At the end of each quarter, Woodward estimates the tax that will be provided for the current fiscal year stated as a percentage of estimated “ordinary income.” The term ordinary income refers to earnings from continuing operations before income taxes, excluding significant unusual or infrequently occurring items.

The estimated annual effective rate is applied to the year-to-date ordinary income at the end of each quarter to compute the estimated year-to-date tax applicable to ordinary income. The tax expense or benefit related to ordinary income in each quarter is equal to the difference between the most recent year-to-date and the prior quarter year-to-date computations.

The tax effects of significant unusual or infrequently occurring items are recognized as discrete items in the interim period in which the events occur. The impact of changes in tax laws or rates on deferred tax amounts, the effects of changes in judgment about beginning of the year valuation allowances, and changes in tax reserves resulting from the finalization of tax audits or reviews are examples of significant unusual or infrequently occurring items that are recognized as discrete items in the interim period in which the events occur.

The determination of the annual effective tax rate is based upon a number of significant estimates and judgments. In addition, as a global commercial enterprise, Woodward’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, changes in the estimate of the amount of undistributed foreign earnings that Woodward considers indefinitely reinvested, and other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

Within the calculation of Woodward’s annual effective tax rate, Woodward has used assumptions and estimates that may change as a result of future guidance, interpretation, and rule-making from the IRS, the SEC, and the FASB and/or various other tax jurisdictions. Changes in corporate tax rates, the net deferred tax assets and/or liabilities relating to Woodward’s U.S. operations, the taxation of foreign earnings, and the deductibility of expenses contained in the Tax Act or other future tax reform legislation could have a material impact on Woodward’s future income tax expense.

The following table sets forth the tax expense and the effective tax rate for Woodward’s earnings before income taxes:



	Three-Months Ended
	December 31,
	2019		2018
Earnings before income taxes	$	61,548	$	61,515
Income tax expense		8,175		12,395
Effective tax rate		13.3%		20.1%

The decrease in the effective tax rate for the three-months ended December 31, 2019, compared to the three-months ended December 31, 2018 is primarily attributable to a larger favorable increase in the net excess income tax benefits from stock-based compensation, the tax benefit associated with the impairment of assets held for sale, and smaller unfavorable adjustment to prior period tax items. This decrease is partially offset by increased earnings in higher taxed jurisdictions and the impact of increased pre-tax earnings when compared to tax incentives, such as the research credit.

Gross unrecognized tax benefits were $10,631 as of December 31, 2019, and $10,305 as of September 30, 2019. At December 31, 2019, the amount of the liability for unrecognized tax benefits that, if recognized, would impact Woodward’s effective tax rate was $4,582. At this time, Woodward does not believe it is reasonably possible that the liability for unrecognized tax benefits will decrease in the next twelve months. Woodward accrues for potential interest and penalties related to unrecognized tax benefits and all other interest and penalties related to tax payments in tax expense. Woodward had accrued gross interest and penalties of $481 as of December 31, 2019 and $437 as of September 30, 2019.