17. INCOME TAXES

The following is a summary of the components of the provision (benefit) for income taxes for Verso Paper:

	Year Ended December 31,
(Dollars in thousands)	2011			2010			2009
Current tax provision (benefit):
U.S. federal	$	-		$	(76	)	$	76
U.S. state and local		281			70			779
		281			(6	)		855
Deferred tax provision (benefit):
U.S. federal		(40,038	)		(44,345	)		36,507
U.S. state and local		(7,047	)		(3,269	)		6,277
		(47,085	)		(47,614	)		42,784
Valuation allowance		47,001			47,765			(42,894	)
Income tax provision	$	197		$	145		$	745

A reconciliation of income tax expense using the statutory federal income tax rate compared with actual income tax expense follows:

	Year Ended December 31,
(Dollars in thousands)	2011			2010			2009
Tax at Statutory U.S. Rate of 34%	$	(46,456	)	$	(44,564	)	$	36,294
Increase resulting from:
Goodwill impairment		6,356			-			-
Meals and entertainment		169			132			171
Equity award expense		55			94			101
Nondeductible lobbying expenses		38			102			2
Other		1			2			2
Net permanent differences		6,619			330			276
Valuation allowance		47,001			47,765			(42,894	)
State income taxes (benefit)		(6,861	)		(3,199	)		7,056
Return to provision		(106	)		(87	)		13
Other		-			(100	)		-
Total income tax provision	$	197		$	145		$	745

The following is a summary of the significant components of our deferred tax position:

	Year Ended December 31,
(Dollars in thousands)	2011			2010
Deferred tax assets:
Net operating loss and credit carryforwards	$	232,177		$	200,293
Pension		10,225			5,694
Payment-in-kind interest		7,702			5,666
Compensation reserves		6,223			4,062
Unrealized hedge losses		4,550			852
Inventory reserves		4,410			3,987
Inventory capitalization		2,059			-
Bad debt reserves		1,004			763
Other		1,295			1,492
Gross deferred tax assets		269,645			222,809
Less: valuation allowance		(132,136	)		(80,541	)
Deferred tax assets, net of allowance		137,509			142,268
Deferred tax liabilities:
Property, plant, and equipment	$	(103,629	)	$	(106,978	)
Cancellation of debt income deferral		(26,054	)		(25,960	)
Intangible assets		(10,819	)		(11,315	)
Deferred repair charges		(4,639	)		(4,578	)
Prepaid expenses		(469	)		(704	)
Inventory capitalization		(1	)		(918	)
Total deferred tax liabilities		(145,611	)		(150,453	)
Net deferred tax liabilities	$	(8,102	)	$	(8,185	)

The valuation allowance for deferred tax assets as of December 31, 2011 and 2010 was $132.1 million and $80.5 million, respectively. The increase in the valuation allowance of $51.6 million is primarily attributable to additional federal and state losses incurred during 2011 for which is it less than more likely than not Verso Paper will realize those benefits in the future.

Income tax benefits related to the pension prior service liability have been credited to other comprehensive income. The benefits have been reduced by a valuation allowance of $9.3 million. Income tax benefits related to hedging activity have been credited to other comprehensive income, and the benefits have been reduced by a valuation allowance of $1.9 million.

Verso Paper’s policy is to record interest paid with respect to income taxes as interest expense or interest income, respectively, in the consolidated statements of operations.

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based on the unique alternative fuel mixture tax credit income in 2009 and our lack of historical earnings, management believes it is more likely than not that Verso Paper will not realize the benefits of those deductible differences.

Verso Paper has federal net operating loss carryforwards totaling approximately $622.3 million on December 31, 2011, which begin to expire in 2026.

Verso Paper has state net operating loss carryforwards totaling approximately $377.9 million on December 31, 2011, which begin to expire in 2013.

Verso Paper is subject to various federal, state, and local income tax audits for the tax years ended December 31, 2008 through 2011. As of the current date, there are no ongoing federal or state income tax audits.