Income Tax Expense

The components of income (loss) before income taxes are as follows:



	Years Ended December 31,
	2012			2011			2010
United States	$	(98,335	)	$	(86,085	)	$	(84,751	)
Foreign	50,329			89,498			79,438
Income (loss) before income tax expense	$	(48,006	)	$	3,413		$	(5,313	)

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share amounts)

(19) Income Tax Expense (Continued)

The components of the provision for income taxes are as follows:



	Years Ended December 31,
	2012			2011			2010
Current
U.S. Federal	$	(133	)	$	440		$	7,565
U.S. State	(90		)	215			25
Foreign	9,969			13,504			6,210
Total	9,746			14,159			13,800
Deferred
U.S. Federal	3,154			2,000			100,982
U.S. State	687			87			16,882
Foreign	1,034			(263		)	12,224
Total	4,875			1,824			130,088
Total income tax expense	$	14,621		$	15,983		$	143,888

The reconciliation of the U.S. federal statutory tax rate to the actual tax rate is as follows:



	Years Ended December 31,
	2012		2011		2010
Statutory U.S. federal income tax rate	35.0	%	35.0	%	35.0	%
U.S. state income taxes, net of federal benefit	7.0	%	(132.2	)%	141.9	%
Federal benefit of R&D and AMT credits, net	4.8	%	(2.5	)%	9.5	%
Foreign earnings at lower rates than U.S. federal rate	13.8	%	(530.2	)%	170.9	%
Federal (benefit) expense of U.S. permanent differences	(56.1	)%	246.9	%	(251.9	)%
Federal valuation allowance adjustments	(35.1	)%	853.3	%	(2,816.1	)%
Other	0.1	%	(1.6	)%	1.8	%
Effective income tax rate	(30.5	)%	468.7	%	(2,708.9	)%

The effective tax rate in 2012 is (30.5%) compared to 468.7% in 2011. The income tax expense in 2012 is primarily attributable to income tax expense in our international jurisdictions. The effective tax rate for 2012 does not include the benefit of the current year U.S. tax loss as a result of the valuation allowance against our U.S. deferred tax assets.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and the amounts used for income tax purposes.

The deferred income tax balances are established using the enacted statutory tax rates and are adjusted for changes in such rates in the period of change.

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share amounts)

(19) Income Tax Expense (Continued)



	December 31,
	2012			2011
Deferred tax assets:
Inventory valuation	$	11,426		$	9,844
Reserves and other accrued expenses	3,683			6,215
Compensation not currently deductible	7,139			9,168
Employee pension benefit included in other comprehensive (loss) income	5,348			3,097
Unrealized losses and income from derivative financial instruments included in other comprehensive (loss) income	470			—
Share based compensation	10,144			26,326
Net operating loss carry forwards	166,673			136,018
Tax credit carry forwards	32,750			41,881
Differences in financial reporting and tax basis for:
Property and Equipment	17,115			14,649
Valuation allowance	(241,156		)	(236,296		)
Realizable deferred tax assets	13,592			10,902
Deferred tax liabilities:
Deferred costs and prepaid expenses	(2,781		)	(2,795		)
Unrealized losses and income from derivative financial instruments included in other comprehensive (loss) income	—			(44		)
Differences in financial reporting and tax basis for:
Identifiable intangible assets	(61,092		)	(51,628		)
Total deferred tax liabilities	(63,873		)	(54,467		)
Net deferred tax liabilities on balance sheet	(50,281		)	(43,565		)
Reported As:
Current deferred tax assets	6,800			3,606
Non-current deferred tax assets	6,281			12,709
Current deferred tax liabilities	(1,097		)	(3,616		)
Non-current deferred tax liabilities	(62,265		)	(56,264		)
Net deferred tax liabilities on the balance sheet	$	(50,281	)	$	(43,565	)

In accordance with ASC 740, Income Taxes, the current and non-current components of our deferred tax balances are generally based on the balance sheet classification of the asset or liability creating the temporary difference. If the deferred tax asset or liability is not related to a component of our balance sheet, such as our net operating loss carry forwards, the classification is presented based on the expected reversal date of the temporary difference. Our valuation allowance has been classified as current or non-current based on the percentage of current and non-current deferred tax assets to total deferred tax assets.

