Note 16. Income taxes

Income taxes consisted of the following:



		Year Ended September 30,
		2014		2013		2012
Current:
	Federal	$	48,327	$	29,438	$	47,862
	State		5,752		4,760		4,452
	Foreign		16,594		10,612		11,594
Deferred:
	Federal		(4,378)		13,904		(9,632)
	State		(2,966)		885		(200)
	Foreign		(1,929)		(5,970)		2,142
		$	61,400	$	53,629	$	56,218

Earnings before income taxes by geographical area consisted of the following:



	Year Ended September 30,
	2014		2013		2012
United States	$	148,837	$	148,604	$	146,535
Other countries		78,407		50,967		51,272
	$	227,244	$	199,571	$	197,807

Significant components of deferred income taxes presented in the Consolidated Balance Sheets are related to the following:



		At September 30,
		2014		2013
Deferred tax assets:
	Defined benefit plans, Other postretirement	$	10,762	$	10,563
	Foreign net operating loss carryforwards		5,552		7,058
	Inventory		21,608		16,944
	Deferred and stock-based compensation		24,987		18,657
	Defined benefit pension		227		866
	Other reserves		10,513		9,055
	Credits and incentives		8,178		8,046
	Other		11,422		10,584
	Valuation allowance		(9,486)		(11,783)
	Total deferred tax assets, net of valuation allowance		83,763		69,990
Deferred tax liabilities:
	Goodwill and intangibles - net		(96,493)		(97,804)
	Property, plant and equipment		(18,288)		(17,175)
	Other		(7,419)		(3,391)
	Total deferred tax liabilities		(122,200)		(118,370)
Net deferred tax liabilities		$	(38,437)	$	(48,380)

Woodward has recorded a net operating loss (“NOL”) deferred tax asset of $5,552 as of September 30, 2014 and $7,058 as of September 30, 2013. A portion of these carryforwards will expire by 2020 and are currently offset by a valuation allowance, while the remaining portion has an indefinite carryforward period and has no valuation allowance against it.

Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Both positive and negative evidence are considered in forming Woodward’s judgment as to whether a valuation allowance is appropriate, and more weight is given to evidence that can be objectively verified. Valuation allowances are reassessed whenever there are changes in circumstances that may cause a change in judgment. The change in the valuation allowance was primarily the result of current year earnings in a wholly owned subsidiary that had net operating losses subject to a full valuation allowance, and a change in judgment about the utilization of tax credits in various jurisdictions.

At September 30, 2014, Woodward has not provided for taxes on undistributed foreign earnings of $253,797 that it considered indefinitely reinvested. These earnings could become subject to income taxes if they are remitted as dividends, are loaned to Woodward or any of Woodward’s subsidiaries located in the United States, or if Woodward sells its stock in the foreign subsidiaries. Any additional U.S. taxes could be offset, in part or in whole, by foreign tax credits. The amount of such taxes and application of tax credits would be dependent on the income tax laws and other circumstances at the time these amounts are repatriated. Based on these variables, it is impractical to determine the income tax liability that might be incurred if these funds were to be repatriated.

The following is a reconciliation of the U.S. Federal statutory tax rate of 35 percent to Woodward’s effective income tax rate:



	Year Ending September 30,
Percent of pretax earnings	2014		2013		2012
Statutory tax rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal tax benefit	1.3		1.8		1.6
Taxes on international activities	(3.7)		(1.7)		(3.3)
Research credit	(0.7)		(3.1)		(0.8)
Retroactive extension of research credit	-		(2.5)		-
Domestic production activities deduction	(1.3)		(2.0)		(1.9)
Adjustments of prior period tax items	(2.9)		(0.6)		(1.5)
Other items, net	(0.7)		-		(0.7)
Effective tax rate	27.0	%	26.9	%	28.4	%

In determining the tax amounts in Woodward’s financial statements, estimates are sometimes used that are subsequently adjusted in the actual filing of tax returns or by updated calculations. In addition, we occasionally have resolutions of tax items with tax authorities related to prior years due to the conclusion of audits and the lapse of applicable statutes of limitations. Such adjustments are included in the “Adjustments of prior period tax items” line in the above table. The majority of the fiscal year 2014 adjustments are related to the conclusion of audits, effective settlement, and lapse of applicable statutes of limitations in various tax jurisdictions.

On January 2, 2013, the American Taxpayer Relief Act of 2012 (the “Taxpayer Relief Act”) was enacted, which retroactively extended the U.S. research and experimentation tax credit through December 31, 2013. As a result, income taxes for the year ended September 30, 2013 included a net expense reduction related to the retroactive impact from the last three quarters of fiscal year 2012 of the U.S. research and experimentation tax credit pursuant to the Taxpayer Relief Act.

Income taxes for the year ended September 30, 2012 included a tax benefit of $3,326 related to a reduction in the anticipated amount of undistributed earnings of certain of Woodward’s foreign subsidiaries that were previously expected to be repatriated to the United States within the foreseeable future. Woodward anticipates that a portion of those earnings will remain indefinitely invested outside the United States and accordingly it reversed the deferred tax liability associated with repatriating those earnings. This item is included in the “Taxes on international activities” line in the rate reconciliation above.

A reconciliation of the beginning and ending amounts of gross unrecognized tax benefits follows:



	Year Ending September 30,
	2014		2013		2012
Beginning balance	$	22,694	$	18,069	$	16,931
Additions to current year tax positions		8,830		5,587		1,444
Reductions to prior year tax positions		(9,684)		-		(169)
Additions to prior year tax positions		1,844		1,079		-
Lapse of applicable statute of limitations		(997)		(2,041)		(137)
Ending balance	$	22,687	$	22,694	$	18,069

Included in the balance of unrecognized tax benefits are $12,807 as of September 30, 2014 and $17,838 as of September 30, 2013 of tax benefits that, if recognized, would affect the effective tax rate. At this time, Woodward estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by as much as $114 in the next twelve months due to the completion of reviews by tax authorities and the expiration of certain statutes of limitations. Woodward accrues for potential interest and penalties related to unrecognized tax benefits in tax expense. Woodward had accrued interest and penalties of $1,158 as of September 30, 2014 and $2,066 as of September 30, 2013.

Woodward’s tax returns are audited by U.S., state, and foreign tax authorities, and these audits are at various stages of completion at any given time. Reviews of tax matters by authorities and lapses of the applicable statutes of limitations may result in changes to tax expense. With a few exceptions, Woodward’s fiscal years remaining open to examination in the United States include fiscal years 2011 and thereafter, and fiscal years remaining open to examination in significant foreign jurisdictions include 2005 and thereafter.