Note 9 - Income Taxes

12 Months Ended

Dec. 31, 2012

Income Tax Disclosure [Text Block]

(9)           INCOME TAXES

The total provision for income taxes consists of the following:

	Years Ended December 31,
	2012			2011
	(in thousands)
Current Taxes:
Federal	$	-		$	-
State		-			-
Deferred Taxes:
Federal		(80	)		(573	)
State		-			-
Total tax benefit	$	(80	)	$	(573	)

The following is a reconciliation of the reported amount of income tax benefit for the years ended December 31, 2012 and 2011 to the amount of income tax expense that would result from applying domestic federal statutory tax rates to pretax income:

	Years Ended December 31,
	2012			2011
	(in thousands)
Statutory tax benefit	$	(892	)	$	(1,387	)
Increase (decrease) in valuation allowance
Change in valuation allowance		(3,137	)		1,318
Effect of subsidiary tax consolidation		-			(573	)
Expiration of capital loss carryforwards		9			22
Expiration of NOL carryforwards		4,007			18
Benefit realized on settlement of unrecognized tax benefit		(80	)		-
Effect of permanent differences and other		13			29
Total tax benefit	$	(80	)	$	(573	)

At December 31, 2012, we had available for U.S. federal income tax reporting purposes, a net operating loss (NOL) carryforward for regular tax purposes of approximately $98 million which expires in varying amounts during the tax years 2013 through 2032, an alternative minimum tax NOL carryforward of approximately $79 million which expires in varying amounts during the tax years 2013 through 2032, and a statutory depletion carryforward of approximately $9 million which can be carried forward indefinitely to offset our future taxable income, subject to certain limitations imposed by the Internal Revenue Code.  Additionally, at December 31, 2012, we have a capital loss carryforward of approximately $8 million which will expire during the years 2013 through 2015. Current federal income tax law allows corporations to deduct capital losses only if they offset capital gains. In 2003, we underwent a change in ownership, within the meaning of Internal Revenue Code Section 382, which significantly restricts our ability to utilize our domestic NOLs and capital losses.

In June 2009, we acquired a 19.5% interest in BWI and were deemed to be the primary beneficiary, and as a result, we consolidated BWI in our consolidated financial statements.  Pursuant to our investment in BWI, a deferred tax liability was calculated by applying the domestic statutory tax rates to the difference between the book purchase price and the tax basis and recording a valuation allowance to a portion of the net operating loss carryovers of BWI resulting in a net deferred tax liability of $573 thousand. During 2011 we acquired the remaining interests of BWI, and BWI is now consolidated with HKN for tax purposes. As a result, we recorded a tax benefit of $573 thousand from the reversal of the valuation allowance equal to the net deferred tax liability. The acquisition of BWI resulted in a change in control under the meaning of Internal Revenue Code Section 382, which would restrict our ability to utilize the NOLs of BWI.

The components of our federal deferred income taxes were as follows for the years ended December 31, 2012 and 2011:

	2012			2011
	(in thousands)
Deferred tax assets:
Net operating losses (NOL) carryover	$	33,444		$	36,460
Depletion carryover		3,020			3,020
Share based compensation		28			-
Deferred book liabilities		1			-
Loan origination fees		41			-
Book vs. tax basis in investments		19,165			20,180
Capital loss carryover		2,688			2,697
Total gross deferred tax assets		58,387			62,357
Deferred tax liabilities:
Property and equipment		(753	)		(781	)
Net deferred tax assets		57,634			61,576
Less valuation allowances		(57,634	)		(61,576	)
Deferred tax liabilities, net of valuation allowance	$	-		$	-

Our policy is to recognize potential interest and penalties accrued related to unrecognized tax benefits within income tax expense. The tax years 2009-2012 remain open to examination for federal income tax purposes and by the other major taxing jurisdictions to which we are subject.  The tax years 2008-2012 also remain open for examination purposes for the Texas Franchise tax.

In May 2006, the Governor of Texas signed into law a Texas margin tax (H.B. No. 3) which restructured the state business tax by replacing the taxable capital and earned surplus components of the current franchise tax with a new “taxable margin” component.  Specifically, we became subject to an entity level tax on the portion of our total revenue (as that term is defined in the legislation) that is generated in Texas beginning in our tax year ending December 31, 2007. The Texas margin tax is imposed at a maximum effective rate of 0.7% of our total revenue that is apportioned to Texas.

In 2009, we recorded an income tax contingency related to an IRS tax examination of $225 thousand, including interest and penalties, in our consolidated financial statements. We settled this contingency during 2012, resulting in a gain realized as an income tax benefit of $73 thousand within our consolidated financial statements during the second quarter 2012. For a complete discussion of the IRS tax contingency, see Note 15 - “Commitments and Contingencies.”

The following table illustrates changes in our gross unrecognized tax benefits (in thousands) for the years ending December 31, 2012 and 2011.

	2012			2011
Unrecognized tax benefits at January 1,	$	225		$	225
Increases for positions taken in current year		-			-
Decreases for positions taken in current year		-			-
Decreases for settlements with taxing authorities		(225	)		-
Decreases for lapses in the applicable statute of limitations		-			-
Unrecognized tax benefits at December 31,	$	-		$	225