At December 31, 2012, we had net operating loss ("NOL") carry forwards (tax-effected) for federal, state and foreign income tax purposes of $88,899, $25,803 and $51,971, respectively. If not utilized, the federal and state tax loss carry forwards will expire through 2032. Certain of our federal NOL carry forwards are limited due to prior-year changes in ownership. The foreign NOL carry forwards can be carried forward for periods that vary from ten years to indefinitely.

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share amounts)

(19) Income Tax Expense (Continued)

We have foreign tax credit carry forwards of approximately $18,239 which if unutilized will expire through 2018, research and development tax credit carry forwards of $9,550 which if unutilized will expire through 2031, alternative minimum tax credit carry forwards of $2,107 which can be carried forward indefinitely, state tax credits of $2,094 which if unutilized will expire through 2022, and other non-U.S. tax credits of $759 which can be carried forward indefinitely.

At December 31, 2012 and December 31, 2011, we established a valuation allowance of $241,156 and $236,296 against the U.S. and foreign deferred tax assets that, in the judgment of management, are more likely than not to expire before they can be utilized. In assessing the recoverability of our deferred tax assets, we analyzed all evidence, both positive and negative. We considered, among other things, our deferred tax liabilities, our historical earnings and losses, projections of future income, and tax-planning strategies available to us in the relevant jurisdiction.

At December 31, 2012 and December 31, 2011, we established valuation allowances of $144,264 and $146,681, respectively, against the benefit of U.S. federal deferred tax assets and valuation allowances of $33,077 and $29,170, respectively, against the benefit of state deferred tax assets.

At December 31, 2012 and 2011, we established valuation allowances of $18,239 and $30,067, respectively, against the benefit of the deferred tax assets related to the U.S. foreign tax credit carry forwards. The decrease in the foreign tax credit valuation allowance in 2012 is due to the Company's election to amend its 2008 U.S. federal income tax return and deduct foreign taxes previously recorded as credits.

At December 31, 2012 and 2011, we established valuation allowances of $45,576 and $30,378, respectively, against the benefit of the deferred tax assets related to foreign NOL carry forwards to measure them at their expected realizable value.

The net increase in the Company's total U.S. and foreign valuation allowances for 2012 and 2011 was $4,860 and $1,483, respectively.

Deferred taxes have not been provided on the excess of book basis over tax basis in the shares of certain foreign subsidiaries because these basis differences are not expected to reverse in the foreseeable future and are essentially permanent in duration. Our intention is to continue to reinvest the earnings of our foreign subsidiaries indefinitely. The estimated cumulative amount of earnings from foreign subsidiaries that are permanently invested outside of the U.S. is $265,474 as of December 31, 2012.

Unrecognized Tax Benefits

The Company applies a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company recognizes the impact of a tax position in the financial statements when the position is more likely than not of being sustained on audit based on the technical merits of the position.

The total amount of unrecognized tax benefits as of December 31, 2012 was approximately $1,781. Of this amount, approximately $1,272, if recognized, would be included in our statement of operations and have an impact on our effective tax rate. The Company does not anticipate a material reduction of its liability for unrecognized tax benefits before December 31, 2013.

We recognize interest accrued for unrecognized tax benefits in interest expense and recognize penalties in income tax expense. During the years ended December 31, 2012, 2011 and 2010, we recognized approximately $44, $67 and $102, respectively, in interest and penalties. We had approximately $396 and $440 for the payment of interest and penalties accrued at December 31, 2012 and 2011, respectively.

We and our subsidiaries file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2009.

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share amounts)

(19) Income Tax Expense (Continued)

The Company had the following activity for unrecognized tax benefits:



	Year Ended December 31,
	2012			2011			2010
Balance at beginning of period	$	1,876		$	1,760		$	6,612
Tax positions related to current year additions	41			162			—
Additions for tax positions of prior years	89			165			211
Tax positions related to prior years reductions	—			—			—
Reductions due to lapse of statute of limitations on tax positions	—			—			(5,020		)
Settlements	(225		)	(211		)	(43		)
Balance at end of period	$	1,781		$	1,876		$	1,760