11. Income Taxes

The income tax provision shown in the consolidated statements of operations is reconciled to amounts of tax that would have been payable (recoverable) from the application of the federal tax rate to pre-tax profit, as follows:

Amounts are expressed in thousands of dollars.


	Year ended December 31,
	2012						2011						2010
	Amount			Percentage			Amount			Percentage			Amount			Percentage
U.S. federal statutory income tax rate	$	(184	)		35.0	%	$	6,246			35.0	%	$	23,797			35.0	%
U.S. state and local income taxes, net of U.S. federal income tax benefits		(1,585	)					840			4.7	%		3,569			5.2	%
Unrecognized tax benefits		1,524						—			0.0	%		—			0.0	%
Tax exempt income, net of interest expense		(561	)					(647	)		-3.6	%		(473	)		-0.7	%
Business promotion and other non-deductible expenses		851						620			3.5	%		616			0.9	%
Adjustments to reflect prior year tax return filings		(294	)					(552	)		-3.1	%		24			0.0	%
Tax rate change on deferred income taxes		390						(734	)		-4.1	%		955			1.4	%
Insurance proceeds, non-taxable		(349	)					(821	)		-4.6	%		—			0.0	%
Non-U.S. Operations		678						348			1.9	%		(232	)		-0.3	%
Other		(146	)					(69	)		-0.4	%		(1,045	)		-1.5	%

Total Income Tax Expense	$	324			n/m		$	5,231			29.3	%	$	27,211			40.0	%

n/m = not meaningful

Income taxes included in the consolidated statements of operations represent the following:

Expressed in thousands of dollars.


	Year ended December 31,
	2012			2011			2010
Current:
U.S. federal tax (benefit)	$	19,918		$	5,312		$	(11,471	)
State and local tax (benefit)		2,765			19			6,390
Non-U.S. operations		(61	)		113			685

		22,622			5,444			(4,396	)
Deferred:
U.S. federal tax (benefit)		(17,303	)		143			27,799
State and local tax (benefit)		(4,890	)		(1,029	)		3,356
Non U.S. operations (benefit)		(105	)		673			452

		(22,298	)		(213	)		31,607

	$	324		$	5,231		$	27,211

Profit (loss) before income taxes with respect to foreign operations was $(2.4) million, $1.3 million and $3.7 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Tax expense for 2012 was lower than in 2011 primarily because of pretax losses in 2012 versus pretax income in 2011. Moreover, the Company recorded tax credits of $1.9 million (net of federal taxes) related to state investment and employment incentives for investments previously made. These tax credits had the effect of lowering tax expense. However, there were several items that increased tax expense during 2012 compared to what it would have been otherwise. During the three months ended June 30, 2012, the Company recorded adjustments of $1.3 million related to prior periods (this figure reflecting the tax effects of interest deductions) to establish additional reserves for taxes and to adjust related interest. Tax expense was also increased in 2012 by higher nondeductible penalties in 2012 compared to 2011 due to various settlements during 2012 and by lower nontaxable benefits received in 2012 (compared to 2011) with respect to life insurance on employees of which the Company is the beneficiary.

The Company permanently reinvests eligible earnings of its foreign subsidiaries and, accordingly, does not accrue any U.S. income taxes that would arise if these earnings were repatriated. The unrecognized deferred tax liability associated with earnings of foreign subsidiaries, net of associated U.S. foreign tax credits, is $1.4 million for those subsidiaries with respect to which the Company would be subject to residual U.S. tax on cumulative earnings through 2012 were those earnings to be repatriated.

Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when such differences are expected to reverse. Significant components of the Company’s deferred tax assets and liabilities at December 31, 2012 and 2011 were as follows:

Expressed in thousands of dollars.


	December 31,
	2012		2011
Deferred tax assets:
Employee deferred compensation plans	$	22,819	$	17,280
Reserve for litigation and legal fees		17,019		5,469
Book versus tax depreciation differences		5,931		3,675
Involuntary conversion		1,686		1,534
Allowance for doubtful accounts		941		1,044
Other		18,973		16,317

Total deferred tax assets		67,369		45,319
Deferred tax liabilities:
Goodwill amortization (Section 197)		39,391		34,915
Change in accounting method		—		8,075
Partnership investments		6,273		7,020
Capital markets acquisition (2008)		—		4,801
Mortgage Servicing Rights		6,679		3,387
Other		2,559		1,247

Total deferred tax liabilities		54,902		59,445
U.S. deferred tax asset/(liabilities) , net		12,467		(14,126	)
Non U.S. deferred tax asset/(liabilities), net		3,873		3,824

Deferred tax asset/(liabilities), net	$	16,340	$	(10,302	)

The Company has a deferred tax asset arising from a net operating loss of $2.8 million and $1.0 million related to Oppenheimer Israel (OPCO) Ltd. and Oppenheimer Investments Asia Ltd., respectively, at December 31, 2012. The Company believes that realization of the deferred tax asset is more likely than not based on expectations of future taxable income in Israel and Asia. These net operating losses carry forward indefinitely and are not subject to expiration, provided that these subsidiaries and their underlying businesses continue operating normally (as is anticipated).

The Company has a deferred tax asset of $982,000 as of December 31, 2012 arising from New York State Investment Tax Credits and Employment Incentive Credits carried forward to future years. These credits will expire if not used by 2027.

Goodwill arising from the acquisitions of Josephthal Group Inc. and the Oppenheimer Divisions is being amortized for tax purposes on a straight-line basis over 15 years. The difference between book and tax is recorded as a deferred tax liability.

The Company or one or more of its subsidiaries file income tax returns in the U.S. federal jurisdiction, and in various states and foreign jurisdictions. The Company is currently under examination in the U.S. federal jurisdiction by the Internal Revenue Service (the “IRS”) for 2009 and loss carryback years 2004 and 2005. The Company has closed other tax years through 2008 in the U.S. federal jurisdiction.

The Company is under examination in various states and overseas jurisdictions in which the Company has significant business operations. The Company has closed tax years through 2007 for New York State and is currently under exam for the period 2008 to 2011. The Company also has closed tax years through 2007 with New York City and is currently under exam for the 2008 tax year. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 2008.

The Company regularly assesses the likelihood of additional assessments in each of the taxing jurisdictions resulting from the aforementioned examinations and those that may be take place for subsequent years. The Company has established tax reserves that the Company believes are adequate in relation to the potential for additional assessments. Once established, the Company adjusts tax reserves only when more information is available or when an event occurs necessitating a change to the reserves. The Company believes that the resolution of tax matters will not have a material effect on the consolidated financial condition of the Company, although a resolution could have a material impact on the Company’s consolidated statement of operations for a particular future period and on the Company’s effective income tax rate for any period in which such resolution occurs.

The Company has unrecognized tax benefits of $5.2 million as of December 31, 2012. Of this amount, $661,000 would favorably impact the effective tax rate if recognized. A reconciliation of the beginning and ending amount of unrecognized tax benefit follows:

Expressed in thousands of dollars.


	2012		2011
Balance at January 1	$	2,317	$	—
Additions for tax positions of prior years		2,919		2,317

Balance at December 31	$	5,236	$	2,317

The Company records interest and penalties accruing on unrecognized tax benefits in pretax income as interest expense and other expense on its statement of operations, respectively. For the years ended December 31, 2012 and 2011, the Company recorded tax-related interest (benefit) expense of $(408,000) and $753,000, respectively, in its statement of operations. At December 31, 2012 and 2011, the Company had an income tax-related interest payable of $345,000 and $753,000, respectively, on its consolidated statement of financial condition.