Income Taxes:

The significant components of the Provision for income tax expense related to continuing operations are as follows (in millions):



	For the Year Ended December 31,
	2013			2012			2011
Current:
Federal	$	0.9		$	0.7		$	1.4
State and local	5.4			5.2			(0.8		)
Total current expense	6.3			5.9			0.6
Deferred:
Federal	11.3			104.2			48.2
State and local	(4.9		)	(1.5		)	(11.7		)
Total deferred expense	6.4			102.7			36.5
Total income tax expense related to continuing operations	$	12.7		$	108.6		$	37.1

A reconciliation of differences between the federal income tax at statutory rates and our actual income tax expense on our income from continuing operations, which include federal, state, and other income taxes, is presented below:



	For the Year Ended December 31,
	2013		2012		2011
Tax expense at statutory rate	35.0	%	35.0	%	35.0	%
Increase (decrease) in tax rate resulting from:
State income taxes, net of federal tax benefit	4.0	%	3.7	%	3.0	%
Decrease in valuation allowance	(2.3	)%	(2.8	)%	(11.6	)%
Settlement of tax claims	(28.7	)%	0.3	%	(7.2	)%
Noncontrolling interests	(5.1	)%	(5.1	)%	(6.5	)%
Adjustments to net operating loss carryforwards	—	%	—	%	2.9	%
Interest, net	(0.1	)%	(0.2	)%	(1.6	)%
Other, net	0.4	%	1.0	%	1.3	%
Income tax expense	3.2	%	31.9	%	15.3	%

In April 2013, we entered into closing agreements with the IRS that settled federal income tax matters related to the previous restatement of our 2000 and 2001 financial statements, as well as certain other tax matters, through December 31, 2008. As a result of these closing agreements, we increased our deferred tax assets, primarily our federal net operating loss carryforward (“NOL”), and recorded a net federal income tax benefit of approximately $115 million in the second quarter of 2013. This federal income tax benefit primarily resulted from an approximate $283 million increase to our federal NOL on a gross basis.

The Provision for income tax expense in 2013 is less than the federal statutory rate primarily due to: (1) the IRS settlement discussed above, (2) the impact of noncontrolling interests, and (3) a decrease in our valuation allowance, as discussed below, offset by (4) state income tax expense. See Note 1, Summary of Significant Accounting Policies, “Income Taxes,” for a discussion of the allocation of income or loss related to pass-through entities, which is referred to as the impact of noncontrolling interests in the above table.

The Provision for income tax expense in 2012 is less than the federal statutory rate primarily due to: (1) the impact of noncontrolling interests and (2) a decrease in the valuation allowance, as discussed below, offset by (3) state income tax expense.

The Provision for income tax expense in 2011 is less than the federal statutory rate primarily due to: (1) an approximate $28 million benefit associated with a current period net reduction in the valuation allowance and (2) an approximate $18 million net benefit associated with settlements with various taxing authorities including the settlement of federal income tax claims with the Internal Revenue Service for tax years 2007 and 2008 offset by (3) approximately $7 million of net expense primarily related to corrections to 2010 deferred tax assets associated with our NOLs and corresponding valuation allowance. See Note 1, Summary of Significant Accounting Policies, “Out-of-Period Adjustments.”

Deferred income taxes recognize the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes and the impact of available NOLs. The significant components of HealthSouth’s deferred tax assets and liabilities are presented in the following table (in millions). See also Note 1, Summary of Significant Accounting Policies, “Reclassifications.”



	As of December 31,
	2013			2012
Deferred income tax assets:
Net operating loss	$	416.5		$	432.5
Property, net	44.3			40.3
Insurance reserve	28.5			30.7
Stock-based compensation	26.8			26.8
Allowance for doubtful accounts	15.3			14.9
Alternative minimum tax	11.1			11.9
Carrying value of partnerships	19.8			14.7
Other accruals	19.0			18.9
Capital losses	1.2			6.5
Other	2.0			0.4
Total deferred income tax assets	584.5			597.6
Less: Valuation allowance	(30.7		)	(39.8		)
Net deferred income tax assets	553.8			557.8
Deferred income tax liabilities:
Intangibles	(29.2		)	(26.5		)
Convertible debt interest	(28.0		)	—
Other	(3.3		)	(0.3		)
Total deferred income tax liabilities	(60.5		)	(26.8		)
Net deferred income tax assets	493.3			531.0
Less: Current deferred tax assets	139.0			137.5
Noncurrent deferred tax assets	$	354.3		$	393.5

At December 31, 2013, we had an unused federal NOL of $325.1 million (approximately $929.0 million on a gross basis) and state NOLs of $91.4 million. Such losses expire in various amounts at varying times through 2031. Our reported federal NOL as of December 31, 2013 excludes $8.6 million related to operating loss carryforwards resulting from excess tax benefits related to share-based awards, the tax benefits of which, when recognized, will be accounted for as a credit to additional paid-in-capital when they reduce taxes payable.

