Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

Income Taxes

10. Income Taxes

        Total income tax benefit for 2011, 2010 and 2009 is as follows (in thousands):

• Holdings

	Year ended December 31,
	2011			2010			2009
Current:
Federal	$	—		$	(268	)	$	721
State		4,254			3,469			2,562
Total current tax provision		4,254			3,201			3,283
Deferred:
Federal		(20,991	)		(28,797	)		(35,585	)
State		(4,430	)		(3,544	)		(2,760	)
Total deferred tax provision		(25,421	)		(32,341	)		(38,345	)
Total income tax benefit	$	(21,167	)	$	(29,140	)	$	(35,062	)

• Guitar Center

	Year ended December 31,
	2011			2010			2009
Current:
Federal	$	4,917		$	16,004		$	14,904
State		3,620			1,335			4,975
Total current tax provision		8,537			17,339			19,879
Deferred:
Federal		(29,171	)		(16,823	)		(29,160	)
State		(3,516	)		(2,778	)		(3,034	)
Total deferred tax provision		(32,687	)		(19,601	)		(32,194	)
Total income tax benefit	$	(24,150	)	$	(2,262	)	$	(12,315	)

        Holdings' charge in lieu of taxes attributable to tax benefit from employee stock options was $0.6 million in 2010 and $0.2 million in 2009. There was no charge in lieu of taxes attributable to tax benefit from employee stock options in 2011.

        Actual income taxes differ from the statutory tax rate of 35% as applied to net loss before income taxes as follows (in thousands):

• Holdings

	Year Ended December 31,
	2011			2010			2009
Expected income tax benefit	$	(90,337	)	$	(29,622	)	$	(78,722	)
State income taxes, net of federal tax benefit		(1,463	)		(440	)		(1,189	)
Goodwill impairment		37,460			—			43,332
Stock options		—			(159	)		—
Change in valuation allowance		32,247			—			—
Meals & entertainment and non-deductible items		348			337			266
Other		578			744			1,251
Actual income tax benefit	$	(21,167	)	$	(29,140	)	$	(35,062	)

• Guitar Center

	Year Ended December 31,
	2011			2010			2009
Expected income tax benefit	$	(62,249	)	$	(3,894	)	$	(55,981	)
State income taxes, net of federal tax benefit		(253	)		746			444
Goodwill impairment		37,460			—			41,745
Stock options		—			(159	)		—
Meals & entertainment and non-deductible items		348			337			266
Other		544			708			1,211
Actual income tax benefit	$	(24,150	)	$	(2,262	)	$	(12,315	)

        The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are presented below (in thousands):

	Holdings						Guitar Center
	December 31,						December 31,
	2011			2010			2011			2010
Deferred tax assets:
Net operating loss	$	43,179		$	18,712		$	—		$	—
State net operating loss carryforward		2,042			1,128			—			—
Accrued liabilities		26,572			22,823			26,572			22,823
Merchandise inventories		2,961			2,962			2,961			2,962
Intangibles		8,084			8,093			8,084			8,093
Stock options		2,652			2,461			2,652			2,461
Capital loss carryover		129			129			129			129
Fixed assets		(2,203	)		4,394			(2,203	)		4,394
Total gross deferred tax assets		83,416			60,702			38,195			40,862
Less valuation allowance		(32,558	)		(311	)		(310	)		(311	)
Net deferred tax assets		50,858			60,391			37,885			40,551
Deferred tax liabilities:
Depreciation		(5,813	)		(7,754	)		(5,813	)		(7,754	)
Intangibles		(120,196	)		(153,528	)		(120,196	)		(153,528	)
Other		(441	)		(548	)		(441	)		(548	)
Total gross deferred tax liabilities		(126,450	)		(161,830	)		(126,450	)		(161,830	)
Net deferred tax liabilities	$	(75,592	)	$	(101,439	)	$	(88,565	)	$	(121,279	)

        In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.

        We consider scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

        Holdings has incurred losses in each of the four most recent years. Based on the available objective evidence, management believes it is more likely than not that Holdings will not fully realize the benefits of these deductible temporary differences. Accordingly, we increased the valuation allowance on Holdings' federal and state net operating losses and other deferred tax assets by $32.2 million in 2011.

        Holdings' available unused net operating loss carryforwards, which may be applied against future taxable income, expire between 2027 and 2029.

        We account for the tax benefit resulting from the employee exercises of non-qualifying stock options or the disqualified disposition of incentive stock options as a reduction in income tax payable and an increase to additional paid-in capital.

        We did not record any material tax benefits in additional paid-in capital for 2011 or 2010. We recorded $0.2 million of tax benefit in 2009.

        The reconciliation of unrecognized tax benefits in 2011, the balance of which is classified as other current assets in the consolidated balance sheet, is as follows (in thousands):

Balance at January 1, 2011	$	1,530
Additions based on tax positions of current years		—
Reductions based on tax positions of prior years		260
Payments and settlements		(276	)
Balance at December 31, 2011	$	1,514

        The amount of unrecognized tax benefits that, if recognized, would impact the effective rate as of December 31, 2011 is $1.5 million.

        As of December 31, 2011 and 2010, accrued interest and penalties related to uncertain tax positions were not material. Our policy is to classify interest and penalties as income tax expense.

        Tax years that remain subject to examination are 2007 and forward by the Internal Revenue Service and 2006 and forward by other state and local jurisdictions. It is reasonably possible that our recognized tax benefit could change. However, we do not expect any such change to be material.