NOTE 8

Income Taxes

Earnings (loss) before income taxes is comprised of the following amounts in each tax jurisdiction:


(In thousands)	2011			2010		2009
United States	$	72,156		$	76,196	$	275,685
Canada		(1,236	)		—		—

Earnings before income taxes	$	70,920		$	76,196	$	275,685

The income tax provision is comprised of the following:


(In thousands)	2011			2010			2009
Current
Federal	$	9,619		$	12,331		$	87,543
State		6,880			5,056			10,804
Foreign		(30	)		—			—

		16,469			17,387			98,347
Deferred
Federal		12,865			(16,371	)		(5,095)
State		1,931			1,380			(31)
Foreign		(19	)		—			—

		14,777			(14,991	)		(5,126)

Income tax provision	$	31,246		$	2,396		$	93,221

The income tax provision differs from the amount computed by applying the statutory federal income tax rate of 35.0% to earnings before income taxes due to the following:


(In thousands)	2011			2010			2009
Computed expected tax provision	$	24,822		$	26,668		$	96,490
State and local taxes, net of federal income tax impact		1,482			4,157			6,035
Adjustment for state deferred tax rate		2,916			—			—
State investment tax credits		—			(1,649	)		958
Federal credits		(412	)		(25,153	)		(9,922)
Federal manufacturing deduction		(2,443	)		(2,993	)		(2,373)
Uncertain tax positions		2,610			(3,796	)		—
Patient Protection and Affordable Care Act		—			3,290			—
Non-deductible acquisition costs		(1,215	)		1,263			—
Change in valuation allowances		2,796			—			—
U.S. tax provision on foreign operations		365			—			—
Other		325			609			2,033

Income tax provision	$	31,246		$	2,396		$	93,221

Effective tax rate		44.1	%		3.1	%		33.8%

Excess tax benefits associated with equity-based compensation plans were allocated directly to additional paid-in capital as a component of stockholders’ equity in the amount of $885, $855 and $64, in the years ended December 31, 2011, 2010, and 2009, respectively.

The tax effects of significant temporary differences creating deferred tax assets and liabilities at December 31 were:


(In thousands)	2011			2010
Deferred tax assets:
Employee benefits	$	7,930		$	11,599
Postretirement employee benefits		47,024			55,186
Incentive compensation		7,949			2,835
Pensions		34,919			22,067
Federal and state credit carryforwards		30,809			45,238
Net operating losses		16,749			21,444
Federal benefit from state taxes resulting from uncertain tax positions		5,595			5,595
Other		6,492			3,146

Total deferred tax assets	$	157,467		$	167,110
Valuation allowance		(8,025	)		(5,229	)

Deferred tax assets, net of valuation allowance	$	149,442		$	161,881

Deferred tax liabilities:
Plant and equipment	$	(166,885	)	$	(168,572	)
Intangible assets		(10,879	)		(13,238	)
Inventories		(1,570	)		(3,350	)
Other		—			(411	)

Total deferred tax liabilities		(179,334	)		(185,571	)

Net deferred tax liabilities	$	(29,892	)	$	(23,690	)

Net deferred tax assets (liabilities) consist of:


(In thousands)	2011			2010
Current deferred tax assets	$	41,237		$	37,374
Current deferred tax liabilities		(1,771	)		—

Net current deferred tax assets		39,466			37,374

Non-current deferred tax assets		108,205			124,507
Non-current deferred tax liabilities		(177,563	)		(185,571	)

Net non-current deferred tax liabilities		(69,358	)		(61,064	)

Net deferred tax liabilities	$	(29,892)		$	(23,690	)

We are registered with the Internal Revenue Service, or IRS, as both an alternative fuel mixer and a producer of cellulosic biofuel. During 2009 we received refundable tax credit payments in connection with our use of “black liquor”, a by-product of the pulp manufacturing process, in an alternative fuel mixture to produce energy at our pulp mills. The amount of the refundable tax credit is equal to $0.50 per gallon of alternative fuel mixture used. The Alternative Fuel Mixture Tax Credit, or AFMTC, expired on December 31, 2009. The Cellulosic Biofuel Producer Credit, or CBPC, enables us to claim $1.01 per gallon in regards to black liquor produced and used as a fuel by us at our pulp mills in 2009. During 2010, the IRS clarified the ability to convert previously claimed gallons from the AFMTC to the CBPC. We are eligible to convert gallons previously claimed under the AFMTC to the CBPC; however, due to CBPC carryovers from 2010, we did not convert additional gallons during 2011. Under current federal tax law, we have the ability to convert additional gallons to CPBC until 2013.

During 2011, we recorded a $2.9 million tax expense, reflecting a remeasurement of state deferred tax assets and liabilities using anticipated future tax rates which will be in effect when the underlying assets and liabilities will reverse. The change in state tax rate is primarily attributable to the change in our tissue business operations after the acquisition of Cellu Tissue on December 27, 2010.

