INCOME TAXES

12 Months Ended

Dec. 31, 2011

INCOME TAXES

INCOME TAXES

14. INCOME TAXES

        Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the deferred tax assets (liabilities) as of December 31, 2011 and 2010 are as follows (in thousands):

	December 31,
	2011			2010
Deferred tax assets:
Accrued liabilities	$	3,592		$	1,149
Deferred rent		126			109
Deferred revenues		1,969			639
Stock—based compensation		5,223			2,749
Credit carryforward		628			131
Depreciation		410			(56	)
Outside basis difference in foreign subsidiary held for sale		4,717			0
Net operating losses		44,604			24,795
Other		185			158
Gross deferred tax assets		61,454			29,674
Valuation allowance		(49,749	)		(17,256	)
Net deferred tax assets		11,705			12,418
Deferred tax liability:
Amortizable intangible at subsidiary		(11,109	)		(12,409	)
Amortizable intangible at parent		(890	)		(305	)
Trademarks with indefinite lives		(5,895	)		(5,887	)
Total deferred tax liability		(17,894	)		(18,601	)
Net deferred tax liability		(6,189	)		(6,183	)
Non-current portion of net deferred tax liability	$	(6,189	)	$	(6,183	)

        Income taxes are provided in the accompanying consolidated statement of operations as follows (in thousands):

	Successor
								Predecessor
						For the Period from (the inception January 7 date) through December 31, 2009
	For the Year Ended 2011			For the Year Ended 2010				For the Nine Months Ended September 30, 2009
Current:
Federal	$	35		$	—	$	—	$	—
State		109			11		—		—
Foreign		—			—		—		—
Total current		144			11		—		—
Deferred:
Federal		(11	)		13		—		—
State		(1	)		1		—		—
Foreign		—			—		—		—
Total deferred		(12	)		14		—		—
Total income tax provision	$	132		$	25	$	0	$	0

        The effective tax rate on pretax income differs from the US federal statutory tax rate for the periods presented as follows:

	Successor
										Predecessor
							For the Period from (the inception January 7 date) through December 31, 2009
	For the Year Ended 2011			For the Year Ended 2010						For the Nine Months Ended September 30, 2009
Statutory tax rate		34.0	%		34.0	%		34.0	%		34.0	%
Valuation allowance		(22.5	)%		(14.7	)%		18.3	%		(21.4	)%
Revenues from governmental entities		—			2.8	%		(51.5	)%		—
Nondeductible expenses related to governmental entities		—			(15.0	)%		14.7	%		—
Gain on adjustment of investment to fair value		—			—			(26.7	)%		—
Change in fair value of warrant liability		(17.7	)%		(17.4	)%		5.7	%		(19.3	)%
Other—net		6.1	%		10.3	%		5.5	%		6.7	%
Effective tax rate		(0.1	)%		—	%		—	%		—	%

        During the year ended December 31, 2011, the Company recognized income tax expense of $0.1 million. As required by FASB ASC Topic 740, for each reporting period, management evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets and establishes a valuation allowance for deferred tax assets if it is more likely than not that such assets will not be realized. For the years ended December 31, 2011 and 2010, and the 2009 Consolidated Period, a valuation allowance was maintained against substantially all deferred tax assets primarily due to the trend in cumulative historical and anticipated losses. During the years ended December 31, 2011 and 2010, the 2009 Consolidated Period and the 2009 Predecessor Period, the valuation allowance increased by $32.5 million, $7.9 million, $1.0 million and $5.6 million, respectively.

        At December 31, 2011, 2010 and 2009, federal and state net operating loss carryforwards ("NOLs") totaled approximately $113.7 million, $63.0 million and $60.8 million, respectively. These federal and state net operating loss carryforwards will begin expiring in the years 2021 and 2012, respectively.

        As previously discussed, Digital Domain was acquired by the Company in 2009 (see Note 2). Under Internal Revenue Code Section 382, a change of control occurred for income tax purposes on October 15, 2009. Accordingly, the Company's ability to use Digital Domain's pre-acquisition net operating loss carryforwards and other pre-acquisition tax attributes to offset its post-acquisition income is limited.

        Also, Digital Domain's usage of net operating loss carryforwards is limited by an ownership change that occurred in 2006. Pursuant to Section 382, Digital Domain's annual Section 382 limitation is $0.6 million with respect to net operating losses generated prior to the ownership change in 2006.

        If an "ownership change" for federal income tax purposes were to occur in the future, the Company's ability to use its pre-ownership change federal and state net operating loss carryforwards (and certain built-in losses, if any) would be subject to an annual usage limitation, which under certain circumstances may prevent the Company from being able to utilize a portion of such loss carryforwards in future tax periods and may reduce its after-tax cash flow.

        Interest on uncertain tax positions is recognized in interest expense and penalties in Selling, general and administrative expenses. For the years ended December 31, 2011 and 2010, the 2009 Consolidated Period and the 2009 Predecessor Period, no such interest and penalties had been incurred. The Company has no uncertain tax positions.

        The Company files income tax returns in the US federal jurisdiction and various state jurisdictions. The Company and Digital Domain filed separate tax returns for 2010 and 2009. A tax return may be audited anytime within three years for Federal returns and four years for California returns from the later of the due date or the filing date. The open tax years on each of the returns subject to examination are for the years ended December 31, 2008 to 2010 for Federal returns and for the years ended December 31, 2008 to 2010 for California returns.