Note 9 - Income Taxes

The Company and its domestic subsidiaries file a consolidated federal income tax return. The Company recognizes both the current and deferred tax consequences of all transactions that have been recognized in the consolidated financial statements, calculated based on the provisions of enacted tax laws, including the tax rates in effect for current and future years. Net deferred tax assets are recognized immediately when a more likely than not criterion is met; that is, a greater than 50% probability exists that the tax benefits will actually be realized sometime in the future.

The components of income tax expense (benefit) are as follows:

(in thousands)	Three Months Ended						Nine Months Ended
	September 30, 2013			September 30, 2012			September 30, 2013			September 30, 2012
Federal – current	$	237		$	-		$	509		$	-
State – current		429			11			969			33
Total current		666			11			1,478			33

Federal – deferred		(291	)		(182	)		(742	)		(517	)
Change in valuation allowance		291			182			742			517
Total deferred		-			-			-			-

Income tax expense (benefit)	$	666		$	11		$	1,478		$	33

The components of pretax income (loss) and the difference between income taxes computed at the statutory federal rate and the provision for income taxes are as follows:

(in thousands)	Three Months Ended						Nine Months Ended
	September 30, 2013			September 30, 2012			September 30, 2013			September 30, 2012
Income (loss) before income taxes	$	(832	)	$	(520	)	$	(2,120	)	$	(1,476	)
Tax expense (benefit):
Tax at statutory federal rate	$	(291	)	$	(182	)	$	(742	)	$	(517	)
State income taxes		64			11			192			33
Federal interest		237			-			509			-
State interest		365			-			777			-
Permanent items		-			-			-			-
Accounting loss benefit not recognized		-			-			-			-
Change in valuation allowance		291			182			742			517

Income tax expense (benefit)	$	666		$	11		$	1,478		$	33

A reconciliation of the United States federal statutory rate to the Company's effective income tax rate is as follows:

	Three Months Ended				Nine Months Ended
	September 30, 2013		September 30, 2012		September 30, 2013		September 30, 2012
Tax at statutory federal rate	35.0	%	35.0	%	35.0	%	35.0	%
State income taxes	(7.7	)	(2.1	)	(9.0	)	(2.1	)
Federal interest	(28.4	)	-		(24.0	)	-
State interest	(43.9	)	-		(36.7	)	-
Permanent differences, tax credits and other adjustments	-		-		-		-
Accounting loss benefit not recognized	-		-		-		-
Change in valuation allowance	(35.0	)	(35.0	)	(35.0	)	(35.0	)
Effective income tax rate	(80.0	)%	(2.1	)%	(69.7	)%	(2.2	)%

AMBASE CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

The Company has recorded a reserve for uncertain tax positions as of September 30, 2013 and December 31, 2012, as noted herein below. It is unclear whether any significant changes in unrecognized income tax benefits are currently expected to occur over the next year. Interest and/or penalties related to underpayments of income taxes, or if applicable on uncertain tax positions, would be included as a component of income tax (benefit). The accompanying financial statements do not include any amounts for penalties.

The Company's federal income tax returns for the years subsequent to 1992 have not been reviewed by the Internal Revenue Service ("IRS") or state authorities, except for tax year 2007, which was reviewed by the IRS and has been concluded. The Company has not been notified of any other potential tax audits by any federal, state or local tax authorities. As such, the Company believes the statutes of limitations for the assessment of additional federal and state tax liabilities are generally closed for tax years prior to 2009.

Based on the Company's 2012 federal income tax ("FIT") return as filed (subject to IRS audit adjustment/review), as prepared by the Company's outside tax advisors, the Company recognized a $152 million worthless stock deduction for the Company's remaining tax basis related to its investment in Carteret (the "Carteret Worthless Stock Deduction" or "Carteret Tax Basis") in the computation of the Company's 2012 taxable income. The Company further reduced its 2012 federal taxable income through the utilization of $25 million of its previously available federal tax net operating loss ("NOL") carryforward deductions in the computation of the Company's 2012 federal tax liability. The federal NOL carryforwards were required to be utilized in tax year 2012 as a result of the Internal Revenue Code ("IRC") regulations that require NOLs to be utilized in the first year in which the Company has taxable income; otherwise, use of the NOL carryforwards would be lost. The Carteret Worthless Stock Deduction was required to be recognized in the year of worthlessness, i.e. 2012.

