NOTE 10 – INCOME TAXES

Income (loss) before income taxes consists of the following:



	Year Ended December 31,
(In thousands)	2012		2011
Sources of income (loss) before income taxes:
United States	$	(4,717)	$	3,196
Foreign		1,582		2,531
Total income (loss) before income taxes	$	(3,135)	$	5,727

The provision (benefit) for income taxes consists of the following:



	Year Ended December 31,
(In thousands)	2012		2011
Current:
Federal	$	(1,010)	$	622
State		(3)		61
Foreign		(219)		58
Total current	$	(1,232)	$	741
Deferred:
Federal	$	4,377	$	259
State		409		166
Foreign		22		204
Total deferred	$	4,808	$	629
Total provision for income taxes	$	3,576	$	1,370

A reconciliation of the statutory rate to the effective income tax rate is as follows:



	Year Ended December 31,
	2012			2011
Federal statutory rate		34.0	%		34.0	%
State income taxes, net of federal benefit		1.0			1.2
Domestic manufacturing tax deduction		(4.7)			(1.5)
U.S. Subpart F income		(1.8)			1.3
Stock based compensation		(0.5)			0.5
Research and experimentation credit		—			(1.9)
Foreign rate difference		37.9			(11.1)
Reserve for income taxes		1.8			0.4
Valuation allowance		(181.1)			1.4
Other, net		(0.6)			(0.4)
Effective tax rate		(114.0)	%		23.9	%

Our effective tax rate for 2012 and 2011 reflects the impact of having a significant portion of our operations in Singapore where corporate income tax rates are substantially lower than the United States. Lower tax rates in foreign jurisdictions negatively impacted our 2012 income tax rate by 37.9% and favorably impacted our 2011 tax rate by 11.1%.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits (“UTB”) is as follows:



	Year Ended December 31,
(In thousands)	2012		2011
Gross UTB balance at beginning of year	$	1,599	$	1,543
Additions based on tax positions related to the current year		92		101
Additions for tax positions of prior years		39		52
Reductions for tax positions of prior years		(75)		(69)
Reductions due to lapse of applicable statute of limitations		(155)		(28)
Gross UTB balance at end of year	$	1,500	$	1,599
Net UTB balance at end of year	$	686	$	840

The ending net UTB results from adjusting the gross balance for items such as federal, state, and non-U.S. deferred items, interest and penalties, and deductible taxes. The net UTB is a long-term income tax reserve within our Consolidated Balance Sheets. We recognize interest and penalties related to unrecognized tax benefits in tax expense. Accrued interest and penalties on a gross basis were $169,000 as of December 31, 2012 and $177,000 as of December 31, 2011.

During the year ended December 31, 2012 we recorded a $56,000 decrease in liabilities for uncertain tax positions that was recorded as income tax benefit. Estimated gross interest and penalties included in this amount total $23,000. During the year ended December 31, 2011 we recorded a $22,000 increase in liabilities, net of deferred tax benefit, for uncertain tax positions that was recorded as income tax expense. Estimated gross interest and penalties included in this amount total $18,000.

We file income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. During 2012, the Internal Revenue Service completed an audit of our 2010 federal income tax return. The audit resulted in no change to our reported level of taxable income or income tax liability, and had no impact on our financial condition. Due to the carryback of our 2009 federal taxable loss to the years 2004-2007, the Internal Revenue Service could potentially examine our federal income tax returns for these years. The statute of limitations for examination of these returns had previously expired. We are no longer subject to state and local income tax examinations by tax authorities for years before 2008.

Deferred tax assets and liabilities consist of the following:



	December 31, 2012					December 31, 2011
(In thousands)	Assets		Liabilities		Assets		Liabilities
Fixed asset and intangible amortization, net	$	683	$	109	$	940	$	34
Inventory allowances		466		15		497		—
Accrued liabilities		328		—		309		—
Warranty accrual		241		—		344		—
Deferred revenue		332		—		500		—
Accounts receivable allowance		269		—		328		—
Federal and state tax credits		2,569		—		2,220		—
Federal and state net operating loss carry forwards		634		—		262		—
Foreign net operating loss carry forwards		882		—		311		—
Stock based compensation		411		—		468		—
Unrealized gains and losses - other
comprehensive income (loss)		7		72		164		—
Other, net		141		—		138		—
Subtotal		6,963		196		6,481		34
Valuation allowance		(6,333)		—		(833)		—
Total deferred tax assets and liabilities	$	630	$	196	$	5,648	$	34

We currently have significant deferred tax assets as a result of temporary differences between taxable income on our tax returns and U.S. GAAP income, research and development tax credit carry forwards and federal, state and foreign net operating loss carry forwards. A deferred tax asset generally represents future tax benefits to be received when temporary differences previously reported in our financial statements become deductible for income tax purposes, or when net operating loss carry forwards are applied against future taxable income, or when tax credit carry forwards are utilized on our tax returns. We assess the realizability of our deferred tax assets and the need for a valuation allowance based on the guidance provided in current financial accounting standards.

Significant judgment is required in determining the realizability of our deferred tax assets. The assessment of whether valuation allowances are required considers, among other matters, the nature, frequency and severity of any current and cumulative losses, forecasts of future profitability, the duration of statutory carry forward periods, our experience with loss carry forwards not expiring unused and tax planning alternatives.

At December 31, 2012, we concluded that a valuation allowance is needed for substantially all of our United States and Singapore based deferred tax assets due to the decline in our level of profitability and near term financial outlook. In analyzing the need for a valuation allowance, we first considered our history of operating results for income tax purposes over the past three years in each of the tax jurisdictions where we operate, our financial performance in recent quarters, statutory carry forward periods and tax planning alternatives. Finally, we considered both our near and long-term financial outlook and timing regarding when we might return to profitability. After considering all available evidence both positive and negative, we concluded that a valuation allowance with respect to substantially all of our U.S. and Singapore based deferred tax assets was required, resulting in the significant increase in our valuation allowance at December 31, 2012. The valuation allowance at December 31, 2011 was needed for various long-term state tax credit carry forwards, state operating loss carry forwards and capital losses for which recovery was not deemed to be more likely than not. We reduced our valuation allowance by $178,000 in 2012 for the effect of various state tax credit carry forwards that expired unused. At December 31, 2012 we had federal R&D tax credits of $2,658,000 that will begin to expire in 2019 and a federal net operating loss carry forward of $925,000 that will expire in 2022, if unused.

Deferred tax assets at December 31, 2012, include $226,000 for net operating loss carry forwards incurred in the UK by CyberOptics Ltd., which was acquired in 1999. A valuation allowance has not been recorded against these deferred tax assets. The utilization of these net operating loss carry forwards is dependent on CyberOptics Ltd.’s ability to generate sufficient UK taxable income during the carry forward period. We reduced our deferred tax asset for UK net operating loss carry forwards by $14,000 in 2012 and $44,000 in 2011 due to reductions in the future UK income tax rate.

Cash payments for income taxes, net of refunds received, were $170,000 for the year ended December 31, 2012 and $822,000 for the year ended December 31, 2011.

We have been granted a tax holiday with respect to a wholly owned foreign subsidiary allowing us to pay a reduced rate of tax for a period of five years through 2013. The tax holiday had no impact on income tax expense in 2012 and decreased income tax expense in 2011 by $115,000, if income tax expense had been computed using the statutory rate in the foreign jurisdiction where the subsidiary operates.

It is the intention of management to permanently reinvest all undistributed earnings of international subsidiaries, and accordingly, we have not provided United States taxes on such earnings. It is not practicable to determine the income tax liability that would be payable if such earnings were not indefinitely reinvested.