Income Taxes

12 Months Ended

Dec. 31, 2012

Income Taxes [Abstract]

Income Taxes

7. Income Taxes

The provision for income taxes consists of the following:

	Year Ended December 31,
	2012			2011		2010
	(In thousands)
Current:
Federal	$	12,981		$	3,605	$	—
State and local		2,138			2,793		355
Foreign		1,315			1,194		1,348
Total current provision		16,434			7,592		1,703
Deferred:
Federal		8,951			20,531		14,494
State and local		1,238			2,890		3,170
Foreign		(6	)		16		115
Total deferred provision		10,183			23,437		17,779
Provision for income taxes	$	26,617		$	31,029	$	19,482

Pre-tax income from U.S. operations was $82.0 million, $74.3 million and $46.1 million for the years ended December 31, 2012, 2011 and 2010, respectively. Pre-tax income from foreign operations was $4.7 million, $4.4 million and $4.8 million for the years ended December 31, 2012, 2011 and 2010, respectively.

The difference between the Company’s reported provision for income taxes and the U.S. federal statutory rate of 35% is as follows:

	Year Ended December 31,
	2012			2011			2010
U.S. federal tax at statutory rate		35.0	%		35.0	%		35.0	%
State and local taxes—net of federal benefit		2.4			5.2			4.6
Release of previously unrecognized tax benefits		(7.8	)		—			—
Other, net		1.1			(0.8	)		(1.4	)
Provision for income taxes		30.7	%		39.4	%		38.3	%

The following is a summary of the Company’s net deferred tax assets:

	As of December 31,
	2012			2011
	(In thousands)
Deferred tax assets
U.S net operating loss carryforwards	$	7,175		$	4,589
Foreign net operating loss carryforwards		160			165
Stock compensation expense		5,296			5,312
Other		2,839			3,280
Total deferred tax assets		15,470			13,346
Valuation allowance		(727	)		(287	)
Net deferred tax assets		14,743			13,059
Deferred tax liabilities
Depreciation and amortization		(2,025	)		(1,905	)
Capitalized software development costs		(2,752	)		(1,980	)
Intangible assets		(524	)		(1,085	)
Deferred tax assets, net	$	9,442		$	8,089

As of December 31, 2012, the Company had deferred tax assets associated with stock-based compensation of approximately $5.3 million. There is a risk that the ultimate tax benefit realized upon the exercise of stock options or vesting of restricted stock could be less than the tax benefit previously recognized and exhaust the additional-paid-in-capital pool. If this should occur, any excess tax benefit previously recognized would be reversed, resulting in an increase in tax expense. Since the tax benefit to be realized in the future is unknown, it is not currently possible to estimate the impact on the deferred tax balance. As of December 31, 2012, the additional paid-in-capital pool, which is determined under a one pool approach for employee and non-employee awards, was approximately $42.9 million. The additional paid-in-capital pool is currently sufficient to absorb a complete write-off of the stock-based compensation deferred tax asset.

As of December 31, 2012, the Company had restricted U.S. federal net operating loss carryforwards of approximately $17.1 million, which begin to expire in 2021, and $0.7 million of foreign loss carryforwards, which begin to expire in 2025. In 2001 and 2000, MarketAxess Holdings Inc. and MarketAxess Corporation had an ownership change within the meaning of Section 382 of the Internal Revenue Code. Net operating loss carryforwards relating to this ownership change were $25.6 million as of December 31, 2012 of which $10.6 million is deemed utilizable and recognized as a net operating loss carryforward. Greenline experienced an ownership change within the meaning of Section 382 of the Internal Revenue Code in 2008. The Company does not believe that this ownership change significantly impacts the ability to utilize acquired net operating loss carryforwards, which amounted to $6.5 million as of December 31, 2012. In addition, the Company’s net operating loss carryforwards may be subject to additional annual limitations if there is a 50% or greater change in the Company’s ownership, as determined over a rolling three-year period.

The Company issued warrants to certain broker-dealer stockholders at the time that they made an equity investment in the Company. All of the warrants were exercised prior to 2008. Through December 31, 2009, the tax benefit on a portion of the tax deduction generated on the exercise of the warrants had not yet been recorded. During 2010, the Company recognized a portion of the tax benefits amounting to $11.4 million as an increase to additional paid-in-capital due to the utilization of the related tax loss carryforwards of $31.0 million. During the first quarter of 2011, the Company recognized the remaining portion of the tax benefit, amounting to $4.2 million, as an increase to additional paid-in-capital due to the expected utilization of the related tax loss carryforwards of $10.4 million.

The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences become deductible. If it is not more likely than not that some portion or all of the gross deferred income tax assets will be realized in future years, a valuation allowance is recorded. As of December 31, 2012, the valuation allowance relates to certain foreign and state tax loss carryforwards that are not expected to be realized. A summary of the changes in the valuation allowance follows:

	Year Ended December 31,
	2012		2011		2010
	(In thousands)
Valuation allowance at beginning of year	$	287	$	249	$	666
Increase (decrease) to valuation allowance attributable to:
Net operating losses		440		38		(132	)
Tax credits		—		—		(285	)
Valuation allowance at end of year	$	727	$	287	$	249

The Company or one of its subsidiaries files U.S. federal, state and foreign income tax returns. No income tax returns have been audited, with the exception of New York city (through 2003) and state (through 2006) and Connecticut state (through 2003) tax returns. An examination of the Company’s New York state franchise tax returns for 2007 through 2009 is currently underway. The Company cannot estimate when the examination will conclude.

In the fourth quarter of 2012, the Company recorded a reduction to the income tax provision of $6.7 million. The Company updated the recognition of certain acquired net operating loss carryforwards in response to a private letter ruling received from the Internal Revenue Service. As a result, the reserve for unrecognized tax benefits amounting to $3.6 million was reversed and deferred tax assets were increased by $3.1 million to recognize additional tax loss carryforwards. A reconciliation of the unrecognized tax benefits is as follows (in thousands):

	Year Ended December 31,
	2012			2011			2010
	(In thousands)
Balance at beginning of year	$	3,647		$	3,329		$	2,924
Additions for tax positions of prior years		—			366			277
Additions for tax positions of current year		—			—			128
Reductions for tax positions of prior years		(3,598	)		(48	)		—
Balance at end of year	$	49		$	3,647		$	3,329