As of December 31, 2011, we had deferred tax assets arising from deductible temporary differences, tax losses and tax credits of $157.5 million before the offset of certain deferred tax liabilities. With the exception of certain deferred tax assets related to federal foreign tax credits, state tax losses and state tax credits, management believes it is more likely than not that forecasted income, together with the tax effect of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets.

During 2011, the valuation allowance for deferred tax assets increased by a net $2.8 million. We increased the valuation allowances for state tax losses incurred by certain subsidiaries and state tax credits by $2.5 million and $2.2 million, respectively. Both of these items were recorded as current period deferred tax expense. We also reduced the valuation allowance relating to foreign tax credits by $1.9 million, which was recorded as a deferred tax benefit to the income tax provision. The reduction is based upon tax planning strategies that we believe will more likely than not allow us to utilize a portion of the foreign tax credits before they expire. The valuation allowance did not change in 2010 or 2009.

Tax years subject to examination by major taxing jurisdictions are as follows:


Jurisdiction		Years
United States		2008 – 2011
Canada		2008 – 2011
Arkansas		2008 – 2011
California		2007 – 2011
Georgia		2008 – 2011
Idaho		2008 – 2011
Illinois		2008 – 2011
Wisconsin		2007 – 2011

Tax credits and losses subject to expiration by major taxing jurisdictions are as follows (in thousands):


Jurisdiction	Gross Values		Years
United States
Net operating losses	$	31,203		2030
Cellulosic biofuel producer tax credits		15,879		2015
Foreign tax credits		3,832		2016 – 2019
Other federal tax credits		3,677		2026 – 2030
Connecticut tax losses		2,722		2029 – 2031
Georgia tax losses		1,296		2028 – 2031
Idaho tax credits		5,321		2012 – 2025
North Carolina tax credits		3,454		2015
Oklahoma tax losses		2,580		2030 – 2031

As of December 31, 2011 there were no undistributed earnings relating to our Canadian subsidiary, Interlake Acquisition Corporation, as all historical earnings were repatriated under Cellu Tissue ownership. Management’s intent is to reinvest future earnings indefinitely.

A review of our uncertain income tax positions at December 31, 2011 indicates that liabilities are required to be recorded for gross unrecognized tax benefits following authoritative accounting guidance. The following presents a roll forward of our unrecognized tax benefits and associated interest and penalties, as included in the Accrued Taxes line item in non-current liabilities in our Consolidated Balance Sheets.


(In thousands)	Gross Unrecognized Tax Benefits, Excluding Interest and Penalties			Interest and Penalties		Total Gross Unrecognized Tax Benefits
Balance at January 1, 2011	$	69,633		$	2,378	$	72,011
Changes in prior year tax positions		(174	)		—		(174)
Increase in current year tax positions		222			2,435		2,657
Reductions as a result of a lapse of the applicable statute of limitations		(30	)		—		(30)

Balance at December 31, 2011	$	69,651		$	4,813	$	74,464

Unrecognized tax benefits at December 31, 2011, if recognized, would favorably impact our effective tax rate by decreasing our tax provision by $68.9 million.

We reflect accrued interest related to tax obligations, as well as penalties, in our provision for income tax. For each of the years ended December 31, 2011 and 2010, we accrued $2.4 million of interest and no penalties in our income tax provision. For the year ended December 31, 2009, we recognized no interest or penalties in our income tax provision and we had no amounts accrued for the payment of interest.

We entered into a tax sharing agreement with Potlatch upon the December 2008 spin-off that will generally govern each party’s rights, responsibilities and obligations with respect to taxes, including ordinary course of business taxes and taxes, if any, incurred as a result of any failure of the spin-off to be tax free. Under the tax sharing agreement, we expect that, with certain exceptions, we will be responsible for the payment of all income and non-income taxes attributable to our operations. The tax sharing agreement also sets forth our rights and responsibilities for tax obligations and refunds attributable to tax periods prior to the spin-off date.

Under the tax sharing agreement, we will be responsible for any taxes imposed on Potlatch that arise from the failure of the spin-off, together with certain related transactions, to qualify as a tax-free distribution for U.S. federal income tax purposes, including any tax that would result if Potlatch were to fail to qualify as a REIT as a result of income recognized by Potlatch if the spin-off were determined to be taxable, to the extent such failure to qualify is attributable to actions, events or transactions relating to our stock, assets or business, or a breach of the relevant representations or covenants we made in the tax sharing agreement. The tax sharing agreement imposes restrictions on our and Potlatch’s ability to engage in certain actions following the spin-off and sets forth the respective obligations of each party with respect to the filing of tax returns, the administration of tax contests, assistance and cooperation and other matters.