Tredegar recorded tax expense of $2.4 million on pretax net income of $6.1 million in the first three months of 2017. Therefore, the effective tax rate in the first three months of 2017 was 39.5%, compared to 30.6% in the first three months of 2016. The significant differences between the U.S. federal statutory rate and the effective income tax rate for the three months ended March 31, 2017 and 2016 are as follows:



	Percent of Income Before Income Taxes
Three Months Ended March 31,	2017		2016
Income tax expense at federal statutory rate	35.0		35.0
Foreign rate differences	5.9		(0.9	)
State taxes, net of federal income tax benefit	4.2		0.6
Valuation allowance for foreign operating loss carry-forwards	2.3		0.1
Non-deductible expenses	1.9		1.0
Changes in estimates related to prior year tax provision	1.9		(0.2	)
Income tax contingency accruals and tax settlements	1.2		0.9
Unremitted earnings from foreign operations	(1.1	)	(0.9	)
Research and development tax credit	(2.4	)	(0.9	)
Domestic production activities deduction	(2.8	)	(2.7	)
Foreign investment write-up	(6.6	)	(0.3	)
Valuation allowance for capital loss carry-forwards	—		(1.1	)
Effective income tax rate	39.5		30.6

Tredegar accrues U.S. federal income taxes on unremitted earnings of all foreign subsidiaries. Prior to the second quarter of 2016, deferred U.S. federal income taxes had not been recorded for the undistributed earnings for Terphane Ltda. because the Company had intended to permanently reinvest these earnings. Due to concerns about the political and economic conditions in Brazil, Terphane Ltda. began making cash distributions to the Company in 2016. During the second quarter of 2016, Terphane Ltda. paid a dividend of $10.7 million to the Company. Because of the accumulation of significant losses related to foreign currency translations at Terphane Ltda., there were no unrecorded deferred tax liabilities associated with the U.S. federal income taxes and foreign withholding taxes on Terphane Ltda.’s undistributed earnings as of March 31, 2017 and December 31, 2016.

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 Holdings LLC’s (“Terphane”) 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 to 15.25% levied on the operating profit on certain of its products. The incentives have been granted for a 10-year period, which has a retroactive commencement date of January 1, 2015. No benefit was recognized from these tax incentives in the first three months of 2017 or 2016.

In connection with its capacity expansion project in Brazil, the Company paid certain social taxes associated with the purchase of machinery and equipment and construction of buildings and other long-term assets. Payments of these taxes in Brazil were included in “Net cash used in investing activities” given the nature of the underlying use of cash (e.g. the purchase of property, plant and equipment). The Company can recover tax credits associated with the purchase of machinery and equipment at different points over a period up to 24 months. Once the machinery and equipment was placed into service in the fourth quarter of 2014, the Company started applying these tax credits against various other taxes due in Brazil, with their recovery being reflected as cash received from investing activities, consistent with the classification of the original payments.

Income taxes in 2017 included a partial reversal of a valuation allowance of less than $0.1 million related to the expected limitations on the utilization of assumed capital losses on certain investments that were recognized in prior years. Income taxes in 2016 included the partial reversal of a valuation allowance of $0.1 million related to the expected limitations on the utilization of assumed capital losses on certain investments. The Company had a valuation allowance for excess capital losses from investments and other related items of $11.2 million at March 31, 2017. Tredegar continues to evaluate opportunities to utilize these loss carryforwards prior to their expiration at various dates in the future. As events and circumstances warrant, allowances will be reversed when it is more likely than not that future taxable income will exceed deductible amounts, thereby resulting in the realization of deferred tax assets.

Tredegar and its subsidiaries file income tax returns in the U.S., various states and jurisdictions outside the U.S. With few exceptions, Tredegar and its subsidiaries are no longer subject to U.S. federal, state or non-U.S. income tax examinations by tax authorities for years before 2013.