Note 13.

Income Taxes

Our pre-tax income attributable to foreign operations is not material. The provision for income tax expense (benefit) consisted of the following:


	(In thousands)
	Years Ended December 31,
	2012			2011			2010
Current tax expense (benefit)
Federal	$	7,608		$	2,133		$	6,204
State		(579	)		(223	)		(854	)

		7,029			1,910			5,350

Deferred tax expense (benefit)
Federal		(260	)		(6,044	)		(686	)
State		(1,191	)		(608	)		191

		(1,451	)		(6,652	)		(495	)

Income tax expense (benefit)	$	5,578		$	(4,742	)	$	4,855

Deferred tax assets (liabilities) were composed of the following:


	(In thousands)
	December 31,
	2012			2011
Accrued expenses	$	386		$	672
Allowance for doubtful accounts		213			195
Contract overrun reserves		139			192
Deferred compensation		164			1,139
Employment-related reserves		6,088			5,700
Environmental reserves		762			895
Inventory reserves		4,123			5,238
Pension obligation		4,445			4,574
Prepaid insurance		406			308
State net operating loss carryforwards		818			818
State tax credit carryforwards		3,253			1,849
Stock-based compensation		4,012			4,003
Workers’ compensation		35			17
Other		970			286

		25,814			25,886
Depreciation		(5,424	)		(7,663	)
Goodwill		(5,764	)		(3,400	)
Intangibles		(66,604	)		(71,163	)
Unbilled receivables		(1,251	)		(1,675	)
Valuation allowance		(4,120	)		(2,008	)

Net deferred tax assets (liabilities)	$	(57,349	)	$	(60,023	)

We have state tax credit carryforwards of $5.7 million, which begin to expire in 2017, and state net operating losses of $20.0 million, which begin to expire in 2016. We have recorded benefits for those carryforwards we expect to be utilized on tax returns filed in the future.

We have established a valuation allowance for items that are not expected to provide future tax benefits. We believe it is more likely than not that we will generate sufficient taxable income to realize the benefit of the remaining deferred tax assets.

The principal reasons for the variation between expected and effective tax rates were as follows:


	Years Ended December 31,
	2012			2011			2010
Statutory federal income tax rate		35.0	%		(35.0	)%		35.0	%
State income taxes (net of federal benefit)		(2.8	)		(2.2	)		0.3
Acquisition costs		—			2.0			—
Benefit of qualified domestic production activities		(2.7	)		(0.5	)		(3.5	)
Benefit of research and development tax credits		(4.3	)		(2.6	)		(6.2	)
Book income not subject to tax		—			—			(0.8	)
Goodwill impairment		—			28.8			—
Increase in valuation allowance		9.9			—			2.4
Reduction of state effective tax rate		(7.0	)		—			—
Reduction of tax reserves		(4.0	)		—			(7.4	)
Unremitted earnings (losses) of foreign subsidiary		0.8			0.3			(0.5	)
Other		0.4			0.1			0.4

Effective income tax rate		25.3	%		(9.1	)%		19.7	%

The deduction for qualified domestic production activities is treated as a “special deduction” which has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction is reported in our rate reconciliation.

Income tax expense increased in 2012 compared to 2011 primarily as a result of higher pre-tax income. The effective tax rate was 25.3% in 2012, compared to an income tax benefit of 9.1% in 2011. The 2012 tax rate was impacted by a charge for a valuation allowance for state research and development tax credits of $2.2 million, partially offset by a $1.6 million tax benefit as of result of the LaBarge Acquisition, which allowed us to file state consolidated tax returns in 2012. The $2.2 million valuation allowance was the result of new state legislation passed in the fourth quarter of 2012. The new legislation reduces the amount of Company income apportioned to California, thus reducing our ability to realize the benefits of the state research and development tax credits previously recorded. In addition, our effective tax rate for 2012 reflected no current year federal research and development tax benefits; whereas, the effective tax rate for 2011 included federal research and development tax benefits. As a result of the American Taxpayer Relief Act of 2012 passed in January 2013, which includes a reinstatement of the federal research and development tax credit for the amounts paid or incurred after December 31, 2011 and before January 1, 2014, we will record approximately $2.0 million of federal research and development tax benefits in the first quarter of 2013.

We record the interest and penalty charge, if any, with respect to uncertain tax positions as a component of tax expense. During the three years ended December 31, 2012, 2011 and 2010, we recognized approximately ($0.1) million, $0.1 million and ($0.1) million in interest expense (benefit) related to uncertain tax positions. We had approximately $0.1 million and $0.2 million for the payment of interest and penalties accrued at December 31, 2012 and 2011, respectively.

Our total amount of unrecognized tax benefits was approximately $1.7 million and $2.2 million at December 31, 2012 and December 31, 2011, respectively. Most of these amounts, if recognized, would affect the annual income tax rate. It is reasonably possible that the unrecognized tax benefits could be reduced by $0.3 million in the next twelve months.

A reconciliation of the beginning and ending amount of unrecognized tax benefits was as follows:


	(In thousands)
	Years Ended December 31,
	2012			2011
Balance at January 1,	$	2,194		$	1,343
Additions based on tax positions related to the current year		214			536
Additions for tax positions for prior years		68			482
Reductions for tax positions of prior years		(820	)		(167	)

Balance at December 31,	$	1,656		$	2,194

During the fourth quarter of 2012, the Internal Revenue Service concluded its examination of our 2009 federal income tax return and the Franchise Tax Board concluded its examination of our 2008 and 2009 California franchise (income) tax returns. Each of these examinations resulted in “no change” to our returns as filed. Federal income tax returns after 2009, California franchise (income) tax returns after 2009 and other state income tax returns after 2007 are subject to examination.