17 INCOME TAXES

Income from continuing operations before income taxes and income taxes are as follows:


(In Thousands)		2012			2011			2010
Income from continuing operations
before income taxes:
Domestic	$	35,488		$	29,491		$	30,430
Foreign		26,016			9,298			10,060
Total	$	61,504		$	38,789		$	40,490
Current income taxes:
Federal	$	10,905		$	2,958		$	14,329
State		796			639			1,409
Foreign		7,372			4,500			4,308
Total		19,073			8,097			20,046
Deferred income taxes:
Federal		1,212			3,243			(6,225	)
State		163			(211	)		(771	)
Foreign		(2,129	)		(885	)		599
Total		(754	)		2,147			(6,397	)
Total income taxes	$	18,319		$	10,244		$	13,649

The significant differences between the U.S. federal statutory rate and the effective income tax rate for continuing operations are as follows:


	Percent of Income Before Income Taxes for Continuing Operations
	2012		2011		2010
Income tax expense at federal statutory rate	35.0		35.0		35.0
Valuation allowance for capital loss carry-forwards	1.9		.9		.5
State taxes, net of federal income tax benefit	1.1		1.7		.9
Unremitted earnings from foreign operations	.6		1.8		1.3
Non-deductible expenses	.3		.8		.3
Non-deductible acquisition expenses	-		3.5		-
Write-off of tax receivable from indemnification	-		-		1.8
Research and development tax credit	-		(1.0	)	(.8	)
Deduction for divestiture of subsidiary stock	-		(15.3	)	-
Valuation allowance for foreign operating loss carry-forwards	(.1	)	1.4		1.3
Reversal of income tax contingency accruals and tax settlements	(.5	)	.3		.6
Changes in estimates related to prior year tax provision	(.5	)	(.1	)	(4.1	)
Domestic Production Activities Deduction	(.6	)	-		(1.1	)
Foreign rate differences	(.6	)	(.7	)	(1.8	)
Tax incentive	(7.0	)	(1.8	)	-
Other	.2		(.1	)	(.2	)
Effective income tax rate	29.8		26.4		33.7

The Brazilian federal statutory income tax rate is a composite of 34.0% (25.0% of income tax and 9.0% of social contribution on income). Terphane's manufacturing facility in Brazil is the beneficiary of certain income tax incentives that allow for a reduction in the statutory Brazilian federal income tax rate levied on the operating profit of its products. These incentives produce a current tax rate of 15.25% for Terphane Ltda. (6.25% of income tax and 9.0% social contribution on income). The current incentives will expire at the end of 2014, but we anticipate that we will qualify for additional incentives that will extend beyond 2014. The benefit from the tax incentives was $4.3 million (13 cents per share) and $0.7 million (2 cents per share) in 2012 and 2011, respectively.

Deferred tax liabilities and deferred tax assets at December 31, 2012 and 2011, are as follows:


(In Thousands)		2012		2011
Deferred tax liabilities:
Amortization of goodwill	$	47,956	$	48,407
Depreciation		34,110		40,754
Foreign currency translation gain adjustment		8,795		8,638
Derivative financial instruments		568		-
Total deferred tax liabilities		91,429		97,799
Deferred tax assets:
Pensions		30,488		21,169
Employee benefits		10,532		9,841
Excess capital losses and book/tax basis differences
on investments		4,923		5,514
Asset write-offs, divestitures and environmental accruals		3,234		3,177
Inventory		2,086		2,439
Tax benefit on state and foreign NOL and credit
carryforwards		1,676		1,898
Allowance for doubtful accounts and sales returns		756		919
Timing adjustment for unrecognized tax benefits on
uncertain tax positions, including portion relating to
interest and penalties		236		360
Derivative financial instruments		-		249
Other		974		1,024
Deferred tax assets before valuation allowance		54,905		46,590
Less: Valuation allowance		18,635		12,427
Total deferred tax assets		36,270		34,163
Net deferred tax liability	$	55,159	$	63,636
Included in the balance sheet:
Noncurrent deferred tax liabilities in excess of assets	$	60,773	$	70,769
Current deferred tax assets in excess of liabilities		5,614		7,133
Net deferred tax liability	$	55,159	$	63,636

