14 INCOME TAXES

Ambac files a consolidated Federal income tax return with its subsidiaries. Ambac and its subsidiaries also file separate or combined income tax returns in various states, local and foreign jurisdictions. The following are the major jurisdictions in which Ambac and its affiliates operate and the earliest tax years subject to examination:


Jurisdiction	Tax Year
United States		2005
New York State		2008
New York City		2011
United Kingdom		2006
Italy		2007

As described in Note 17, on February 24, 2012, Ambac, the Creditors' Committee, Ambac Assurance, the Segregated Account, OCI, and the Rehabilitator submitted to the Department of Justice, Tax Division a proposal (the "Offer Letter") to settle the IRS Dispute which includes the following terms that Ambac believes will be acceptable to the United States: (i) a payment by Ambac Assurance of approximately $100,000; (ii) a payment by Ambac of approximately $1,900; (iii) Ambac's consolidated tax group will relinquish its claim to all loss carry-forwards resulting from losses on credit default swap contracts and arising on or before December 31, 2010 to the extent such loss carry-forwards exceed $3,400,000; and (iv) the IRS will be paid 12.5% of any payment to Ambac by Ambac Assurance associated with NOL Usage Tier C and the IRS will be paid 17.5% of any payment to Ambac by Ambac Assurance associated with NOL Usage Tier D. See Note 1 to the Consolidated Financial Statements for a description of NOL usage payments and NOL usage tiers. Finality of the settlement will require the satisfaction of certain conditions and the approval of the United States, the Bankruptcy Court and the Rehabilitation Court. There can be no assurance that the IRS Settlement will be finalized on the terms described above, if at all, or as to the timing of any such settlement. Nevertheless, this possible settlement is being provided for in the year ending December 31, 2011 in accordance with ASC Topic 740, Income Taxes.

In 2011, Ambac settled tax years 2000 through 2010 with New York City for a cash payment of $2,000 and forfeiture of a $1,234 over payment, which was being applied to future tax years.

Ambac's provision for income taxes charged to income from continuing operations is comprised of the following:


	2011		2010
Current taxes	$	77,422	$	135
Deferred taxes		—		—

	$	77,422	$	135

The total effect of income taxes on net income and stockholders' equity for the years ended December 31, 2011 and 2010 is as follows:


	2011			2010
Total income taxes charged to net income	$	77,422		$	135

Income taxes charged (credited) to stockholders' equity:
Unrealized gains (losses) on investment securities		58,597			121,769
Valuation Allowance to Equity		(58,597	)		(119,116	)
Adoption of new consolidation accounting guidance for VIEs		—			245,715
Other		—			8,597

Total charged to stockholders' equity:		—			256,965

Total effect of income taxes	$	77,422		$	257,100

The tax provisions in the accompanying Consolidated Statements of Operations reflect effective tax rates differing from prevailing Federal corporate income tax rates. The following is a reconciliation of these differences:


	2011			%			2010			%
Tax on income from continuing operations at statutory rate	($	659,032	)		35.0	%	($	263,551	)		35.0	%
Reductions in expected tax resulting from:
Tax-exempt interest		(19,872	)		1.1	%		(24,700	)		3.3	%
Valuation allowance		685,787			(36.4	)%		288,195			(38.3	)%
Net addition to (release of) tax reserves		73,850			(3.9	)%		—			—
Other, net		(3,311	)		0.2	%		191			—

Tax expense on income from continuing operations	$	77,422			(4.1	)%	$	135			0.0	%

The tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities and deferred tax assets at December 31, 2011 and 2010 are presented below:


	2011		2010
Deferred tax liabilities:
Variable interest entities	$	28,773	$	50,324
Deferred acquisition costs		65,238		92,784
Unearned premiums and credit fees		41,342		33,638
Other		22,481		23,902

Total deferred tax liabilities		157,834		200,648

Deferred tax assets:
Unrealized losses & impairments on investments		47,919		148,728
Net operating loss carryforward		2,751,802		2,450,724
Loss reserves		514,150		18,106
Compensation		6,693		10,733
Other		6,672		9,195

Sub-total deferred tax assets		3,327,236		2,637,486
Valuation allowance		3,169,402		2,436,838

Total deferred tax assets		157,384		200,648

Net deferred tax assets	$	—	$	—

A reconciliation of the beginning and ending amount of unrecognized tax benefits for 2011 and 2010 is as follows:


	2011		2010
Balance at January 1,	$	23,050	$	22,850
Increases related to prior year tax positions		73,850		200
Decreases related to prior year tax positions		—		—

Balance at December 31,	$	96,900	$	23,050

Included in these balances at December 31, 2011 and 2010 are $96,900 and $23,050, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax rate. During 2011 and 2010, Ambac recognized interest of approximately $0 and $200, respectively. Ambac had approximately $0 and $15,220 for the payment of interest accrued at December 31, 2011 and 2010, respectively.

As a result of the development of additional losses and the related impact on the Company's cash flows, management believes it is more likely than not that the Company will not generate sufficient taxable income to recover the deferred tax operating asset. As of December 31, 2011, the company had a valuation allowance of $3,169,402.

In June 2010, Ambac Assurance settled its obligations under certain CDS by paying the CDS counterparties $2,600,000 in cash and issuing $2,000,000 face amount of surplus notes that have a stated interest rate of 5.1% per annum. Contemporaneously with issuing the notes, Ambac Assurance entered into call option agreements with several CDS counterparties giving Ambac Assurance the right for a limited time to repurchase Surplus Notes with an aggregate face amount of $940,000 for an aggregate price of $232,000 plus accrued and unpaid interest. Ambac Assurance concluded that the issue price on these notes was equal to the call strike price and that they were properly classified as applicable high interest discount obligations, subject to IRC Section 163(e)(5) restrictions on the deductibility of interest.

As of December 31, 2011 Ambac has an ordinary U. S. federal net operating tax carryforward of approximately $7,150,893, which if not utilized will begin expiring in 2028 and will fully expire in 2031. As disclosed above, to settle the IRS Dispute Ambac has proposed to relinquish its claim to all net operating loss carry-forwards resulting from losses on credit default swap contracts arising on or before December 31, 2010 to the extent such net operating loss carry-forwards exceed $3,400,000. The exact amount of the loss carry-forward relinquishment will be determined upon the execution of a closing agreement.