16. INCOME TAXES

ALC's results of operations are included in a consolidated federal tax return.

The income tax expense consists of the following for the years ended December 31:

	2011		2010		2009
	(In thousands)
Federal:
Current	$	7,412	$	2,585	$	4,449
Deferred		3,109		5,245		1,615
Total Federal	$	10,521	$	7,830	$	6,064
State:
Current		989		1,265		1,228
Deferred		590		354		51
Total State		1,579		1,619		1,279
Total income tax expense	$	12,100	$	9,449	$	7,343

The differences between the effective tax rates on income before income taxes and the United States federal income tax rate are as follows:

	2011			2010			2009
Statutory federal income tax rate		35.0	%		35.0	%		35.0	%
Increase (reduction) in tax rate resulting from:
State income taxes, net of federal income tax benefit		4.0			4.0			10.4
Work opportunity credit		(1.0	)		(1.2	)		(2.8	)
Deductible goodwill amortization		(1.2	)		(1.7	)		(5.3	)
Non-deductible goodwill		-			-			50.7
Settlement with former parent		(2.0	)		-			-
Decrease is state tax reserve		(1.6	)		-			-
Other, net		-			0.4			2.1
Effective tax rate		33.2	%		36.5	%		90.1	%

Unrecognized tax benefits

A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows (in thousands):

	2011			2010
Gross unrecognized tax benefits at December 31, 2010	$	722		$	722
Decrease due to expiration of statute of limitations		(597	)		-
Gross unrecognized tax benefits at December 31, 2011	$	125		$	722

Included in the balance of unrecognized tax benefits at December 31, 2011 and 2010 are tax positions related to past state income tax filings which will not reoccur in the future. There are no unrecognized tax benefits related to federal income tax issues.

The total amount of net unrecognized tax benefits that, if recognized, would affect the effective tax rate was $0.1 million at December 31, 2011. We accrue interest and penalties related to unrecognized tax benefits in our provision for income taxes. At December 31, 2011, we had no accrued interest and penalties related to unrecognized tax benefits.

ALC and its subsidiaries file income tax returns in the U.S. and in various state and local jurisdictions. Federal tax returns for all periods after December 31, 2007 are open for examination. Various state tax returns for all periods after December 31, 2006 are open for examination. For the tax periods between February 1, 2005 and November 10, 2006, ALC was included in the consolidated federal tax returns of Extendicare Holdings, Inc. (“EHI”). Tax issues between ALC and Extendicare were governed by a Tax Allocation Agreement entered into by ALC and Extendicare at the time of the Separation. During 2009, the Internal Revenue Service completed an examination of the partial tax year ended December 31, 2005 and the partial tax year ended November 10, 2006. In May 2011, EHI and ALC agreed to settle this matter, and all matters under the Tax Allocation Agreement, with a $0.8 million payment from EHI to ALC. The $0.8 million settlement was paid in the second quarter of 2011 and is included as a reduction of the income tax provision in the consolidated statements of operations for the year ended December 31, 2011. As a result of this settlement, ALC wrote-off $2.9 million of net operating losses and a related $2.7 million of valuation allowance which off-set these net operating losses.

The components of the net deferred tax assets and liabilities as of December 31 are as follows:

	2011			2010
	(In thousands)
Deferred tax assets:
Employee benefit accruals	$	4,233		$	3,835
Accrued liabilities		835			848
Accounts receivable reserves		1,172			569
Deferred revenue		712			632
Operating loss carryforwards		7,820			12,300
Goodwill/Intangibles		2,683			2,766
Fair value adjustment for leases		565			752
Fair value adjustment for debt		31			105
Deferred financing fee		155			219
Alternative minimum tax carry forward		46			560
Unrealized loss – derivative		-			350
Write down of investments		290			709
Other assets		2,714			2,920
Total deferred tax assets before valuation allowance		21,256			26,565
Valuation allowance		(163	)		(2,840	)
Total deferred tax assets		21,093			23,725
Deferred tax liabilities:
Depreciation		40,710			37,910
Unrealized loss – equity investments		91			289
Miscellaneous		228			921
Total deferred tax liabilities		41,029			39,120
Net deferred tax liabilities	$	(19,934	)	$	(15,395	)

Valuation allowance:
Beginning of year	$	(2,840	)	$	(2,840	)
Decrease during year		2,677			-
End of year	$	(163	)	$	(2,840	)

	2011			2010
	(In thousands)
Deferred tax assets (liabilities) as presented on the consolidated balance sheet:
Current deferred tax assets	$	4,027		$	5,108
Long-term deferred tax liabilities		(23,961	)		(20,503	)
Net deferred tax liabilities	$	(19,934	)	$	(15,395	)

ALC paid state income taxes of $1.5 million, $1.3 million and $1.0 million in 2011, 2010 and 2009, respectively.

As of December 31, 2011, ALC has $21.2 million (before a $0.2 million valuation allowance) of net operating losses available for federal income tax purposes, which will expire between 2012 and 2026. These net operating losses were partially generated prior to and after ALC's emergence from bankruptcy on January 1, 2002. The emergence from bankruptcy created an ownership change as defined by the IRS. Section 382 of the Internal Revenue Code and imposes limitations on the utilization of the loss carryfowards and built-in losses after certain ownership changes of a loss company. ALC was deemed to be a loss company for these purposes. Under these provisions, ALC's ability to utilize the pre-acquisition loss carryforwards generated prior to ALC's emergence from bankruptcy and built-in losses in the future will generally be subject to an annual limitation of approximately $1.6 million. Any unused amount is added to and increases the limitation in the succeeding year. ALC's net unrealized built-in losses were $20.9 million as of December 31, 2011, and $29.1 million as of December 31, 2010. The deferred tax assets include loss carryforwards and built-in losses and their related tax benefit available to ALC to reduce future taxable income within the allowable IRS carryover period.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Management believes it is more likely than not ALC will realize the benefits of these deductible differences, net of the valuation allowances.