For the years ended December 31, 2013, 2012, and 2011, the net decreases in our valuation allowance were $9.1 million, $10.5 million, and $62.4 million, respectively. The decrease in our valuation allowance in 2013 related primarily to our capital loss carryforwards, our current forecast of future earnings in each jurisdiction, and changes in certain state tax laws. During the second quarter of 2013, we determined a valuation allowance related to our capital loss carryforwards was no longer required as sufficient positive evidence existed to substantiate their utilization. This evidence included our partial utilization of these assets as a result of realizing capital gains in 2013 and the identification of sufficient taxable capital gain income within the available capital loss carryforward period. Substantially all of the decrease in the valuation allowance in 2012 and approximately $21 million of the decrease in the valuation allowance during 2011 related primarily to our determination it is more likely than not a substantial portion of our deferred tax assets will be realized in the future. In addition, approximately $34 million of the decrease in the valuation allowance in 2011 was due to the corrections made to the valuation allowance, as discussed above. Approximately $7 million of the decrease in the valuation allowance in 2011 resulted from our settlement with the IRS for tax years 2007 and 2008 which enabled us to utilize certain capital losses previously offset by a valuation allowance.

As of December 31, 2013, we have a remaining valuation allowance of $30.7 million. This valuation allowance remains recorded due to uncertainties regarding our ability to utilize a portion of our state NOLs before they expire. The amount of the valuation allowance has been determined for each tax jurisdiction based on the weight of all available evidence including management’s estimates of taxable income for each jurisdiction in which we operate over the periods in which the related deferred tax assets will be recoverable. It is possible we may be required to increase or decrease our valuation allowance at some future time if our forecast of future earnings varies from actual results on a consolidated basis or in the applicable state tax jurisdictions, or if the timing of future tax deductions differs from our expectations.

Our utilization of NOLs could be subject to limitations under Internal Revenue Code Section 382 (“Section 382”) and may be limited in the event of certain cumulative changes in ownership interests of significant stockholders over a three-year period exceed 50%. Section 382 imposes an annual limitation on the use of certain carryforward losses to an amount that approximates the value of a company at the time of an ownership change multiplied by the long-term tax exempt rate. At this time, we do not believe these limitations will restrict our ability to use any NOLs before they expire. However, no such assurances can be provided.

As of January 1, 2011, total remaining gross unrecognized tax benefits were $12.6 million, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax benefits was $1.1 million as of January 1, 2011. The amount of unrecognized tax benefits changed during 2011 primarily due to the settlement of federal income tax claims with the IRS for tax years 2007 and 2008 and the lapse of the applicable statute of limitations for certain federal and state claims. Total remaining gross unrecognized tax benefits were $6.0 million as of December 31, 2011, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax benefits as of December 31, 2011 was $0.1 million. The amount of unrecognized tax benefits changed during 2012 primarily based on our then ongoing discussions with taxing authorities as part of our continued pursuit of the maximization of our tax benefits, primarily related to our federal NOL. Total remaining gross unrecognized tax benefits were $78.0 million as of December 31, 2012, $76.0 million of which would affect our effective tax rate if recognized. The amount of unrecognized tax benefits changed during 2013 primarily due to the April 2013 IRS settlement discussed above. Total remaining gross unrecognized tax benefits were $1.1 million as of December 31, 2013, $0.4 million of which would affect our effective tax rate if recognized.

A reconciliation of the beginning and ending liability for unrecognized tax benefits is as follows (in millions):



	Gross Unrecognized Income Tax Benefits			Accrued Interest and Penalties
January 1, 2011	$	12.6		$	1.1
Gross amount of increases in unrecognized tax benefits related to prior periods	19.8			—
Gross amount of decreases in unrecognized tax benefits related to prior periods	(3.0		)	—
Decreases in unrecognized tax benefits relating to settlements with taxing authorities	(20.2		)	—
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations	(3.2		)	(1.0		)
December 31, 2011	6.0			0.1
Gross amount of increases in unrecognized tax benefits related to prior periods	75.8			—
Gross amount of decreases in unrecognized tax benefits related to prior periods	(2.5		)	—
Decreases in unrecognized tax benefits relating to settlements with taxing authorities	(0.9		)	—
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations	(0.4		)	(0.1		)
December 31, 2012	78.0			—
Gross amount of increases in unrecognized tax benefits related to prior periods	46.7			0.3
Gross amount of decreases in unrecognized tax benefits related to prior periods	(1.9		)	—
Decreases in unrecognized tax benefits relating to settlements with taxing authorities	(121.7		)	—
December 31, 2013	$	1.1		$	0.3

Our continuing practice is to recognize interest and penalties related to income tax matters in income tax expense. For the years ended December 31, 2013, 2012, and 2011, we recorded $0.2 million, $0.7 million, and $4.7 million of net interest income, respectively, primarily related to amended state income tax returns, as part of our income tax provision. Total net accrued interest (expense) income was $(0.1) million and $0.2 million as of December 31, 2013 and 2012, respectively.

HealthSouth and its subsidiaries’ federal and state income tax returns are periodically examined by various regulatory taxing authorities. In connection with such examinations, we have settled federal income tax examinations with the IRS for all tax years through 2010. We are currently under audit by two states for tax years ranging from 2007 through 2011.

For the tax years that remain open under the applicable statutes of limitations, amounts related to these unrecognized tax benefits have been considered by management in its estimate of our potential net recovery of prior years’ income taxes. We do not expect a material change in our unrecognized tax benefits within the next 12 months due to the closing of the applicable statutes of limitation.