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,
	2012			2011		2010
Current:
U.S. Federal	$	24,246		$	30,458	$	33,142
State	6,185			8,313		101
	$	30,431		$	38,771	$	33,243
Deferred:
U.S. Federal	$	(5,779	)	$	7,765	$	(3,381	)
State	(1,557		)	1,601		1,624
	(7,336		)	9,366		(1,757		)
Total	$	23,095		$	48,137	$	31,486

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



	December 31, 2012					December 31, 2011
	Deferred Tax Assets			Deferred Tax Liabilities		Deferred Tax Assets			Deferred Tax Liabilities
Excess of tax basis over book basis- non-consolidated entities	$	3,654		$	—	$	4,488		$	—
Employee benefit accruals	15,125			—		16,418			—
Book/tax differences on fixed and Intangible assets	—			45,439		—			41,616
Book/tax differences on inventory	—			18,165		—			20,865
Book/tax differences on long-term investments	1			—		22			—
Impact of accounting on convertible debt	—			40,040		—			15,990
Impact of timing of settlement payments	31,407			—		38,164			—
Various U.S. state tax loss carryforwards	10,854			—		14,428			—
Other	31,020			33,187		10,200			18,056
Valuation allowance	(6,310		)	—		(9,752		)	—
	$	85,751		$	136,831	$	73,968		$	96,527

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 $6,310 and $9,752 at December 31, 2012 and 2011, 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 2012, 2011 and 2010 as a result of reclassifications between current and deferred tax liabilities. The deferred tax benefit in 2012 results primarily from the non-cash interest charges associated with the Company's convertible debt partially offset by the recognition of temporary differences (related to depreciation and amortization) at the Liggett and Vector Tobacco segments. The deferred tax expense in 2011 results from temporary differences related primarily to bonus depreciation for federal tax purposes at the Liggett segment. The deferred tax benefit in 2010 results from the recognition of various temporary differences at the Liggett segment.

The valuation allowance was reduced in 2012 and 2011, respectively, as a result of changes in estimates 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,
	2012			2011			2010
Income before income taxes	$	53,717		$	123,157		$	85,570
Federal income tax expense at statutory rate	18,801			43,105			29,950
Increases (decreases) resulting from:
State income taxes, net of federal income tax benefits	3,009			6,444			1,121
Non-deductible expenses	3,311			1,974			1,491
Impact of domestic production deduction	(2,026		)	(4,256		)	(654		)
Tax credits	—			—			(25		)
Changes in valuation allowance, net of equity and tax audit adjustments	—			870			(397		)
Income tax expense	$	23,095		$	48,137		$	31,486

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



Balance at January 1, 2010	$	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 prior years	250
Expirations of the statute of limitations	(421		)
Balance at December 31, 2011	6,597
Additions based on tax positions related to prior years	588
Expirations of the statute of limitations	(916		)
Balance at December 31, 2012	$	6,269

In the event the unrecognized tax benefits of $6,269 and $6,597 at December 31, 2012 and 2011, respectively, were recognized, such recognition would impact the annual effective tax rates. During 2012, the accrual for potential penalties and interest related to these unrecognized tax benefits was increased by $149, and in total, as of December 31, 2012, a liability for potential penalties and interest of $1,653 has been recorded. 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.

It is reasonably possible the Company may recognize up to approximately $3,562 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 2012, the Internal Revenue Service concluded an audit of the Company’s income tax return for the year ended December 31, 2008. 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 2009 tax year. The Company believes it has adequately reserved for any potential adjustments that may arise as a result of the audit.