INCOME TAXES

The Company files a consolidated U.S. income tax return that includes its more than 80%-owned U.S. subsidiaries. The amounts provided for income taxes are as follows:



	Year Ended December 31,
	2011		2010			2009
Current:
U.S. Federal	$	30,458	$	33,142		$	94,640
State	8,313		101			19,274
	$	38,771	$	33,243		$	113,914
Deferred:
U.S. Federal	$	7,765	$	(3,381	)	$	(85,158	)
State	1,601		1,624			(25,025		)
	9,366		(1,757		)	(110,183		)
Total	$	48,137	$	31,486		$	3,731

The tax effect of temporary differences which give rise to a significant portion of deferred tax assets and liabilities are as follows:



	December 31, 2011					December 31, 2010
	Deferred Tax Assets			Deferred Tax Liabilities		Deferred Tax Assets			Deferred Tax Liabilities
Excess of tax basis over book basis- non-consolidated entities	$	4,488		$	—	$	10,603		$	—
Employee benefit accruals	16,418			—		10,701			—
Book/tax differences on fixed and Intangible assets	—			41,616		—			34,293
Book/tax differences on inventory	—			20,865		—			21,589
Book/tax differences on long-term investments	22			—		7,067			—
Impact of accounting on convertible debt	—			15,990		—			16,155
Impact of timing of settlement payments	38,164			—		26,962			—
Various U.S. state tax loss carryforwards	14,428			—		14,496			—
Other	10,200			18,056		10,075			16,742
Valuation allowance	(9,752		)	—		(10,290		)	—
	$	73,968		$	96,527	$	69,614		$	88,779

The Company provides a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The valuation allowance of $9,752 and $10,290 at December 31, 2011 and 2010, respectively, consisted primarily of a reserve against various state and local net operating loss carryforwards, primarily resulting from Vector Tobacco’s losses.

The consolidated balance sheets of the Company include deferred income tax assets and liabilities, which represent temporary differences in the application of accounting rules established by generally accepted accounting principles and income tax laws.

Deferred federal income tax expense differs in 2011, 2010 and 2009 as a result of reclassifications between current and deferred tax liabilities. The deferred federal tax benefit in 2009 related to the recognition of a previously deferred gain in 2009 and the reduction of a valuation allowance in 2009. The deferred tax benefit in 2010 results from the recognition of various temporary differences at the Liggett segment. The deferred tax expense in 2011 results from temporary differences related primarily to bonus depreciation for federal tax purposes at the Liggett segment.

The valuation allowance was reduced in 2009 for the recognition of state tax net operating losses at Vector Tobacco after evaluating the impact of the negative and positive evidence that such asset would be realized. The Company based its conclusion on the fact that Vector Tobacco reported state taxable income on a separate company basis for the second consecutive year in 2009. The valuation allowance was increased in 2010 as a result of changes in Vector Tobacco’s state tax apportionment in 2010 which decreased Vector Tobacco’s ability to utilize state tax net operating losses in future years. The valuation allowance was reduced in 2011 as a result of estimated increases in Vector Tobacco's ability to utilize state tax net operating losses in future years because of changes in state tax apportionment and projected taxable income.

Differences between the amounts provided for income taxes and amounts computed at the federal statutory tax rate are summarized as follows:



	Year Ended December 31,
	2011			2010			2009
Income before income taxes	$	123,157		$	85,570		$	28,537
Federal income tax expense at statutory rate	43,105			29,950			9,988
Increases (decreases) resulting from:
State income taxes, net of federal income tax benefits	6,444			1,121			261
Non-deductible expenses	1,974			1,491			1,682
Impact of domestic production deduction	(4,256		)	(654		)	(1,201		)
Tax credits	—			(25		)	(833		)
Equity and other adjustments	—			—			—
Changes in valuation allowance, net of equity and tax audit adjustments	870			(397		)	(6,166		)
Income tax expense	$	48,137		$	31,486		$	3,731

The following table summarizes the activity related to the unrecognized tax benefits:



Balance at January 1, 2009	$	7,503
Additions based on tax positions related to current year	3,380
Additions based on tax positions related to prior years	2,619
Reductions based on tax positions related to prior years	(550		)
Settlements	(903		)
Expirations of the statute of limitations	(1,833		)
Balance at December 31, 2009	10,216
Additions based on tax positions related to current year	847
Additions based on tax positions related to prior years	1,178
Reductions based on tax positions related to prior years	(2,303		)
Settlements	(1,076		)
Expirations of the statute of limitations	(2,094		)
Balance at December 31, 2010	6,768
Additions based on tax positions related to current year	—
Additions based on tax positions related to prior years	250
Reductions based on tax positions related to prior years	—
Settlements	—
Expirations of the statute of limitations	(421		)
Balance at December 31, 2011	$	6,597

In the event the unrecognized tax benefits of $6,597 and $6,768 at December 31, 2011 and 2010, respectively, were recognized, such recognition would impact the annual effective tax rates. During 2011, the accrual for potential penalties and interest related to these unrecognized tax benefits was increased by $413, and in total, as of December 31, 2011, a liability for potential penalties and interest of $1,504 has been recorded. During 2010, the accrual for potential penalties and interest related to these unrecognized tax benefits was reduced by $2,444, and in total, as of December 31, 2010, a liability for potential penalties and interest of $1,091 has been recorded.

It is reasonably possible the Company may recognize up to approximately $250 of currently unrecognized tax benefits over the next 12 months, pertaining primarily to expiration of statutes of limitations of positions reported on state and local income tax returns. The Company files U.S. and state and local income tax returns in jurisdictions with varying statutes of limitations.

In 2009, the Internal Revenue Service concluded an audit of the Company’s income tax return for the year ended December 31, 2005. There was no material impact on the Company’s consolidated financial statements as a result of the audit. The Internal Revenue Service is auditing the Company's 2008 and 2009 tax years. The Company believes it has adequately reserved for any potential adjustments that may arise as a result of the audit.