Except as noted below, we believe that it is more likely than not that future taxable income will exceed future tax deductible amounts thereby resulting in the realization of deferred tax assets. A valuation allowance of $1.3 million at December 31, 2012 and 2011, respectively, is provided against the tax benefit on state and foreign net operating loss carryforwards for possible future tax benefits on domestic state and foreign operating losses generated by certain foreign and domestic subsidiaries that may not be recoverable in the carry-forward period. In addition, the valuation allowance for excess capital losses from investments and other related items was increased from $9.3 million at December 31, 2011 to $15.5 million at December 31, 2012 due to changes in the relative amounts of capital gains and losses generated during the year. The amount of the deferred tax asset considered realizable, however, could be adjusted in the near term if estimates of the fair value of certain investments during the carryforward period change. The valuation allowance for asset impairments in foreign jurisdictions where we believe it is more likely than not that the deferred tax asset will not be realized increased from $1.8 million in 2011 to $1.9 million in 2012.

A reconciliation of our unrecognized uncertain tax positions since January 1, 2010, is shown below:


		Years Ended December 31,
(In Thousands)		2012			2011			2010
Balance at beginning of period	$	1,025		$	1,065		$	996
Increase (decrease) due to tax
positions taken in:
Current period		432			185			184
Prior period		(21	)		10			493
Increase (decrease) due to settlements
with taxing authorities		(398	)		-			(375	)
Reductions due to lapse of statute
of limitations		(128	)		(235	)		(233	)
Balance at end of period	$	910		$	1,025		$	1,065

Additional information related to our unrecognized uncertain tax positions since January 1, 2010 is summarized below:


	Years Ended December 31,
(In Thousands)		2012			2011			2010
Gross unrecognized tax benefits on uncertain tax
positions (reflected in current income tax and other
noncurrent liability accounts in the balance sheet)	$	910		$	1,025		$	1,065
Deferred income tax assets related to unrecognized
tax benefits on uncertain tax positions (reflected in
deferred income tax accounts in the balance sheet)		(212	)		(219	)		(234	)
Net unrecognized tax benefits on uncertain tax
positions, which would impact the effective tax rate if
recognized		698			806			831
Interest and penalties accrued on deductions taken
relating to uncertain tax positions (approximately $(300),
$200 and $(400) reflected in income tax expense in the
income statement in 2012, 2011 and 2010, respectively,
with the balance shown in current income tax and other
noncurrent liability accounts in the balance sheet)		60			373			125
Related deferred income tax assets recognized on
interest and penalties		(23	)		(141	)		(46	)
Interest and penalties accrued on uncertain tax
positions net of related deferred income tax benefits,
which would impact the effective tax rate if
recognized		37			232			79
Total net unrecognized tax benefits on uncertain tax
positions reflected in the balance sheet, which would
impact the effective tax rate if recognized	$	735		$	1,038		$	910

We claimed an ordinary loss on the write-off of our investment in our aluminum extrusions operations in Canada (sold in February 2008) on our 2008 consolidated tax return (included in discontinued operations in the consolidated statement of income in 2007). During an audit, the IRS challenged the ordinary nature of the loss, asserting that the loss should be re-characterized as capital in nature. Had the IRS prevailed in final, non-appealable determinations, it is possible that the matter would have resulted in additional tax payments of up to $12 million, plus any interest and penalties. Prior to issuing a Notice of Deficiency, however, the IRS revised their audit report to allow the ordinary loss treatment to stand. The audit findings have been confirmed by the IRS Joint Committee review, and we expect no further challenge on this issue.

Tredegar and its subsidiaries file income tax returns in the U.S., various states and jurisdictions outside the U.S. Except for refund claims and amended returns, the IRS has provided written confirmation that they do not plan to make any additional changes to our U.S. consolidated tax returns for the years prior to 2010, although the federal statute of limitations was extended for the tax years 2006-2009 through December 31, 2013. With few exceptions, Tredegar and its subsidiaries are no longer subject to state or non-U.S. income tax examinations by tax authorities for years before 2009. We believe that it is reasonably possible that approximately $0.1 million of the balance of unrecognized state tax positions may be recognized within the next twelve months as a result of a lapse of the statute of limitations.