NOTE 9—INCOME TAXES

Components of the provision for income taxes are as follows (in thousands):


	2011			2010			2009
Current provision:
Federal	$	16,918		$	(1,620)		$	13,568
State and local		3,423			1,211			3,435
Foreign		(149	)		116			—

		20,192			(293	)		17,003
Deferred:
Federal		12,798			9,464			(171	)
State and local		1,299			(830	)		3

		14,097			8,634			(168	)

	$	34,289		$	8,341		$	16,835

The Company's income tax expense is different from the amount computed by applying the federal statutory income tax rate to income before taxes as follows (in thousands):


	2011			2010			2009
Federal statutory tax on earnings before income taxes	$	33,280		$	9,765		$	12,081
State income taxes, net of federal income tax benefit		3,283			299			2,406
Non-deductible lobbying and contributions		517			439			349
Tax credits and incentives		(775	)		(36	)		58
Non-deductible transaction costs		—			531			—
Tax adjustments		(434	)		(1,960	)		(7,899	)
Accruals and settlements related to tax audits		(426	)		(853	)		9,624
Valuation allowance		105			—			—
Change in effective state tax rates		(714	)		32			—
Other permanent differences		(547	)		124			216

	$	34,289		$	8,341		$	16,835

During 2003, the Company entered into a Tax Increment Financing ("TIF") Agreement with the Commonwealth of Kentucky. Pursuant to this agreement, the Company is entitled to receive reimbursement for 80% of the increase in Kentucky income and sales tax resulting from its 2005 renovation of the Churchill facility. During 2011, the Company resolved uncertainties with the Commonwealth of Kentucky related to the computation of the tax increase and the Company recognized a $3.1 million reduction of its operating expenses related to the years 2005 through 2011. In addition, the Company recognized a $1.3 million reduction in its income tax expense, net of federal taxes, related to the years 2005 through 2011. The Company received $0.3 million and $0.2 million from the Commonwealth of Kentucky related to the reductions in operating expenses and income tax expense, respectively. As of December 31, 2011, the Company has recorded a sales tax receivable of $2.8 million and an income tax receivable of $1.1 million related to the reimbursement.

For the year ended December 31, 2011, the Company received a refund of $8.5 million related to the overpayment of its 2010 federal income taxes and a refund of $1.9 million related to an amended prior year federal income tax return that served to adjust state lobbying expense deductions.

During 2010, the Company identified adjustments to permanent tax differences related to years prior to January 1, 2008. As a result, the Company increased income taxes receivable and reduced income tax expense by $1.9 million during 2010. The adjustment relates to incorrectly treating deductible, local lobbying expenses incurred during 2005 and 2007 as non-deductible. These adjustments were recorded during the year ended December 31, 2010, as the corrections were deemed immaterial to both the results of operations for the year ended December 31, 2010, and all prior periods affected.

During 2005 and 2006, the Company received approximately $22.9 million of proceeds related to the sale of PSLs sold in connection with the renovation of Churchill Downs. The PSLs that were sold included those with terms of 30 years and 5 years and provided the purchaser the right to purchase tickets to the Kentucky Derby, Kentucky Oaks and Breeders' Cup races each year during the term of the license. Accordingly, for tax purposes, the Company deferred the income for the PSLs over the respective terms of the licenses.

During 2009, the Internal Revenue Service (the "IRS") proposed that the income related to the sale of the PSLs is taxable during the period the proceeds are received by the Company (the "Proposed Audit Adjustment"). As a result, the Proposed Audit Adjustment serves to increase the amount of income taxes due for each of the tax years 2005 and 2006. On April 14, 2010, the Company defended its position of deferring income related to the sale of PSLs using a fast track mediation process offered by the IRS. During the fast track mediation process, the Company agreed to change its method of accounting for proceeds related to the sale of PSLs to the deferral method provided for in Revenue Procedure 2004-34, effective for the taxable year ended December 31, 2007. As a result, the taxable income for each of the years ended December 31, 2007 and 2008 increased by $19.1 million and $0.4 million, respectively. In accordance with the settlement entered into during the fast track mediation process, the Company recognized an income tax benefit from continuing operations of $0.7 million during the year ended December 31, 2010, reflecting a reduction of interest expense previously estimated, partially offset by higher income tax due than previously estimated.

Components of the Company's deferred tax assets and liabilities are as follows (in thousands):


	2011			2010
Deferred tax assets:
Deferred compensation plans	$	11,054		$	7,578
Deferred income		7,656			6,497
Allowance for uncollectible receivables		412			978
Deferred liabilities		5,294			4,057
Net operating losses and credit carryforward		25,828			33,264
Other		189			56

Deferred tax assets		50,433			52,430
Valuation allowance		(1,487	)		(1,381	)

Net deferred tax asset		48,946			51,049

Deferred tax liabilities:
Intangible assets in excess of tax basis		17,762			18,870
Property and equipment in excess of tax basis		38,009			25,166
Other		—			308

Deferred tax liabilities		55,771			44,344

Net deferred tax asset (liability)	$	(6,825	)	$	6,705

Income taxes are classified in the balance sheet as follows:
Net current deferred tax asset	$	8,727		$	16,136
Net non-current deferred tax liability		(15,552	)		(9,431	)

	$	(6,825	)	$	6,705

As of December 31, 2011, the Company had federal net operating losses of $20.3 million, which were acquired in conjunction with the acquisition of Youbet.com. The utilization of these losses is limited on an annual basis pursuant to IRC § 382. However, the Company believes that it will be able to fully utilize all of these losses. In addition, the Company has $5.4 million of state net operating losses; $2.8 million of this loss carryforward was acquired in conjunction with the acquisition of Youbet.com. These losses may be subject to annual limitations similar to IRC § 382. The Company has recorded a valuation allowance of $1.4 million against the state net operating losses due to the fact that it is unlikely that it will generate income in certain states, which is necessary to utilize the assets.

The changes in the valuation allowance for deferred tax assets for the years ended December 31, 2011 and 2010 are as follows (in thousands):


	2011		2010
Balance at beginning of the year	$	1,381	$	—
Charged to costs and expenses		106		—
Charged to comprehensive income		—		—
Charged to other accounts		—		1,381
Deductions		—		—

Balance at end of the year	$	1,487	$	1,381

As of December 31, 2011, the Company had approximately $2.1 million of total gross unrecognized tax benefits. If these benefits were recognized, there would be a $1.4 million effect to the annual effective tax rate. The Company anticipates a decrease in its unrecognized tax positions of approximately $0.8 million during the next twelve months. This anticipated decrease is primarily due to the expiration of statutes of limitations.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):


	2011			2010			2009
Balance as of January 1	$	2,926		$	2,967		$	2,583
Additions for tax positions related to the current year		—			585			572
Additions for tax positions of prior years		—			—			—
Reductions for tax positions of prior years		(817	)		(626	)		(188	)

Balance as of December 31	$	2,109		$	2,926		$	2,967

The Company recognizes interest accrued related to unrecognized tax benefits in income tax expense and penalties in selling, general and administrative expenses in the Consolidated Statements of Net Earnings and Comprehensive Earnings. The Company accrued approximately $0.2 million of interest for each of the years ended December 31, 2011 and 2010.