INCOME TAXES

Income Tax Expense (Benefit)

The components of the Company’s income tax expense (benefit) attributable to continuing operations are as follows:



	Year Ended September 30,
	2013			2012			2011
	(In millions)
Current tax expense (benefit):
Federal	$	66.6		$	(7.0	)	$	(53.6	)
State	6.8			3.1			(6.1		)
	73.4			(3.9		)	(59.7		)
Deferred tax expense (benefit):
Federal	146.3			(616.1		)	—
State	(24.6		)	(93.4		)	—
	121.7			(709.5		)	—
Total income tax expense (benefit)	$	195.1		$	(713.4	)	$	(59.7	)

In fiscal 2013 the Company recorded directly to additional paid-in capital a tax benefit of $6.7 million related to the exercise of stock based awards and to accumulated other comprehensive income tax expense of $1.1 million with respect to the unrealized gain on debt securities classified as available for sale.

The effective tax rate in fiscal 2013 was 29.7%. The Company did not have meaningful effective tax rates in fiscal 2012 and 2011 because its net deferred tax assets were fully offset by a valuation allowance until the third quarter of fiscal 2012 when the Company significantly reduced the valuation allowance on its deferred tax assets.

The income tax benefit in fiscal 2012 was due primarily to a significant reduction of the Company's deferred tax asset valuation allowance. The income tax benefit in fiscal 2011 was due to the Company receiving a favorable result from the Internal Revenue Service (IRS) on a ruling request concerning capitalization of inventory costs.

Reconciliation of Expected Income Tax Expense (Benefit)

Differences between income tax expense (benefit) and tax computed by applying the federal statutory rate of 35% to income before income taxes during each year is due to the following:



	Year Ended September 30,
	2013			2012			2011
	(In millions)
Income taxes at federal statutory rate	$	230.2		$	85.0		$	4.2
Increase (decrease) in tax resulting from:
State income taxes, net of federal benefit	6.5			12.1			2.4
Domestic production activities deduction	(6.5		)	—			—
Uncertain tax positions, net of deferred tax	(12.7		)	(2.3		)	(11.2		)
Valuation allowance	(24.1		)	(806.6		)	(54.1		)
Tax credits	(1.1		)	(1.3		)	(2.2		)
Other	2.8			(0.3		)	1.2
Total income tax expense (benefit)	$	195.1		$	(713.4	)	$	(59.7	)

Deferred Income Taxes

Deferred tax assets and liabilities reflect the tax consequences of temporary differences between the financial statement amounts of assets and liabilities and their tax bases, and of tax loss and credit carryforwards. Components of deferred income taxes are summarized as follows:



	September 30,
	2013			2012
	(In millions)
Deferred tax assets:
Inventory costs	$	74.5		$	68.4
Inventory impairments	267.6			323.4
Warranty and construction defect costs	114.5			116.7
Net operating loss carryforwards	99.3			188.9
Tax credit carryforwards	5.9			7.0
Incentive compensation plans	69.9			53.1
Deferral of profit on home sales	1.9			1.7
Other	21.5			31.8
Total deferred tax assets	655.1			791.0
Valuation allowance	(31.0		)	(41.9		)
Total deferred tax assets, net of valuation allowance	624.1			749.1
Deferred tax liabilities	37.5			39.6
Deferred income taxes, net	$	586.6		$	709.5

Tax benefits of $99.3 million exist for state net operating loss (NOL) carryforwards that will expire (beginning at various times depending on the tax jurisdiction) from fiscal 2014 to fiscal 2032. State tax credit carryforwards of $4.0 million will expire from fiscal 2018 to fiscal 2023 and $1.9 million of state tax credit carryforwards have no expiration date.

The accounting for deferred taxes is based upon estimates of future results. Differences between the anticipated and actual outcomes of these future results could result in changes in the Company's estimates of the valuation of its deferred tax assets and related valuation allowances, and could also have a material impact on the Company's consolidated results of operations or financial position. Also, changes in existing federal and state tax laws and tax rates could affect future tax results and the valuation of the Company's deferred tax assets.

Valuation Allowance

When assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of its deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of sufficient taxable income in future periods. The Company records a valuation allowance when it determines it is more likely than not that a portion of the deferred tax assets will not be realized. At September 30, 2013, the Company determined it was more likely than not that all of the Company’s federal deferred tax assets will be realized.

