Income Taxes

Geographic sources of income (loss) from continuing operations before income taxes are as follows:



($ in thousands)	2011			2010			2009
United States	$	1,213,353		$	1,227,794		$	1,085,704
Foreign	(259,406		)	(226,726		)	(18,777		)
Total income from continuing operations before income taxes	$	953,947		$	1,001,068		$	1,066,927

Income tax expense (benefit) consists of the following for fiscal years 2011, 2010 and 2009:



($ in thousands)	2011			2010			2009
Current:
Federal	$	350,640		$	458,375		$	377,911
State	11,372			131,284			93,350
Foreign	1,129			(218		)	(1,025		)
Total current	363,141			589,441			470,236
Deferred:
Federal	62,474			(106,834		)	(8,667		)
State	10,214			(7,574		)	(4,872		)
Foreign	(15,191		)	(10,970		)	23
Total deferred	57,497			(125,378		)	(13,516		)
Total provision for income taxes	$	420,638		$	464,063		$	456,720

Deferred tax assets and liabilities result primarily from temporary differences in book versus tax basis accounting. Deferred tax assets and liabilities consist of the following as of August 31:



($ in thousands)	2011			2010
Deferred tax assets:
Allowance for doubtful accounts	$	44,364		$	72,344
Deferred rent and tenant improvement allowances	25,198			28,921
Net operating loss carry-forward	10,718			17,629
Litigation charge	61,502			70,383
Share-based compensation	67,697			63,168
Other	59,001			73,821
Gross deferred tax assets	268,480			326,266
Valuation allowance	(10,446		)	(14,645		)
Deferred tax assets, net of valuation allowance	258,034			311,621
Deferred tax liabilities:
Fixed assets	57,314			39,276
Intangible assets	30,738			40,069
Other	1,296			5,531
Gross deferred tax liabilities	89,348			84,876
Net deferred income taxes	$	168,686		$	226,745

The decrease in our valuation allowance during fiscal year 2011 was primarily the result of the write-off of net operating losses and associated valuation allowance due to the closure of Meritus. We have recorded a valuation allowance related to a portion of our net operating losses and to the deferred tax assets of certain of our foreign subsidiaries, as it is more likely than not that these deferred tax assets will not be utilized. In light of our history of profitable operations, we have concluded that it is more likely than not that we will ultimately realize the full benefit of our deferred tax assets other than assets mentioned above. Accordingly, we believe that a valuation allowance should not be recorded for our remaining net deferred tax assets.

The net operating loss carry-forward in the above table represents $17.5 million of U.S. net operating losses that will begin to expire August 31, 2021. We also have $20.7 million of net operating losses in various foreign jurisdictions that do not expire.

We have not provided deferred taxes on unremitted earnings attributable to international companies that have been considered permanently reinvested. As of August 31, 2011, any earnings related to the operations of these foreign subsidiaries are not significant.

We exercise significant judgment in determining our income tax provision due to transactions, credits and calculations where the ultimate tax determination is uncertain. The following is a tabular reconciliation of the total amount of unrecognized tax benefits, excluding interest and penalties, at the beginning and the end of fiscal years 2011 and 2010:



($ in thousands)
Balance at August 31, 2009	$	84,861
Additions based on tax positions taken in the current year	99,590
Additions for tax positions taken in prior years	18,323
Settlement with tax authorities	(20,665		)
Reductions for tax positions of prior years	(11,733		)
Reductions due to lapse of applicable statute of limitations	(4,328		)
Balance at August 31, 2010	166,048
Additions based on tax positions taken in the current year	4,503
Additions for tax positions taken in prior years	15,570
Settlement with tax authorities	(110,980		)
Reductions for tax positions of prior years	(45,231		)
Reductions due to lapse of applicable statute of limitations	(4,099		)
Balance at August 31, 2011	$	25,811

As of August 31, 2011 and 2010, we had $1.2 million and $44.4 million, respectively, of unrecognized receivables included in our unrecognized tax benefits, and the substantial majority of our remaining unrecognized tax benefits are included in other liabilities in our Consolidated Balance Sheets. The decrease in our unrecognized tax benefits during fiscal year 2011 was principally attributable to resolution with the Arizona Department of Revenue regarding the apportionment of income for Arizona corporate income tax purposes. See Arizona Department of Revenue Audit below for further discussion. The decrease was also due to a $9.6 million benefit from resolution with the Internal Revenue Service regarding the deductibility of payments made related to the settlement of a qui tam lawsuit in fiscal year 2010. This benefit is included in litigation charge on our effective income tax rate reconciliation below.

We classify interest and penalties related to uncertain tax positions as a component of provision for income taxes in our Consolidated Statements of Income. We recognized benefits of $1.7 million and $10.4 million in fiscal years 2011 and 2010, respectively, and an expense of $4.4 million in fiscal year 2009 related to interest and penalties. The $1.7 million benefit in fiscal year 2011 is primarily attributable to the reduction of accrued interest related to the resolution with the Arizona Department of Revenue noted above. The $10.4 million benefit in fiscal year 2010 is mainly due to the reduction of accrued interest related to the I.R.S. 162(m) settlement which occurred in November 2009. See Internal Revenue Service Audits below for further discussion. The total amount of interest and penalties included in our Consolidated Balance Sheets was $3.7 million and $5.4 million as of August 31, 2011 and 2010, respectively.

We believe that any change in our existing unrecognized tax benefits in the next 12 months will be immaterial.

