INCOME TAXES

As a REIT, if we meet certain requirements, we generally are not subject to federal and state corporate income taxes on our income from investments in real estate that we distribute to our shareholders. We are, however, subject to corporate taxes on built-in gains (the excess of fair market value at January 1, 2006 over tax basis on that date) with respect to the REIT’s sale of any real property owned at such date within the first ten years following our conversion to a REIT, except for sales that occur in 2011, 2012 and 2013. The Small Business Jobs Act of 2010 modified the built-in gains provisions to exempt sales of real properties by a REIT in 2011, if five years of the recognition period had elapsed before January 1, 2011 and the American Taxpayer Relief Act of 2012, enacted on January 2, 2013, extended the reduced five-year holding period for sales occurring in 2012 and 2013. If applicable, the built-in gains tax is eliminated or deferred if sale proceeds are reinvested in accordance with the like-kind exchange provisions of the Internal Revenue Code. The sale of timber pursuant to a stumpage sale agreement or timber deed is not subject to built-in gains tax. We are required to pay federal and state corporate income taxes on earnings of our Potlatch TRS operations, principally comprised of our wood products manufacturing operations and certain real estate investments held for development and resale.

Due to the varying tax treatments of our activities, such as REIT operations, built-in gains taxes applicable to property sales, like-kind exchanges and TRS activities, our effective tax rate and amount of taxes paid may vary significantly from year to year.

The income tax provision allocated to continuing operations is comprised of the following for the years ended December 31:

(Dollars in thousands)



	2012		2011			2010
Current	$	292	$	(73	)	$	(930	)
Deferred	8,197		4,990			(10,619		)
Benefit of net operating loss carryforwards	8,320		(772		)	16,145
Income tax provision	$	16,809	$	4,145		$	4,596

The income tax provision allocated to continuing operations differs from the amount computed by applying the statutory federal income tax rate of 35% to income before income taxes due to the following for the years ended December 31:

(Dollars in thousands)



	2012			2011			2010
Computed “expected” tax expense	$	20,791		$	15,544		$	15,705
REIT income not subject to federal income tax	(5,241		)	(11,739		)	(9,481		)
State net operating loss and tax credit valuation allowances	—			897			286
State and local taxes, net of federal income tax	1,615			54			311
Adjustment of REIT deferred taxes	—			—			(2,100		)
Deferred tax adjustment—Retiree Health Care Act	—			—			1,441
All other items	(356		)	(611		)	(1,566		)
Income tax provision	$	16,809		$	4,145		$	4,596
Effective tax rate	28.3		%	9.3		%	10.2		%

The effective rate for 2012 differs from 2011 due to the impact of increased operating income earned by Potlatch TRS. The effective rate for 2011 differs from 2010 due to the impact of the operating income earned by Potlatch TRS and a valuation allowance related to a state net operating loss and tax credit carryforwards recorded in 2011.

In association with our REIT conversion in 2006, we estimated the amount of REIT property that may be sold within the next ten years and retained a deferred tax liability at REIT conversion on the book-to-tax difference of approximately $3.0 million. This estimate is periodically reviewed. As a result of the Small Business Jobs Act of 2010, which modified the built-in gains provisions for 2011, and our expected disposal of REIT property through 2015, we reversed $2.1 million of this deferred tax liability in 2010.

The Patient Protection and Affordable Care Act, as amended by the Health Care and Reconciliation Act of 2010, was enacted in March 2010 and included a change in the deductibility of drug expenses reimbursed under the Medicare Part D retiree drug subsidy program beginning after 2012. As a result of this legislation, deferred taxes associated with our retiree health care liabilities based on prior law were required to be adjusted, resulting in a net charge to earnings of approximately $1.4 million in 2010.

Our accounts receivable balances included insignificant amounts of anticipated federal and state refunds at both December 31, 2012 and 2011.

The tax effects of significant temporary differences creating deferred tax assets and liabilities at December 31 were:

(Dollars in thousands)



	2012			2011
Deferred tax assets:
Pensions	$	38,986		$	41,380
Postretirement employee benefits	20,293			25,642
Nondeductible accruals	3,841			4,296
Inventories	3,126			3,459
Incentive compensation	2,843			2,560
Tax credits	2,678			2,994
Employee benefits	1,795			1,695
Net operating loss carryforwards	1,346			9,202
Other	124			152
Total deferred tax assets	75,032			91,380
Valuation allowance	(2,867		)	(2,816		)
Deferred tax assets, net of valuation allowance	$	72,165		$	88,564
Deferred tax liabilities:
Timber and timberlands	$	(6,006	)	$	(6,142	)
Property, plant and equipment	(12,360		)	(12,589		)
Total deferred tax liabilities	(18,366		)	(18,731		)
Net deferred tax assets	$	53,799		$	69,833

Net deferred tax assets and liabilities consist of:

(Dollars in thousands)



	2012			2011
Current deferred tax assets	$	10,507		$	11,909
Noncurrent deferred tax assets	61,658			76,655
Noncurrent deferred tax liabilities	(18,366		)	(18,731		)
Net noncurrent deferred tax assets	43,292			57,924
Net deferred tax assets	$	53,799		$	69,833

A valuation allowance has been recognized for certain state net operating loss and tax credit carryforwards due to uncertainty of sufficient taxable income prior to expiration of available carryover periods. The valuation allowance increased $0.1 million, $0.9 million and $0.3 million in 2012, 2011 and 2010, respectively. State net operating losses expire over the next 1 to 20 years and the tax credits expire over the next 14 years.

With the exception of the valuation allowances discussed above, we believe it is more likely than not that we will have sufficient future taxable income to realize our deferred tax assets. In making this determination, we consider whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which temporary differences are deductible. We consider the scheduled reversal of deferred tax liabilities (including the impact of available carryforward periods), projected taxable income and tax planning strategies in making this assessment. In order to fully realize the deferred tax assets, we will need to generate future taxable income before the expiration of the deferred tax assets governed by the tax code. Based on projected taxable income for Potlatch TRS, over the periods for which the deferred tax assets are deductible, as well as certain tax planning strategies that management has undertaken and expects to have the ability to undertake in the future, we believe that it is more likely than not that we will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2012. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced and management is unable to implement one or more of the tax planning strategies that it has identified.

The following table summarizes the tax years subject to examination by major taxing jurisdictions:



Jurisdiction	Years
Federal	2008	-	2012
Arkansas	2009	-	2012
Michigan	2008	-	2012
Minnesota	2008	-	2012
Idaho	2009	-	2012

We reviewed our tax positions at December 31, 2012, and determined that no uncertain tax positions were taken during 2012, and that no new information was available at that time that would require derecognition of previously taken positions.

We reflect accrued interest related to tax obligations, as well as penalties, in our provision for income taxes. For the years ended December 31, 2012, 2011 and 2010, we recognized a net benefit of approximately $0, $0 and $0.2 million, respectively, related to interest and penalties in our tax provision. At December 31, 2012 and 2011, we had insignificant amounts accrued for the payment of interest related to tax obligations and accrued as a receivable for interest with respect to open tax refunds.