Income Taxes

9 Months Ended

Sep. 30, 2011

Income Taxes [Abstract]

Income Taxes

8. Income Taxes

Our Provision for income tax expense of $18.1 million for the three months ended September 30, 2011 is comprised of: (1) estimated income tax expense of approximately $16 million based on the application of our estimated effective blended federal and state income tax rate of approximately 40% to our pre-tax income from continuing operations attributable to HealthSouth and (2) approximately $4 million of estimated income tax expense primarily associated with federal income tax on state income tax refunds received offset by (3) approximately $2 million of income tax benefit associated with a reduction in unrecognized tax benefits due to settlements with state taxing authorities and the corresponding receipt of interest income on these refunds.

Our Provision for income tax expense of $21.9 million for the nine months ended September 30, 2011 is comprised of: (1) estimated income tax expense of approximately $50 million based on the application of our estimated effective blended federal and state income tax rate of approximately 40% to our pre-tax income from continuing operations attributable to HealthSouth and (2) approximately $4 million of estimated income tax expense primarily associated with federal income tax on state income tax refunds received offset by (3) the settlement of federal income tax claims with the Internal Revenue Service (the “IRS”) for tax years 2007 and 2008 which resulted in an income tax benefit of approximately $24 million and (4) other items, primarily related to a reduction in unrecognized tax benefits due to the lapse of the applicable statute of limitations for certain federal and state claims, which resulted in a tax benefit of approximately $8 million.

We have significant federal and state net operating loss carryforwards (“NOLs”) that expire in various amounts at varying times through 2034. We assess the realization of our deferred tax assets quarterly to determine whether an adjustment to our valuation allowance is required. As a result of these assessments in prior periods, we maintained a valuation allowance against our deferred tax assets, including substantially all of these NOLs. During the fourth quarter of 2010, and as discussed in more detail in Note 19, Income Taxes, to the consolidated financial statements accompanying the 2010 Form 10-K, based on the weight of available evidence, we determined it was more likely than not a substantial portion of our deferred tax assets will be realized on a federal basis and in certain state tax jurisdictions in the future and decreased our valuation allowance by approximately $825 million to approximately $113 million as of December 31, 2010.

The $649.6 million of net deferred tax assets included in the accompanying condensed consolidated balance sheet as of September 30, 2011 ($27.1 million included in Other current assets) reflects management’s assessment it is more likely than not we will be able to generate sufficient future taxable income to utilize those deferred tax assets based on our current estimates and assumptions. As of September 30, 2011, we maintained a valuation allowance of approximately $105 million due to uncertainties related to our ability to utilize a portion of our deferred tax assets, primarily related to state NOLs, before they expire. During the nine months ended September 30, 2011, we reduced our valuation allowance by approximately $8 million. This reduction primarily resulted from our settlement with the IRS for tax years 2007 and 2008, as discussed above, and our ability to utilize certain capital losses as a result of such settlement. The amount of the valuation allowance has been determined for each tax jurisdiction based on the weight of all available evidence including management’s estimates of taxable income for each jurisdiction in which we operate over the periods in which the related deferred tax assets will be recoverable. It is possible we may be required to increase or decrease our valuation allowance at some future time if our forecast of future earnings varies from actual results on a consolidated basis or in the applicable state tax jurisdictions, or if the timing of future tax deductions differs from our expectations.

Our utilization of NOLs could be subject to the Internal Revenue Code Section 382 (“Section 382”) limitation and may be limited in the event of certain cumulative changes in ownership interests of significant shareholders over a three-year period in excess of 50%. Section 382 imposes an annual limitation on the use of these losses to an amount equal to the value of a company at the time of an ownership change multiplied by the long-term tax exempt rate. At this time, we do not believe these limitations will restrict our ability to use any NOLs before they expire. However, no such assurances can be provided.

Our Provision for income tax benefit of $0.4 million for the three months ended September 30, 2010 includes the following: (1) current income tax benefit of $2.3 million primarily attributable to a reduction in our accrual for alternative minimum tax and a reduction in unrecognized tax benefits due to settlements with state taxing authorities and the lapse of the applicable statute of limitations for certain claims offset by (2) current income tax expense of $1.6 million primarily attributable to state income tax expense of subsidiaries which have separate state filing requirements and federal income taxes for subsidiaries not included in our federal consolidated income tax return and (3) deferred income tax expense of $0.3 million primarily attributable to increases in basis differences of certain indefinite-lived assets.

Our Provision for income tax expense of $0.7 million for the nine months ended September 30, 2010 includes the following: (1) current income tax benefit of $7.6 million primarily attributable to a reduction in unrecognized tax benefits due to settlements with state taxing authorities and the lapse of the applicable statute of limitations for certain claims offset by (2) current income tax expense of $5.9 million primarily attributable to state income tax expense of subsidiaries which have separate state filing requirements and federal income taxes for subsidiaries not included in our federal consolidated income tax return and (3) deferred income tax expense of $2.4 million primarily attributable to adjustments for income taxes related to the reversal of previously established other comprehensive income items and increases in basis differences of certain indefinite-lived assets.

Total remaining gross unrecognized tax benefits were $12.6 million as of December 31, 2010, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax benefits as of December 31, 2010 was $1.1 million. The amount of unrecognized tax benefits changed during the nine months ended September 30, 2011 due to the settlement of federal income tax claims with the IRS for tax years 2007 and 2008 and the lapse of the applicable statute of limitations for certain federal and state claims. Total remaining gross unrecognized tax benefits were $8.0 million as of September 30, 2011, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax benefits as of September 30, 2011 was $0.1 million.

A reconciliation of the change in our unrecognized tax benefits from December 31, 2010 to September 30, 2011 is as follows (in millions):

	Gross Unrecognized Income Tax Benefits			Accrued Interest and Penalties
Balance at December 31, 2010	$	12.6		$	1.1
Gross amount of increases in unrecognized tax benefits related to prior periods		23.5			—
Gross amount of decreases in unrecognized tax benefits related to prior periods		(0.1	)		—
Decreases in unrecognized tax benefits relating to settlements with taxing authorities		(24.8	)		—
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations		(3.2	)		(1.0	)
Balance at September 30, 2011	$	8.0		$	0.1

Our continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. For the three and nine months ended September 30, 2011, we recorded $1.2 million and $3.0 million, respectively, of net interest income as part of our income tax provision. For the three and nine months ended September 30, 2010, we recorded $0.5 million and $2.3 million, respectively, of net interest income as part of our income tax provision. There was no accrued interest as of September 30, 2011. Total accrued interest income was $0.3 million as of December 31, 2010.

HealthSouth and its subsidiaries’ federal and state income tax returns are periodically examined by various regulatory taxing authorities. In connection with such examinations, we have settled federal income tax examinations with the IRS for all tax years through 2008. At this time, we have no ongoing income tax audits by regulatory taxing authorities.

For the tax years that remain open under the applicable statutes of limitations, amounts related to unrecognized tax benefits have been considered by management in its estimate of our potential net recovery of prior years’ income taxes. It is reasonably possible a decrease in our unrecognized tax benefits of approximately $0.4 million will occur within the next 12 months due to the closing of the applicable statues of limitations.

We continue to actively pursue the maximization of our remaining state income tax refund claims and other tax benefits. Although management believes its estimates and judgments related to these claims are reasonable, depending on the ultimate resolution of these tax matters, actual amounts recovered could differ from management’s estimates, and such differences could be material.