10. Income Taxes

Components of income (loss) before taxes are as follows for the years ended December 31, (in thousands):


	2009			2010			2011
Income (loss) before taxes:
U.S.	$	(17,084	)	$	(7,958	)	$	(6,310	)
Foreign		3,419			(5,080	)		(15,585	)

Total income (loss) before taxes	$	(13,665	)	$	(13,038	)	$	(21,895	)

Components of the income tax provision (benefit) are as follows for the years ended December 31, (in thousands):


	2009			2010		2011
Current:
Federal	$	(205	)	$	—	$	—
State, local and foreign		145			213		129

		(60	)		213		129

Deferred:
Federal		—			—		—
State, local and foreign		20			—		—

		20			—		—

Total income tax provision (benefit)	$	(40	)	$	213	$	129

The reconciliation of the income tax provision computed using the federal statutory income tax rate to the recognized income tax provision (benefit) is as follows for the years ended December 31, (in thousands):


	2009			2010			2011
Federal statutory rate	$	(4,646	)	$	(4,432	)	$	(7,444	)
State and local income taxes, net of federal benefit		46			(153	)		(85	)
State rate change and other adjustments		—			737			160
Increase in valuation allowance		4,225			3,298			6,302
Foreign tax differential		(23	)		(76	)		(716	)
Research and development credits		(253	)		(48	)		(49	)
Goodwill impairment		—			—			1,408
Share based compensation		555			532			484
Other		56			203			69

Income tax provision (benefit)	$	(40	)	$	213		$	129

The tax effect of temporary differences that give rise to deferred income taxes are as follows as of December 31, (in thousands):


	2010			2011
Deferred tax assets:
Net operating loss and tax credit carry forwards	$	87,204		$	88,675
Inventory reserve and uniform capitalization		1,707			1,959
Stock options and warrants		2,070			2,807
In-process research and development		248			241
Allowance for bad debts		21			265
Vacation accrual		411			354
Deferred rent		513			283
Warranty accrual		364			494
Depreciation and amortization		1,753			1,579
Other accruals and reserves		2,508			4,252
Acquired intangibles		656			1,386

Total deferred tax assets		97,455			102,295
Deferred tax liabilities:
State taxes		(3,677	)		(3,568	)
Cloverleaf intangibles		(1,214	)		(456	)

Total deferred income tax liabilities		(4,891	)		(4,024	)

Valuation allowance		(92,564	)		(98,271	)

Net deferred tax assets	$	—		$	—

As a result of certain realization requirements of ASC 718, the table of deferred tax assets and liabilities shown above does not include deferred tax assets for net operating losses as of December 31, 2011 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by $0.3 million if and when such excess tax benefits are recognized through current taxes payable. The Company uses ASC 740 ordering when determining when excess tax benefits have been realized.

U.S. income and withholding taxes have not been recognized on the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration. This amount becomes taxable upon a repatriation of assets from the subsidiary or a sale or liquidation of the subsidiary. The amount of such temporary differences totals $ 0.5 million at December 31, 2011. Determination of the amount of any unrecognized deferred tax liability on this temporary difference is not practicable.

The following table summarizes the activity related to our unrecognized tax benefits (in thousands):


	2009			2010			2011
Balance, January 1	$	4,756		$	4,842		$	5,111
Increase related to prior period positions		167			367			—
Increase related to current year tax positions		—			91			124
Decrease related to prior period positions		—			(101	)		(210	)
Decrease related to change in prior year estimate		(81	)		(88	)		—

Balance, December 31	$	4,842		$	5,111		$	5,025

At December 31, 2009, December 31, 2010, and December 31, 2011 we had cumulative unrecognized tax benefits of approximately $4.8 million, $5.1 million, and $5.0 million respectively, of which approximately $0.2 million, $0.2 million, and $0.2 million, respectively, are included in other long term liabilities that, if recognized, would affect the effective tax rate. The remaining $4.6 million, $4.9 million and $4.8 million of unrecognized tax benefits will have no impact on the effective tax rate due to the existence of net operating loss carryforwards and a full valuation allowance. Consistent with previous periods, penalties and tax related interest expense are reported as a component of income tax expense. As of December 31, 2009, December 31, 2010 and December 31, 2011, the total amount of accrued income tax related interest and penalties included in the consolidated balance sheet was less than $0.1 million. We do not expect that our unrecognized tax benefit will change significantly within the next 12 months.

Due to net operating losses and other tax attributes going forward, we are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending March 31, 1999 through December 31, 2010. With few exceptions, our state income tax returns are open to audit for the years ended December 31, 2007 through 2010.

We periodically evaluate the likelihood of the realization of deferred tax assets, and adjust the carrying amount of the deferred tax assets by the valuation allowance to the extent the future realization of the deferred tax assets is not judged to be more likely than not. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income or loss, the carryforward periods available to us for tax reporting purposes, and other relevant factors.

At December 31, 2011, based on the weight of available evidence, including cumulative losses in recent years and expectations regarding future taxable income, we determined that it was not more likely than not that our deferred tax assets would be realized and have a $98.3 million valuation allowance associated with our deferred tax assets.

As of December 31, 2011, we had federal and state net operating losses of approximately $194.5 million and $102.3 million, respectively, which begin to expire in the tax years ending 2017 and 2012, respectively. We had foreign net operating losses of $37.0 million, which have no expiration date. In addition, we had federal tax credit carryforwards of $4.2 million, of which approximately $0.5 million can be carried forward indefinitely to offset future tax liability, and the remaining $3.7 million begin to expire in the tax year ending 2012. We also had state tax credit carryforwards of $3.5 million, of which $0.1 million will begin expiring in 2012, and the remaining $3.4 million have no expiration date.

As a result of our equity transactions, an ownership change, within the meaning of IRC Section 382, occurred on September 18, 2003. As a result, annual use of our federal net operating loss and credit carry forwards is limited to (i) the aggregate fair market value of Dot Hill immediately before the ownership change multiplied by (ii) the long-term tax-exempt rate (within the meaning of Section 382 (f) of the IRC) in effect at that time. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the IRC Section 382 limitation for those years.

As a result of our acquisition of Chaparral Network Storage, Inc., or Chaparral, a second ownership change, within the meaning of IRC Section 382, occurred on February 23, 2004. As a result, annual use of Chaparral's federal net operating loss and credit carry forwards may be limited. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the Section 382 limitation for those years.

As a result of our acquisition of Cloverleaf, a third ownership change, within the meaning of IRC Section 382, occurred on January 26, 2010. As a result, annual use of Cloverleaf's federal net operating loss and credit carry forwards may be limited. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the Section 382 limitation for those years.