15. Income Taxes

Income tax benefit for 2012, 2011 and 2010 consist of the following:

	2012			2011			2010
Current tax expense	$	343,252		$	—		$	—
Deferred tax benefit	(35,062,841		)	(8,098,357		)	(16,607,139		)
Income tax benefit	$	(34,719,589	)	$	(8,098,357	)	$	(16,607,139	)

The following is a reconciliation of effective income tax rates by applying the federal statutory rate of 35% to the income and loss for the years ended December 31, 2012, 2011 and 2010, respectively:

	2012			2011			2010
Loss before income taxes	$	(126,710,944	)	$	(23,943,739	)	$	(47,452,036	)

Income tax benefit at statutory rate	$	44,348,830		$	8,380,309		$	16,608,213
Valuation allowance	(10,197,845		)	—			—
Adjustment to NOL carryforward	—			—			(261,154		)
Effect for permanent items	(11,496		)	(17,306		)	(23,699		)
State taxes and other	580,100			(264,646		)	283,779
Income tax benefit	$	34,719,589		$	8,098,357		$	16,607,139

Significant components of our deferred tax assets and liabilities are as follows:

	December 31,
	2012			2011
Deferred tax assets
Net operating loss carryforwards	$	38,988,438		$	59,443,480
Oil and gas properties	19,163,931			—
Deferred compensation	8,057,657			7,177,942
Income tax credits	347,737			281,424
Deferred tax assets before valuation allowance	66,557,763			66,902,846
Valuation allowance	(13,290,201		)	(3,238,656		)
Net deferred tax assets	53,267,562			63,664,190

Deferred tax liabilities
Oil and gas properties	—			(44,780,151		)
Derivative instruments	(532,795		)	(1,349,679		)
Other	(563,451		)	(425,726		)
Deferred tax liabilities	(1,096,246		)	(46,555,556		)
Net deferred tax assets	$	52,171,316		$	17,108,634

As of December 31, 2012, we had federal and state net operating loss (“NOL”) carryforwards of approximately $110.7 million and $6.8 million, respectively, which are available to reduce future taxable income and the related income tax liability. We have a total valuation allowance against federal NOL carryforwards totaling $38.0 million, or $13.3 million tax-adjusted at the federal statutory rate, consisting of two parts. In prior years, we recorded a full valuation allowance against approximately $8.8 million, or $3.1 million tax-adjusted, against NOL carryforwards that we will not be able to utilize due to the limitations of Internal Revenue Code Section 382 (“Section 382”). In the fourth quarter of 2012, we recorded a partial valuation allowance of approximately $29.1 million, or $10.2 million tax-adjusted, against NOL carryforwards that are not impacted by limitations of Section 382 as discussed below.

The combination of significant taxable losses in recent years, lower than budgeted taxable income for the fourth quarter of 2012 and our preliminary budget for 2013, do not allow us to significantly reduce NOL carryforwards in 2012 or 2013 resulting in a material amount of NOL carryforwards. Following the before mentioned events in the fourth quarter of 2012, we concluded that a partial valuation allowance against NOL carryforwards was required. To estimate the amount of NOL carryforwards we can utilize more likely than not within the carryforward period, we projected future taxable income and applied a risk factor to the outer years. Following this methodology, we increased the tax-adjusted valuation allowance against NOL carryforwards by $29.1 million, or $10.2 million tax adjusted.

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of these deductible differences net of a tax-adjusted $13.3 million valuation allowance. The amount of the deferred tax assets considered realizable could be reduced in the future if estimates of future taxable income during the carryforward period are reduced.

Federal NOL carryforwards of $110.7 million expire at various dates beginning in 2013 and ending in 2033. NOL carryforwards of $8.8 million impacted by Section 382 limitations will expire between 2013 and 2016. NOL carryforwards of $101.9 million, associated with losses incurred in recent years and not impacted by Section 382 limitations, expire at various dates beginning in 2026 and ending in 2033. We continue to believe that we will be able to utilize the majority of the NOL carryforwards that are not impacted by Section 382 before they expire. Depending on taxable income in future years, we could increase or decrease the valuation allowance.

ASC 740, Income Taxes (“ASC 740”) prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of income tax positions taken or expected to be taken in an income tax return. For those benefits to be recognized, an income tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. There was not a material impact on our operating results, financial position or cash flows as a result of the adoption of the provisions of ASC 740. A reconciliation of the beginning and ending amount of unrecognized income tax benefits is as follows:

	Unrecognized Tax Benefits
Balance at December 31, 2011	$	518,219
Additions based on tax positions related to the current year	—
Additions based on tax positions related to prior years	—
Additions due to acquisitions	—
Reductions due to a lapse of the applicable statute of limitations	—
Balance at December 31, 2012	$	518,219

Generally, our income tax years of 2008 through the current year remain open and subject to examination by Federal tax authorities or the tax authorities in Texas, Louisiana and Colorado which are the jurisdictions where we have our principal operations. These audits can result in adjustments of taxes due or adjustments of the net operating loss carryforwards that are available to offset future taxable income.

Our policy is to recognize interest and penalties related to uncertain tax positions as income tax benefit (expense) in our Consolidated Statements of Operations. For the years ended December 31, 2012 and 2011, respectively, we recorded no interest expense and penalties related to unrecognized tax benefits associated with uncertain tax positions recognized in our provision for income taxes.

The total amount of unrecognized tax benefit if recognized that would affect the effective tax rate was zero. Our tax returns are subject to periodic audits by the various jurisdictions in which we operate. These audits can result in adjustments of taxes due or adjustments of the net operating loss carryforwards that are available to offset future taxable income.

We do not anticipate that total unrecognized tax benefits will significantly change due to the settlement of audits and the expiration of statute of limitations prior to December 31, 2012. However, due to the complexity of the application of tax law and regulations, it is possible that the ultimate resolution of these positions may result in liabilities which could be materially different from these estimates.