11. Income Taxes

Income Tax Expense

Income before income taxes consists of the following (in thousands):



	2012		2011		2010
Domestic	$	11,686	$	11,238	$	6,936
Foreign		366		228		341
Income before income taxes	$	12,052	$	11,466	$	7,277

Income tax expense consists of the following (in thousands):



	2012		2011		2010
Current:
Federal	$	2,778	$	2,634	$	4,415
State		180		103		255
Foreign		98		84		46
		3,056		2,821		4,716
Deferred:
Federal		1,274		1,087		(1,560)
State		(227)		183		158
Foreign		3		4		19
		1,050		1,274		(1,383)
Income tax expense	$	4,106	$	4,095	$	3,333

The Company’s income tax expense in 2012, 2011, and 2010 included the Company’s federal, state, and foreign tax obligations. The Company’s effective income tax rate was approximately 34%, 36%, and 46% for the years ended December 31, 2012, 2011, and 2010, respectively. The Company’s income tax rate for the year ended December 31, 2012 was favorably impacted by $427,000 in adjustments to valuation allowances on certain of the Company’s state net operating loss carryforwards, based on revised estimates of utilization of these carryforwards. The Company’s income tax rates were also impacted by the unfavorable tax treatment of certain acquisition related expenses due to the acquisition of Hemosphere and by the research and development tax credit, which had not been enacted for the 2012 tax year. The Company’s effective income tax rate for the year ended December 31, 2011 was impacted by the discrete and favorable effect of deductions taken on the Company’s 2010 federal tax returns, which were filed in the third quarter of 2011. This favorable effect was largely offset by the unfavorable tax treatment, recognized in the second quarter of 2011, of certain acquisition related expenses, which the Company incurred related to its acquisition of Cardiogenesis.

The income tax expense amounts differ from the amounts computed by applying the U.S. federal statutory income tax rate of 35% to pretax income as a result of the following (in thousands):



	2012		2011		2010
Tax expense at statutory rate	$	4,220	$	4,013	$	2,547
Increase (reduction) in income taxes resulting from:
Non-deductible transaction costs		151		540		--
State income taxes, net of federal benefit		296		150		347
State valuation allowance adjustment		(427)		100		--
Equity compensation		32		149		334
Non-deductible entertainment expenses		188		142		129
Foreign income taxes		(199)		3		28
Domestic production activities deduction		(407)		(727)		--
Research and development credit		--		(314)		(187)
Other		252		39		135
	$	4,106	$	4,095	$	3,333

Deferred Taxes

The Company generates deferred tax assets primarily as a result of write-downs of deferred preservation costs, inventory, and in-process research and development; accruals for tissue processing and product liability claims; asset impairments; and, in prior periods, due to operating losses. The Company acquired significant deferred tax assets, primarily net operating loss carryforwards, from its acquisitions of Hemosphere and Cardiogenesis in the second quarters of 2012 and 2011, respectively. See Note 4 and Note 6 for a further discussion of the Company’s acquisitions of Hemosphere and Cardiogenesis, respectively.

The tax effects of temporary differences which give rise to deferred tax assets and liabilities at December 31 are as follows (in thousands):



	2012		2011
Deferred tax assets:
Allowance for bad debts	$	194	$	151
Deferred preservation costs and inventory reserves		392		699
Investment in equity securities		925		802
Property		2,644		2,380
Intangible assets		502		--
Accrued expenses		3,782		2,859
Loss carryforwards		17,539		11,842
Credit carryforwards		2,166		4,124
Stock compensation		2,319		1,636
Other		969		717
Less valuation allowance		(2,292)		(2,395)
Total deferred tax assets		29,140		22,815

Deferred tax liabilities:
Prepaid items		(314)		(348)
Intangible assets		(5,814)		(3,935)
Other		(348)		(20)
Total deferred tax liabilities		(6,476)		(4,303)

Total net deferred tax assets	$	22,664	$	18,512

As of December 31, 2012 the Company maintained a total of $2.3 million in valuation allowances against deferred tax assets, related to state net operating loss carryforwards, and a net deferred tax asset of $22.7 million. As of December 31, 2011 the Company maintained a total of $2.4 million in valuation allowances against deferred tax assets, related to state net operating loss carryforwards, and a net deferred tax asset of $18.5 million.

As of December 31, 2012 the Company had approximately $3.4 million of tax-effected state net operating loss carryforwards that began to expire in 2012, $61,000 in research and development tax credit carryforwards that will begin to expire in 2022, and $167,000 in credits from the state of Texas that will fully expire by 2027. Additionally, at December 31, 2012 the Company had $1.9 million in alternative minimum tax credit carryforwards that do not expire.

Uncertain Tax Positions

A reconciliation of the beginning and ending balances of the Company’s uncertain tax position liability, excluding interest and penalties, is as follows (in thousands):



	2012		2011		2010
Beginning balance	$	1,788	$	1,822	$	1,742
Decreases related to prior year tax positions		(15)		(112)		(19)
Increases related to current year tax positions		231		78		99
Ending balance	$	2,004	$	1,788	$	1,822

A reconciliation of the beginning and ending balances of the Company’s liability for interest and penalties on uncertain tax positions is as follows (in thousands):



	2012		2011		2010
Beginning balance	$	418	$	391	$	342
Accrual of interest and penalties		79		65		49
Decreases related to prior year tax positions		(8)		(38)		--
Ending balance	$	489	$	418	$	391

As of December 31, 2012 the Company’s total uncertain tax liability, including interest and penalties of $2.5 million, was recorded as a reduction to deferred tax assets of $103,000 and a non-current liability of $2.4 million on the Company’s Consolidated Balance Sheet. As of December 31, 2011 the Company’s total uncertain tax liability, including interest and penalties of $2.2 million, was recorded as a reduction to deferred tax assets of $309,000 and a non-current liability of $1.9 million on the Company’s Consolidated Balance Sheet.

Other

The Company’s tax years 2009 through 2012 generally remain open to examination by the major taxing jurisdictions to which the Company is subject. However, certain returns from years prior to 2009, in which net operating losses and tax credits have arisen, are still open for examination by the tax authorities.