allowances or net income. We will apply judgment to determine the amount of valuation allowance, if any, that would be required in any given period. We will continue to assess whether we will realize all, part, or none of the deferred tax assets. Due to cumulative losses and our operating results for the year ended December 31, 2012, our valuation allowance, which relates to federal and state deferred tax assets, was increased to $17.1 million as of December 31, 2012. The remaining net deferred tax assets relate to indefinite lived credits and credits that are being utilized on an annual basis. As of December 31, 2012 and 2011, our deferred tax assets and liabilities consisted of the following:

	(in thousands)
Deferred tax assets:	2012			2011
Insurance claims accruals	$	5,754		$	6,096
Allowance for bad debts		631			1,016
Capital lease obligations		829			1,033
Deferred compensation		403			388
Federal and state net operating loss carry forwards		20,623			15,399
Other		1,273			1,350
Gross deferred tax assets		29,513			25,282
Valuation allowance		(17,077	)		(12,002	)
Total deferred tax assets		12,436			13,280

Deferred tax liabilities:
Capital lease obligations		(780	)		(1,034	)
Depreciation		(7,084	)		(8,687	)
Prepaid expenses		(4,260	)		(3,240	)
Total deferred tax liabilities		(12,124	)		(12,961	)
Net deferred tax assets (liabilities)	$	312		$	319

During 2012, there were exercises or lapses in stock options that resulted in tax deductions that were $112,000 less than the previously recorded deferred tax assets. These shortfalls would generally be recorded through income tax expense. However, due to the full valuation allowance, there was no income statement impact. The deferred tax assets were reduced with a corresponding reduction in the valuation allowance through a reclassification on the balance sheet in accordance with ASC 718-740-35-5.

Tax refunds were $496,000, $79,000 and $4.8 million for 2012, 2011 and 2010, respectively. Taxes paid were $231,000, $236,000, and $397,000 in 2012, 2011, and 2010, respectively. Federal gross operating loss carry forwards of $49.9 million will begin to expire in 2028.

We generated significant taxable income and paid significant federal income taxes during 2004 and 2005. The U.S. Worker, Homeownership, and Business Assistance Act of 2009 allowed us to "carry back" our 2009 net operating loss to offset the taxes we incurred and paid for these years.

Frozen Food Express Industries, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

Exercises of stock options that generate tax deductions in excess of previously recorded deferred tax assets result in a "windfall". Although these excess deductions or "windfalls" result in net operating tax loss carry forwards per the Company's federal and state returns, the additional tax benefit is not allowed until the deduction reduces actual taxes payable. At December 31, 2012, windfall tax benefits included in net operating loss carry forwards per the tax return but not reflected in deferred tax assets are $111,000.

Under US GAAP for accounting for uncertainty in income taxes, the Company has analyzed filing positions in its federal tax returns for all open years. The open periods subject to examination for its federal returns are 2009, 2010 and 2011. During 2012, the Internal Revenue Service examined the 2010 federal tax return. The auditor performing the examination issued a "No Change" letter indicating there would be no adjustments to the 2010 return as a result of the examination. The Company also files tax returns in numerous state jurisdictions with varying statutes of limitations. The Company's policy is to recognize interest related to unrecognized tax benefits and penalties as other miscellaneous expenses.