The Company had a valuation allowance of $31.0 million related to its state deferred tax assets at September 30, 2013 because the Company concluded it was more likely than not that a portion of its state NOLs would not be realized due to the more limited carryforward periods that exist in certain states. The Company continues to evaluate both the positive and negative evidence in determining the need for a valuation allowance with respect to its tax benefits for state NOL carryforwards.

During fiscal 2011 and through most of fiscal 2012, the Company's net deferred tax assets were fully offset by a valuation allowance. The Company’s analyses leading to reductions in the valuation allowance during fiscal 2012 and 2013 are discussed below.

At June 30, 2012, the Company determined it was more likely than not that the substantial majority of the Company's deferred tax assets would be realized, which resulted in a $753.2 million reversal of the valuation allowance on its deferred tax assets during the third and fourth quarters of fiscal 2012. The Company evaluated both positive and negative evidence to determine its ability to realize its deferred tax assets. In its evaluation, the Company gave more significant weight to evidence that was objective in nature as compared to subjective evidence. Also, more significant weight was given to evidence that directly related to the Company's recent financial performance as compared to indirect or less recent evidence.

In evaluating its valuation allowance at June 30, 2012, the Company gave the most significant weight to the objective, direct positive evidence related to its recent strong financial results, especially its positive and growing levels of pre-tax income and its significant growth in net sales orders and sales order backlog during fiscal 2012. The Company estimated that if its annual pre-tax income remained at the fiscal 2012 level in future years, it would realize all of its federal NOLs in less than five years, well in advance of the expiration of the Company's NOL carryforwards in fiscal 2030 and 2031, and it would also absorb all federal deductible temporary differences as they reverse in future years. Additionally, the Company considered, at a lower weighting, the subjective, direct positive evidence that it expected to increase its pre-tax income in future years by utilizing its strong balance sheet and liquidity position to invest in opportunities to sustain and grow its operations. If industry conditions weakened, the Company expected to be able to adjust its operations to maintain long-term profitability and still realize its deferred tax assets.

Prior to the quarter ended June 30, 2012, the Company had given significant weight to the negative, direct evidence of its three-year cumulative pre-tax loss position as a result of losses incurred in prior years during the housing downturn. As of June 30, 2012, the Company had generated positive cumulative pre-tax income for the past three years and therefore, the prior year losses were weighted less than the recent positive financial results in the Company's evaluation at June 30, 2012. Other negative, indirect evidence, such as the overall weakness in the U.S. economy and the housing market and the restrictive mortgage lending environment, was considered at a lower weighting because the Company's recent financial performance had been achieved in this environment. Also, the negative, direct evidence of the Company's gross profit margins, which were lower than historical levels before the housing downturn, were considered at a lower weight than the direct, positive evidence of its growing pre-tax income levels.

The most significant changes in the Company's evaluation of the realizability of its deferred tax assets at June 30, 2012 were the development of significant positive evidence related to the Company's accelerating growth in pre-tax income, net sales orders and backlog as fiscal 2012 progressed; the Company's expectation to realize all of its federal NOLs in less than five years and to absorb all federal deductible temporary differences as they reverse in future years based on fiscal 2012 pre-tax income levels; the Company's expectation of sustained and increasing profitability in future years; and the lessening of the significance of the negative evidence considered in prior periods related to the Company's pre-tax losses incurred in prior years, because the Company had generated positive cumulative pre-tax income for the past three years as of June 30, 2012. These significant changes in the evidence at June 30, 2012 led the Company to determine that it was appropriate to reverse all of the valuation allowance related to its federal deferred tax assets and a portion of the valuation allowance related to its state deferred tax assets. At September 30, 2012, the Company had tax benefits for state NOL carryforwards of $85.2 million and had a valuation allowance of $41.9 million related to its state deferred tax assets.

Further changes in the valuation allowance were recorded during fiscal 2013 based on the Company’s quarterly evaluations to determine the need for a valuation allowance related to its state deferred tax assets. At March 31, 2013, after considering the impact of significantly improving profits from operations, the Company concluded it was more likely than not that it would realize more of its deferred tax assets related to state NOL carryforwards than previously anticipated. The Company based this conclusion on additional positive evidence related to the actual pre-tax profits achieved during the six months ended March 31, 2013 and higher levels of forecasted profitability for the remainder of fiscal 2013 and in future years. The Company expected these increased profits to result in a greater realization of its NOL carryforwards in certain states before they expire than previously estimated. Accordingly, at March 31, 2013, the Company reduced the valuation allowance on its state deferred tax assets by $18.7 million to a balance of $23.2 million. Because this reduction of the valuation allowance was recognized in an interim period, a portion of the valuation allowance to be reversed was allocated to the remaining interim periods. Therefore, the Company reversed an additional $2.9 million of the valuation allowance in the third and fourth quarters of fiscal 2013. Additionally, approximately $13.2 million of the Company's valuation allowance was attributable to state NOL carryforwards that expired at the end of fiscal 2013, at which time the related unrealized deferred tax assets and valuation allowances were written off. The amount of the Company’s valuation allowance at September 30, 2013 as a result of the activity described above would have been $7.1 million.

