Note 3 - Taxation

12 Months Ended

Dec. 31, 2012

Income Tax Disclosure [Text Block]

3.      TAXATION

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

Origin of income before taxes	2012			2011		2010
United States	$	5,655		$	8,244	$	4,144
Foreign		(577	)		1,013		(458	)
Income before taxes	$	5,078		$	9,257	$	3,686

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

	2012			2011		2010
Current:
Federal	$	1,529		$	1,456	$	2,520
State		425			402		414
Foreign		471			482		103
Total current		2,425			2,340		3,037
Deferred:
Federal		9			674		(1,051	)
State		1			95		(97	)
Foreign		(133	)		-		44
Total deferred		(123	)		769		(1,104	)
Income tax expense	$	2,302		$	3,109	$	1,933

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

	2012			2011			2010
Provision at the U.S. federal statutory rate		34.0	%		34.0	%		35.0	%
State taxes, net of federal benefit		4.2	%		3.2	%		3.9	%
Foreign tax rate differential		0.0	%		(1.2	%)		0.6	%
Valuation allowance		10.5	%		2.7	%		6.5	%
Research credits		(10.0	%)		(6.5	%)		0.0	%
Stock-based compensation		0.3	%		0.0	%		4.4	%
Other		6.3	%		1.4	%		2.0	%
Income tax expense effective rate		45.3	%		33.6	%		52.4	%

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

	2012			2011
Deferred tax assets:
Stock compensation expense	$	7,936		$	7,734
Alternative minimum tax credit		71			71
Warranty reserve		291			118
Accounts receivable		65			161
Vacation accrual		157			118
Commissions and other accruals		205			-
Deferred rent liability		53			47
Equipment		69			-
Intangible assets		778			603
Net operating loss carryforwards		1,868			1,327
Total deferred tax assets		11,493			10,179
Deferred tax liabilities:
Equipment		(1,466	)		(1,513	)
Prepaid expenses		(200	)		(285	)
Patents		(489	)		(384	)
Goodwill		(3,193	)		(2,689	)
Other		(16	)		(20	)
Total deferred tax liabilities		(5,364	)		(4,891	)
Net deferred tax asset before valuation allowance		6,129			5,288
Valuation allowances for deferred tax assets		(1,868	)		(1,327	)
Net deferred tax asset	$	4,261		$	3,961

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

Current assets	$	573	$	163
Long-term assets		3,688		3,798
Net deferred tax asset	$	4,261	$	3,961

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
2010	$	1,177		-		(75	)	$	1,102
2011	$	1,102		-		225		$	1,327
2012	$	1,327		-		541		$	1,868

For the years ended December 31, 2012, 2011 and 2010, Fuel Tech recorded tax benefits from the exercise of stock options in the amount of $0, $77 and $0, respectively.  This amount was recorded as an increase in additional paid-in capital on the consolidated balance sheet 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 $57 and $335 for fully vested options that expired unexercised and by $101 and $0 for the excess of stock-based compensation over the related tax benefit recognized for restricted stock units that vested during 2012 and 2011, respectively.  These reductions in deferred tax assets were 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, 2012, 2011, and 2010:

Description	2012			2011			2010
Balance at beginning of period	$	505		$	664		$	724
Increases in positions taken in a prior period		-			-			-
Decreases in positions taken in a prior period		-			-			-
Increases in positions taken in a current period		39			117			60
Decreases in positions taken in a current period		-			-			-
Decreases due to settlements		(202	)		-			-
Decreases due to lapse of statute of limitations		(303	)		(276	)		(120	)
Balance at end of period	$	39		$	505		$	664

The amount of interest and penalties that we recognized in income tax expense during the years ended December 31, 2012, 2011, and 2010 was $3, $162, and $206, respectively. The total amount of unrecognized tax benefits as of December 31, 2012, 2011, and 2010, including interest and penalties, was $42, $667 and $870, respectively, all of which if ultimately recognized will reduce Fuel Tech’s annual effective tax rate.  We estimate that none of the 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, 2012, 2011, and 2010, Fuel Tech had accrued approximately $3, $162, and $206, 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 2009. The Company was under examination for federal tax and state of Illinois purposes for the 2009 and 2010 tax years, and any potential tax obligations in those jurisdictions have been settled or effectively settled and are no longer subject to tax examination.

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.

Fuel Tech, Inc. considers its investment in the Company’s foreign subsidiaries to be indefinite in duration and therefore has not provided a provision for deferred U.S. income taxes on the un-remitted earnings from those subsidiaries. A provision has not been established because it is not practicable to determine the amount of unrecognized deferred tax liability for such unremitted foreign earnings and because it is our present intention to reinvest the undistributed earnings indefinitely.

At December 31, 2012, Fuel Tech has tax loss carry-forwards of approximately $6,794 available to offset future foreign income in Italy. We have recorded a full valuation allowance against the resulting $1,868 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 2013 if not used by that date.