As of August 31, 2011, $18.4 million of our total unrecognized tax benefits would favorably affect our effective tax rate if recognized. If amounts accrued are less than amounts ultimately assessed by the taxing authorities, we would record additional income tax expense in our Consolidated Statements of Income.

Our U.S. federal tax years and various state tax years from 2006 remain subject to income tax examinations by tax authorities. In addition, tax years from 2006 related to our foreign taxing jurisdictions also remain subject to examination.

The provision for income taxes differs from the tax computed using the statutory U.S. federal income tax rate as a result of the following items for fiscal years 2011, 2010 and 2009:



	2011		2010		2009
Statutory U.S. federal income tax rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal benefit⁽¹⁾	1.8	%	6.3	%	5.1	%
Non-deductible compensation, net⁽²⁾	0.3	%	(1.1	)%	0.4	%
Foreign taxes	0.8	%	1.1	%	0.6	%
Litigation charge	(1.0	)%	—	%	0.9	%
Goodwill impairments	7.4	%	5.8	%	—	%
Meritus closure	(0.8	)%	—	%	—	%
Other, net	0.6	%	(0.7	)%	0.8	%
Effective income tax rate	44.1	%	46.4	%	42.8	%

⁽¹⁾In fiscal year 2011, we realized a $43.3 million benefit associated with our resolution with the Arizona Department of Revenue. See further discussion below.

⁽²⁾In fiscal year 2010, we recorded benefits of $10.2 million and $1.2 million associated with our settlement of a dispute with the Internal Revenue Service. See further discussion below.

Internal Revenue Service Audits

In fiscal year 2007, the Internal Revenue Service commenced an examination of our U.S. federal income tax returns for fiscal years 2003 through 2005. In February 2009, the Internal Revenue Service issued an examination report and proposed to disallow certain deductions relating to stock option compensation and also proposed the additions of penalties and interest. In March 2009, we commenced administrative proceedings with the Office of Appeals of the Internal Revenue Service challenging the proposed adjustments, including penalties and interest. In November 2009, we executed a Closing Agreement with the Internal Revenue Service Office of Appeals to settle this matter. The settlement resolves only the disputed tax issues between the Internal Revenue Service and us and is not an admission by us of liability, wrongdoing, legal compliance or non-compliance for any other purpose.

Prior to the settlement, we had a total accrual of $50.5 million included in our reserve for uncertain tax positions relating to this issue. As a result of this settlement, we paid $27.3 million during fiscal year 2010 and the remaining accrual was reversed through a reduction in the provision for income taxes, a decrease in deferred tax assets, and an increase in additional paid-in capital in the amounts of $10.2 million, $1.5 million and $11.5 million, respectively.

Based on the agreed upon settlement, we believe that we are entitled to certain deductions related to stock option compensation that were not claimed on our tax returns for the years ended in 2006 through 2009. During fiscal year 2010, we recorded the benefit of these deductions through provision for income taxes, deferred taxes, and additional paid-in-capital in the amounts of $1.2 million, $0.9 million and $16.0 million, respectively. We submitted claims to the Internal Revenue Service for the deductions that were not taken on our tax returns for the years ended in 2006, 2007 and 2008. These claims have been accepted by the Internal Revenue Service. We have also claimed the deductions related to stock option compensation in subsequent year income tax returns.

Our U.S. federal income tax returns for our fiscal years 2006 through 2010 are currently under review by the Internal Revenue Service.

Arizona Department of Revenue Audit

The Arizona Department of Revenue commenced an audit during fiscal year 2010 relating to our Arizona income tax returns for fiscal years 2003 through 2009. During fiscal year 2010, we filed amended Arizona income tax returns for fiscal years 2003 through 2007 to change our method of sourcing service income to a destination basis, rather than on an origin basis, for sales factor apportionment purposes. In general for state sales factor apportionment purposes, ‘destination sourcing’ assigns revenue to the state of the customer or market, while ‘origin sourcing’ assigns revenue to the state of production. We also reported the final audit adjustments made by the Internal Revenue Service for fiscal years 2003 through 2005. The resulting impact from these adjustments was a net claim for refund of $51.5 million, excluding interest, for fiscal years 2003 through 2007. For fiscal years 2008 through 2010, we filed our original Arizona income tax returns sourcing our service revenues on a destination basis and we did not take a benefit related to our Arizona destination sourcing position in our financial statements.

In March 2011, the Arizona Department of Revenue issued a notice of proposed assessment for fiscal years 2003 through 2009 asserting our services revenues should be based on an origin sourcing method. The proposed assessment also denied our refund claims for this same reason. In May 2011, we filed our protest to the proposed assessment and refund denials, and began the administrative review process to assert our destination sourcing position. On August 4, 2011, we executed a Closing Agreement with the Arizona Department of Revenue to settle this matter. The settlement resolves the sales factor sourcing issue for the audit period and provides an agreed upon sales factor sourcing methodology for fiscal years 2010 through 2020.

Based on the agreed upon settlement, we have foregone our refund claims of $51.5 million, paid or will pay $59.8 million, and made applicable adjustments to our deferred taxes. These amounts were previously included in our unrecognized tax benefits, and the settlement resulted in a $43.3 million benefit. The benefit includes state tax accrued throughout fiscal year 2011 based on the uncertainty prior to settlement.

In addition to the audits discussed above, we are subject to numerous ongoing audits by federal, state, local and foreign tax authorities. Although we believe our tax accruals to be reasonable, the final determination of tax audits in the U.S. or abroad and any related litigation could be materially different from our historical income tax provisions and accruals.