As part of the Settlement Agreement in the Company's Supervisory Goodwill legal proceedings, the Company is entitled to a tax gross-up in an amount to be determined if and when any federal taxes should be imposed on the Settlement Amount. Based on the Company's 2012 federal income tax return as filed (subject to IRS audit adjustment/review), in March 2013, the Company paid $500,729 of federal income taxes attributable to Alternative Minimum Tax ("AMT") rate calculations (the "2012 Federal Income Tax Paid"). On May 3, 2013, the Company filed a Rule 60(b) Motion with the Court of Federal Claims seeking a tax gross-up from the United States for the 2012 Federal Income Tax Paid, plus applicable tax consequences relative to the reimbursement of this amount. On August 6, 2013, Senior Judge Smith issued an opinion which addressed the relief sought by AmBase. In summary, the Court held that the settlement agreement is a contract and that it entitles the Company to receive both "(1) the amount of the tax consequences resulting from taxation of the damages award plus (2) the tax consequences of receiving the first component." But the Court did not award additional damages for the second component of the damages at that time given the remaining uncertainty surrounding the ultimate tax treatment of the settlement proceeds and the gross-up, as well as uncertainty relating to the Company's future income. The Court indicated that either the Company or the government is entitled to seek further relief "if, and when, the facts justify." The Court also stated that the "plain meaning of the agreement precludes state taxes from being included in any possible future gross-up calculations." Additionally, the Court indicated that AmBase "would first have to generate income" before it could attempt to recover compensation for the use of its NOLs to shield the settlement proceeds from federal taxation.

Based on the Company's 2012 federal income tax return as filed, the Company recorded a receivable as of December 31, 2012, for the 2012 Federal Income Tax Paid to reflect a portion of the tax gross-up reimbursement the Company sought pursuant to the Settlement Agreement, which was recognized as a component of the Indemnification asset - federal tax gross-up in the Company's Consolidated Balance Sheet which amount was received by the Company in September 2013. For additional information, see Note 10 – Legal Proceedings.

AMBASE CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

Pursuant to the accounting principles with regard to recognition of uncertain tax positions, (ASC 740-10, Accounting for Income Taxes), the Company was required to record an aggregate tax reserve of approximately $35,443,000 ($18.9 million for federal) as of September 30, 2013, and $34,157,000 ($18.4 million for federal) as of December 31, 2012, to reflect the net tax effect plus accrued interest through September 30, 2013, for potential tax audit and uncertainty that the Carteret Worthless Stock Deduction, (uncertain tax position), could be disallowed in whole or in part by the tax authorities. The Company believes that if any additional federal tax is owed as a result of any adjustments, these potential amounts would be reimbursable to the Company pursuant to the tax gross-up provision of the Settlement Agreement. As a result the Company recorded an indemnification asset of $18.4 million to reflect the net amount of the federal uncertain tax position reserve recognized (excluding accrued interest), as noted herein. The calculation of the net federal uncertain tax position reserve amount factors in the assumed use of the Company's remaining NOL carryforwards as of 2012 totaling $24.1 million and use of the Company's remaining AMT Tax Credits as of 2012 totaling $21.0 million. A portion of the uncertain tax position reserve as of September 30, 2013 and December 31, 2012, is attributable to certain state taxes on the Settlement Amount which are not reimbursable to the Company as part of the Settlement Agreement.

In connection with the uncertain tax positions as noted herein, the Company recorded a federal and state interest expense accrual for potential underpayment of taxes for tax year 2012. The interest expense is included as a component of income tax expense (benefit) in the Condensed Consolidated Statement of Operations and as a component of the uncertain tax position reserve in the Condensed Consolidated Balance Sheets.

The interest expense related to the uncertain tax positions is as follows:

(in thousands)	Three Months Ended				Nine Months Ended
	September 30, 2013		September 30, 2012		September 30, 2013		September 30, 2012
Federal	$	237	$	-	$	509	$	-
State jurisdictions		365		-		777		-

Interest expense - taxes	$	602	$	-	$	1,286	$	-

State income tax amounts for the three months and nine months ended September 30, 2013 include accrued interest for uncertain tax position and a provision for a minimum tax on capital imposed by the state jurisdictions. State income tax amounts for the three and nine months ended September 30, 2012 are primarily attributable to a provision for a minimum tax on capital imposed by the state jurisdictions. Based on the state tax returns as filed the Company has approximately $1.9 million of state NOL carryforward deductions remaining available for future use, which expire beginning in 2030.

