Note 3. Taxation

12 Months Ended

Dec. 31, 2011

Income Tax Disclosure [Text Block]

3.   TAXATION

The components of income (loss) before taxes for the years ended December 31 are as follows:

Origin of income (loss) before taxes	2011		2010			2009
United States	$	8,244	$	4,144		$	(3,378	)
Foreign		1,013		(458	)		(32	)
Income (loss) before taxes	$	9,257	$	3,686		$	(3,410	)

Significant components of income tax expense (benefit) for the years ended December 31 are as follows:

	2011		2010			2009
Current:
Federal	$	1,456	$	2,520		$	195
State		402		414			28
Foreign		482		103			-
Total current		2,340		3,037			223
Deferred:
Federal		674		(1,051	)		(1,219	)
State		95		(97	)		(108	)
Foreign		-		44			-
Total deferred		769		(1,104	)		(1,327	)
Income tax expense (benefit)	$	3,109	$	1,933		$	(1,104	)

A reconciliation between the provision for income taxes calculated at the U.S. federal statutory income tax rate and the consolidated income tax expense (benefit) in the consolidated statements of operations for the years ended December 31 is as follows:

	2011			2010			2009
Provision at the U.S. federal statutory rate		34.0	%		35.0	%		(35.0	)%
State taxes, net of federal benefit		3.2	%		3.9	%		(2.2	)%
Foreign tax rate differential		(1.2	%)		0.6	%		0.3	%
Valuation allowance		2.7	%		6.5	%		0.0	%
Research credits		(6.5	%)		0.0	%		(1.8	)%
Stock-based compensation		0.0	%		4.4	%		4.1	%
Other		1.4	%		2.0	%		2.2	%
Income tax expense (benefit) effective rate		33.6	%		52.4	%		(32.4	)%

The deferred tax assets and liabilities at December 31 are as follows:

	2011			2010
Deferred tax assets:
Stock compensation expense	$	7,734		$	7,442
Alternative minimum tax credit		71			-
Warranty reserve		118			82
Accounts receivable		161			31
Vacation accrual		118			80
Commissions and other accruals		-			177
Deferred rent liability		47			52
Intangible assets		603			403
Net operating loss carryforwards		1,327			1,102
Total deferred tax assets		10,179			9,369
Deferred tax liabilities:
Equipment		(1,513	)		(1,243	)
Prepaid expenses		(285	)		(110	)
Patents		(384	)		(195	)
Goodwill		(2,689	)		(1,630	)
Other		(20	)		-
Total deferred tax liabilities		(4,891	)		(3,178	)
Net deferred tax asset before valuation allowance		5,288			6,191
Valuation allowances for deferred tax assets		(1,327	)		(1,102	)
Net deferred tax asset	$	3,961		$	5,089

Net deferred tax assets and liabilities are recorded as follows within the consolidated balance sheets:

Current assets	$	163	$	89
Long-term assets		3,798		5,000
Net deferred tax asset	$	3,961	$	5,089

The change in the valuation allowance for deferred tax assets for the years ended December 31 is as follows:

Year	Balance at January 1		Charged to costs and expenses		(Deductions)/Other			Balance at December 31
2009	$	1,421		-		(244	)	$	1,177
2010	$	1,177		-		(75	)	$	1,102
2011	$	1,102		-		225		$	1,327

For the years ended December 31, 2011 and 2010, Fuel Tech recorded tax benefits from the exercise of stock options in the amount of $77 and $0, respectively.  The amounts were recorded as an increase in additional paid-in capital on the consolidated balance sheets and as cash from financing activities on the consolidated statements of cash flows.   Fuel Tech also reduced the deferred tax asset related to stock based compensation by $335 and $318 for fully vested options that expired unexercised during 2011 and 2010, respectively.  This reduction in the deferred tax asset was recorded against additional paid-in capital and had no impact on our results from operations.

As required by ASC 740, Fuel Tech recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit.  For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority.

The following table summarizes Fuel Tech’s unrecognized tax benefit activity (excluding interest and penalties) during the years ended December 31, 2011, 2010, and 2009:

Description	2011			2010			2009
Balance at beginning of period	$	664		$	724		$	713
Increases in positions taken in a prior period		-			-			11
Decreases in positions taken in a prior period		-			-			-
Increases in positions taken in a current period		117			60			-
Decreases in positions taken in a current period		-			-			-
Decreases due to settlements		-			-			-
Decreases due to lapse of statute of limitations		(276	)		(120	)		-
Balance at end of period	$	505		$	664		$	724

The amount of interest and penalties that we recognized in income tax expense during the years ended December 31, 2011, 2010, and 2009 was $162, $206, and $146, respectively. The total amount of unrecognized tax benefits as of December 31, 2011, 2010, and 2009, including interest and penalties, was $667, $870 and $870, respectively, all of which if ultimately recognized will reduce Fuel Tech’s annual effective tax rate.  We estimate that $398 of this unrecognized tax benefit will be recognized into income in 2012 due to the lapsing of statute of limitations.

Fuel Tech recognizes interest and penalties related to unrecognized tax benefits in income tax expense for all periods presented.  At December 31, 2011, 2010, and 2009, Fuel Tech had accrued approximately $162, $206, and $146, respectively, for the payment of interest and penalties.

Fuel Tech is subject to income taxes in the U.S. federal jurisdiction, and various states and foreign jurisdictions.  Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply.  With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before 2008. The Company is currently undergoing examination in the U.S. for the 2009 and 2010 tax years with anticipated completion occurring in 2012.

The management of Fuel Tech periodically estimates the probable tax obligations of the Company using historical experience in tax jurisdictions and informed judgments.  There are inherent uncertainties related to the interpretation of tax regulations in the jurisdictions in which we transact business. The judgments and estimates made at a point in time may change based on the outcome of tax audits, as well as changes to or further interpretations of regulations.  If such changes take place, there is a risk that the tax rate may increase or decrease in any period.  Tax accruals for tax liabilities related to potential changes in judgments and estimates for both federal and state tax issues are included in current liabilities on the consolidated balance sheet.

At December 31, 2011, Fuel Tech has tax loss carry-forwards of approximately $4,825 available to offset future foreign income in Italy. We have recorded a full valuation allowance against the resulting $1,327 deferred tax asset because we cannot anticipate when or if this entity will have taxable income sufficient to use the net operating losses in the future. There is no expiration of the net operating loss carry-forwards related to tax losses generated during the first three years of this entity’s operations.  The portion of the foreign loss carry-forwards related to periods subsequent to the first three years of operations have a five year carry-forward period and will begin to expire in 2012 if not used by that date.