Income Taxes

Following the Mergers, the Company and its subsidiaries will file a consolidated federal income tax return as well as combined state income tax returns in certain jurisdictions. In other jurisdictions, the Company and its subsidiaries will file separate company state and local income tax returns. Prior to the Mergers, GETCO and the majority of its subsidiaries were treated as partnerships or disregarded entities for U.S. income tax purposes and, accordingly, were not subject to federal income taxes. Instead, former GETCO members were liable for federal income taxes on their proportionate share of taxable income; however, certain subsidiaries were subject to corporate income taxes related to the taxable income generated by their operations.

Upon completion of the Mergers, the Company became subject to U.S. corporate income taxes. As described in Footnote 2 “Merger of GETCO and Knight”, following the Mergers the Company recorded $65.9 million of deferred tax assets as a result of recording Knight’s assets and liabilities under the purchase method of accounting as well as recording the value of Knight’s NOLs and tax credit carryforwards as described below.

As a result of the Company becoming subject to U.S. corporate income taxes, the Company also recorded a nonrecurring $103.5 million deferred tax benefit and corresponding deferred tax asset relating to GETCO's existing tax attributes. This deferred tax asset primarily relates to differences between GETCO’s book and tax bases in its intangible assets and its strategic investments.

The following table reconciles the U.S. federal statutory income tax to the Company's actual income tax from continuing operations (in thousands):



	For the three months ended September 30,						For the nine months ended September 30,
	2013			2012			2013			2012

U.S. federal statutory income tax (benefit) expense	$	41,949		$	5,114		$	12,543		$	12,224
Income not subject to U.S. corporate income tax	(44,790		)	(3,515		)	(14,071		)	(9,801		)
U.S. state and local income taxes, net of U.S. federal income tax effect	(391		)	533			82			825
Deferred tax benefit resulting from the Company becoming subject to U.S. corporate income taxes	(103,499		)	—			(103,499		)	—
Nondeductible charges ⁽¹⁾	(1,114		)	74			(944		)	166
Foreign taxes	—			2,581			3,559			6,958
Other, net	78			18			(148		)	(4		)
Income tax (benefit) expense	$	(107,767	)	$	4,805		$	(102,478	)	$	10,368

⁽¹⁾ Nondeductible charges include nondeductible compensation and meals and entertainment.

Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. Valuation allowances recorded on the balance sheet dates are necessary in cases where management believes that it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Based on the weight of the positive and negative evidence considered, management believes that it is more likely than not that the Company will be able to realize its federal deferred tax assets in the future, and therefore no valuation allowance has been recorded at September 30, 2013. Management believes that positive evidence including the Company's history of sustainable profitability, and its forecasts of future profitability outweighs the negative evidence. Also, a significant portion of Knight’s customer base has remained unchanged and the overall businesses acquired as a result of the Mergers are profitable, and the Company does not expect losses to recur. The Company has recorded a full valuation allowance against state and local deferred tax assets as it is more likely than not that the benefit of such items will not be realized due to limitations on utilization in the particular jurisdictions in which the Company operates.

Included in the Company’s deferred tax assets are benefits associated with NOL carryforwards generated by Knight in periods prior to the Mergers. At September 30, 2013, the Company had projected overall U.S. federal NOL carryforwards of $89.2 million. The Company recorded a related deferred income tax asset for its NOLs of $31.2 million as of September 30, 2013, and an offsetting valuation allowance of $6.8 million which represents the portion of these net operating loss carryforwards that are considered more likely than not to expire unutilized.

In accordance with Section 382 of the Internal Revenue Code, a change in equity ownership of greater than 50% of a corporation within a three-year period results in an annual limitation on the corporation’s ability to utilize its NOL carryforwards that were created during tax periods prior to the change in ownership. As a result of the Mergers as well as prior ownership changes, Knight experienced ownership changes under Section 382 and as a result, the rate of utilization of NOL carryforwards generated by Knight may be limited. The Company does not believe these limitations will have a significant effect on the Company's ability to utilize its anticipated federal NOL carryforward. The Company's U.S. federal NOL carryforwards will begin to expire in 2019.

At September 30, 2013 the Company recorded a valuation allowance for substantially all of its state and local NOL carryforwards as it is more likely than not that the benefit of such items will not be realized due to limitations on utilization in the particular jurisdictions in which the Company operates. Certain of these carryforwards are subject to annual limitations on utilization and they will begin to expire in 2019.

At September 30, 2013, the Company had non-U.S. NOL carryforwards of $68.7 million which were generated by Knight in periods prior to the Mergers. The Company recorded a foreign deferred income tax asset of $17.9 million for these NOL carryforwards as of September 30, 2013, along with an offsetting U.S. federal deferred tax liability of $17.9 million for the expected future reduction in U.S. foreign tax credits associated with the use of the non U.S. loss carryforwards. These non-U.S. net operating losses may be carried forward indefinitely. At September 30, 2013 the Company had tax credit carryforwards which were generated by Knight in periods prior to the Mergers, comprising foreign tax credit carryforwards of $3.2 million (and an offsetting valuation allowance of $1.6 million), general business credit carryforwards of $2.5 million and alternative minimum tax credit carryforwards $6.8 million.

At September 30, 2013, the Company had $1.4 million of unrecognized tax benefits, all of which would affect the Company's effective tax rate if recognized.

As of September 30, 2013, the Company is subject to U.S. Federal income tax examinations for the tax years 2009 through 2012, and to non U.S. income tax examinations for the tax years 2007 through 2012. In addition, the Company is subject to state and local income tax examinations in various jurisdictions for the tax years 2007 through 2012. The final outcome of these examinations is not yet determinable. However, the Company anticipates that adjustments to the unrecognized tax benefits, if any, will not result in a material change to the results of operations or financial condition.

The Company's policy for recording interest and penalties associated with audits is to record such items as a component of income or loss from continuing operations before income taxes. Penalties, if any, are recorded in Other expenses and interest paid or received is recorded in Interest expense and Interest, net, on the Consolidated Statements of Operations.