Note 10. Income Taxes

Income tax provision (benefit) for the fiscal years 2012, 2011 and 2010 is as follows:


	Years Ended December 31,
	2012			2011			2010
	(in thousands)
Income tax provision from continuing operations	$	3,665		$	5,582		$	3,021
Income tax (benefit) from discontinued operations		(570	)		(5,051	)		(3,351	)

Total income tax provision (benefit)	$	3,095		$	531		$	(330	)

Income from continuing operations before provision for income taxes consists of the following:


	Years Ended December 31,
	2012		2011		2010
	(in thousands)
Domestic	$	10,820	$	15,304	$	8,073
Foreign		2,202		3,113		4,730

Income from continuing operations before income taxes	$	13,022	$	18,417	$	12,803

The provision for income taxes from continuing operations consists of the following:


	Years Ended December 31,
	2012			2011		2010
	(in thousands)
Current:
Federal	$	2,544		$	2,307	$	(2,317	)
Foreign		719			897		3,343
State		(116	)		202		1,306
Deferred:
Federal		577			1,824		4,058
Foreign		89			203		(2,031	)
State		(148	)		149		(1,338	)

Income tax provision from continuing operations	$	3,665		$	5,582	$	3,021

The benefit for income taxes related to discontinued operations for 2012, 2011, and 2010 was $570,000, $5,051,000, and $3,351,000, respectively.

Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2012 and December 31, 2011 are as follows:


	December 31,
	2012			2011
	(in thousands)
Deferred tax assets related to continuing operations:
Deferred compensation	$	924		$	998
Inventory valuation		664			661
Tax loss carryforward		1,587			1,913
Foreign tax credit carryforward		—			17
R&D tax credit carryforward		1,047			876
Accrued expenses		508			520
Warranty		414			514
Vacation and bonus expense		1,330			1,775
Other		537			342
Less valuation allowances		(415	)		(417	)

Deferred tax assets related to continuing operations		6,596			7,199


Deferred tax liabilities related to continuing operations:
Accelerated depreciation and amortization		2,676			2,866

Net deferred tax assets related to continuing operations		3,920			4,333

Net deferred tax assets related to discontinued operations		9,214			8,981

Net deferred tax assets	$	13,134		$	13,314

The Company has not made a provision for U.S. income taxes and foreign withholding taxes for the anticipated repatriation of certain earnings of foreign subsidiaries of the Company. The Company considers the undistributed earnings of its foreign subsidiaries above the amount already provided to be permanently reinvested. As of December 31, 2012, $10,548,000 of the undistributed earnings are expected to be permanently reinvested.

As of December 31, 2012, the Company has no foreign tax credits. As of December 31, 2011, the Company’s gross foreign tax credits totaled approximately $17,000.

As of December 31, 2012 and December 31, 2011, the Company’s research and development tax credits totaled approximately $1,047,000 and $876,000, respectively. The increase in research and development tax credits during 2012 was primarily due to state credits as well as adjustments to prior year federal credits. No new federal research and development credits were recognized during 2012. Of the December 31, 2012 credits, approximately $368,000 can be carried forward for 15 years and expire between 2015 and 2027, while $679,000 will carry over indefinitely.

As of December 31, 2012, the Company has gross federal and state net operating loss carryforward tax benefits of $3,786,000 and $1,960,000, respectively, which expire at various dates from 2013 to 2032. In addition, the Company has a gross foreign net operating loss carryforward tax benefit of $576,000, which does not expire.

The Company has assessed its past earnings history and trends, sales backlog, budgeted sales, and expiration dates of tax carryforwards and has determined that it is more likely than not that $13,134,000 of the net deferred tax assets as of December 31, 2012 will be realized. The Company has an allowance of $1,987,000 (mostly related to discontinued operations) provided against the gross deferred tax assets, which relates to the inability of the Company to realize the state tax benefit of the environmental expenses and the state net operating loss carryforwards.

The following is a reconciliation of income tax expense (benefit) related to continuing operations at the applicable federal statutory rate and the effective rates from continuing operations:


	Years Ended December 31,
	2012			2011			2010
Statutory rate		35	%		35	%⁽¹⁾		34	%
Tax rate differential on domestic manufacturing deduction benefit		(2	)		(1	)		(1	)
State income taxes, net of federal income tax		1			2			1
Foreign operations		(2	)		(2	)		(2	)
Research and development credits		(4	)		(4	)		(5	)
Other		—			—			(3	)

Effective tax rate		28	%		30	%		24	%

⁽¹⁾	During 2011, the Company’s federal statutory tax rate increased from 34% to 35% due to the increase in the Company’s earnings.

For the fiscal year ended December 31, 2012, included in the research and development credits is the recognition of previously unrecognized tax benefits (including interest) in accordance with the guidance provided in ASC 740-10-25 “Income Taxes, Overall, Recognition.”

Unrecognized Tax Positions

The Company and its subsidiaries file income tax returns in the United States and in various state, local and foreign jurisdictions. The Company and its subsidiaries are occasionally examined by tax authorities in these jurisdictions. During the third quarter of 2011 the Company was contacted by the Internal Revenue Service (the “IRS”) to examine the calendar years 2009 and 2010. The examination was completed during the fourth quarter of 2012 with no material adjustments.

During the second quarter of 2011 the Company reached a favorable settlement with a foreign tax authority which was recorded as part of discontinued operations. The settlement was associated with the Company’s Elektro-Metall Export GmbH subsidiary, which was sold in January 2003. As a result, during the second quarter of 2011, the Company recognized income of $787,000 ($619,000 tax and $168,000 interest) from a previously unrecognized tax position related to the settlement.

A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits, excluding interest and penalties, is as follows:


	December 31,
	2012			2011			2010
Gross unrecognized tax benefits, beginning of year	$	722,000		$	2,358,000		$	2,526,000
Increases in tax positions taken in the current year		65,000			217,000			660,000
Increases in tax positions taken in prior years		60,000			57,000			31,000
Decreases in tax positions taken in prior years		—			(932,000	)⁽¹⁾		(138,000	)
Decreases in tax positions related to settlement with tax authorities		(96,000	)		(564,000	)		(289,000	)
Statute of limitations expired		(156,000	)		(414,000	)		(432,000	)

Gross unrecognized tax benefits, end of year	$	595,000		$	722,000		$	2,358,000

⁽¹⁾

The Company determined that in one state its credit carry-forward in that state was more-likely-than-not not going to be realized. As a result, the Company reclassified such position in the amount of $373,000 from an unrecognized tax position to a valuation allowance as a reduction to the deferred tax asset. In addition, in 2010 the Company established an unrecognized tax position for its method of accounting for an accrual on its tax return for all open tax years. During 2011, the uncertain tax position was released in the amount of $559,000 and a deferred tax liability was established for the repayment of the underpaid tax.

If recognized, all of the net unrecognized tax benefits at December 31, 2012 would impact the effective tax rate. The Company accrues interest and penalties related to unrecognized tax benefits as income tax expense. At December 31, 2012 and December 31, 2011, the Company had accrued interest and penalties related to unrecognized tax benefits of $62,000 and $80,000, respectively.

It is reasonably possible that the Company’s gross unrecognized tax benefits balance may change within the next twelve months due to the expiration of the statutes of limitation of the federal government and various state governments by a range of zero to $37,000. The Company has recorded $657,000 in other long-term liabilities which represents the total gross unrecognized tax benefits, including interest and penalties.