At September 30, 2013 the Company recorded an out-of-period adjustment which increased both the Company’s deferred income taxes and the valuation allowance on its deferred income taxes by $23.9 million. The out-of-period adjustment had no impact on the Company’s statement of operations during fiscal 2013. The increase in the Company’s deferred income taxes of $23.9 million corrected an error in recording the future benefits for state NOL carryforwards based on each of the Company’s legal entities’ NOLs in each state and the current tax rate of each state. The valuation allowance was also increased by $23.9 million because the Company determined it is more likely than not that these state NOL carryforwards will not be realized because the Company estimates it will not have sufficient taxable income within these states' carryforward periods. As a result of this adjustment, the remaining amount of the valuation allowance related to state deferred tax assets was $31.0 million at September 30, 2013. The Company’s valuation allowance is based on an analysis of the amount of NOL carryforwards associated with each of its legal entities in the states in which it conducts business, as compared to its expected level of taxable income under existing apportionment or recognition rules in each state and the carryforward periods allowed in each state's tax code. Had deferred income taxes related to the state NOL carryforwards of each of the Company's legal entities been reflected at state specific tax rates as of September 30, 2012, the Company's deferred income taxes would have increased by $31.6 million and the corresponding valuation allowance on its deferred income taxes would have increased by $37.6 million. This would have resulted in a decrease in the Company’s income tax benefit of $6.0 million in fiscal 2012, which would have reversed and decreased income tax expense by $6.0 million in fiscal 2013. The unadjusted amounts from fiscal 2012 are not material to the Company’s financial statements for fiscal 2012, and the out-of-period adjustment recorded in fiscal 2013 is not material to the current fiscal year’s financial statements.

Unrecognized Tax Benefits

Unrecognized tax benefits are the differences between tax positions taken or expected to be taken in a tax return and the benefits recognized for accounting purposes. A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:



	Year Ended September 30,
	2013			2012			2011
	(In millions)
Unrecognized tax benefits, beginning of year	$	14.1		$	16.3		$	65.0
Reductions attributable to tax positions taken in prior years	(2.4		)	(1.6		)	(48.7		)
Reductions attributable to lapse of statute of limitations	(7.5		)	(0.6		)	—
Unrecognized tax benefits, end of year	$	4.2		$	14.1		$	16.3

Included in the balance of unrecognized tax benefits at September 30, 2013 and 2012 are tax benefits of $2.7 million and $11.8 million, respectively, that, if recognized, would reduce the Company’s income tax expense. Also included in the balance of unrecognized tax benefits at September 30, 2013 and 2012 are tax benefits of $1.5 million and $2.3 million, respectively, that, if recognized, would result in an adjustment to deferred income taxes. At September 30, 2011 all tax positions, if recognized, would have reduced the Company's income tax expense because of the full valuation allowance that existed on its deferred tax assets.

The Company classifies interest expense and penalties on income taxes as income tax expense. During fiscal 2013, 2012 and 2011, the Company recognized interest benefits related to unrecognized tax benefits of $2.8 million, $0.1 million and $12.7 million, respectively, in its consolidated statements of operations. At September 30, 2013 and 2012, the Company’s total accrued interest expense relating to unrecognized tax benefits was $2.2 million and $5.1 million, respectively, and there were no accrued penalties.

A reduction of $4.2 million in the amount of unrecognized tax benefits and $2.2 million of accrued interest is reasonably possible within the next 12 months, of which $4.1 million would be reflected as an income tax benefit in the consolidated statement of operations and $2.3 million would result in an adjustment to deferred income taxes.

Regulations and Legislation

The Company is subject to federal income tax and to income tax in multiple states. The statute of limitations for the Company's major tax jurisdictions remains open for examination for fiscal years 2010 through 2013. The Company is currently being audited by various states.

The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013, and did not have a material effect on the Company's consolidated financial position, results of operations or cash flows.