As a result of the Office of Thrift Supervision's December 4, 1992 placement of Carteret Savings Bank, F.A. in receivership, under the management of the Resolution Trust Corporation ("RTC")/Federal Deposit Insurance Corporation ("FDIC"), and then proposed Treasury Reg. §1.597-4(g), the Company had previously filed its 1992 and subsequent federal income tax returns with Carteret disaffiliated from the Company's consolidated federal income tax return. Based upon the impact of Treasury Reg. §1.597-4(g), which was issued in final form on December 20, 1995, a continuing review of the Company's Carteret Tax Basis, and the impact of prior year tax return adjustments on the Company's 1992 federal income tax return as filed, the Company originally decided not to make an election pursuant to final Treasury Reg. §1.597-4(g) to disaffiliate Carteret from the Company's consolidated federal income tax return effective as of December 4, 1992 (the "Election Decision"). Based on the lack of availability of Carteret and Carteret FSB information from December 1992 forward, the resolution of the Supervisory Goodwill legal proceedings and the Settlement Agreement, the Company filed its 2012 income tax returns with Carteret/Carteret FSB deconsolidated from the Company operations from December 1992 forward.

The Company has made numerous requests to the RTC/FDIC for tax information pertaining to Carteret and the resulting successor institution, Carteret Federal Savings Bank ("Carteret FSB"); however, that information has not been received. Because the Carteret and Carteret FSB tax information has not been received, the Company is unable to determine with certainty the amount of or the years in which any NOL's may ultimately be generated; if the NOL carryforwards/carrybacks will be utilized in prior federal income tax return years; or the final expiration dates of any of the NOL carryforwards/carrybacks ultimately generated relating to the Election Decision noted herein.

AMBASE CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

Based on information received to date the Company estimated as of December 1992, the Carteret Tax Basis. If the Carteret Worthless Stock Deduction is denied by the IRS, the Carteret Tax Basis may be deemed a capital loss, or converted into NOL carryforwards/carrybacks as additional tax losses are incurred by Carteret/Carteret FSB and may be carried back or carried forward to other tax years; may be utilized in other tax years; or could begin to expire no earlier than the 2008 tax year based upon the year any NOL's are ultimately generated. The Company can give no assurances with regard to the final amount or expiration of NOL carryforwards/carrybacks ultimately generated, if any, from the Company's Carteret Tax Basis. NOL's generated from the Company's Carteret Tax Basis are in addition to the NOL carryforwards/carrybacks generated based on the Company's federal income tax returns as previously filed from 1993 forward, as described herein.

The FDIC has previously filed a federal income tax return for Carteret FSB for 1995 (as well as other years), which indicates that Carteret FSB allegedly could owe a 1995 federal income tax liability of $32 million, which including interest and penalty thereon, is alleged to be in excess of $139 million. The FDIC has stated to the United States Court of Federal Claims ("Court of Claims") that the tax amounts are only estimates and are highly contingent. However, it is possible that the IRS may try to collect the alleged Carteret FSB federal income taxes from the Carteret FSB receivership. The Company believes the Carteret FSB federal income tax returns filed by the FDIC were improperly filed and are neither accurate nor valid. Based on the information received to date, if the correct Carteret FSB federal income tax results were included with the Company's originally filed federal income tax returns, the Company, believes that no additional material federal income tax would be owed by the Company, although this cannot be assured because a contrary result is possible, given the uncertainty with various legal and factual assumptions underlying the Company's beliefs. This assessment included among other items a review of the Carteret FSB federal income tax returns as prepared by the FDIC and the correction of errors originally reported therein, the proper application of federal NOL carryforwards and carrybacks, and the adherence to statute of limitation provisions contained in the Internal Revenue Code, as amended.

As explained above, although the Company does not believe that Carteret FSB or the Company will have a material federal income tax liability related to Carteret FSB for tax year 1995 (or any other tax year), the Company can give no assurances of the final amounts, if any, of federal income taxes owed by the Carteret FSB receivership or by the Company as a result of the Carteret FSB receivership operations. The Company believes that the Settlement Agreement, tax regulations and tax positions on the Company's tax returns as filed, would preclude additional tax owed resulting from the Carteret FSB receivership. The discussion of the Carteret FSB federal income tax results is intended to provide details as to the potential inter-relationship of the Carteret FSB federal income tax returns with the Company's federal income tax positions. It is not a reflection of any federal income tax liability of the Company arising from the Carteret receivership operations.