Income taxes include Puerto Rico income taxes as well as applicable U.S. federal and state taxes. As Puerto Rico corporations, Doral Financial and all of its Puerto Rico subsidiaries are generally required to pay U.S. income taxes only with respect to their income derived from the active conduct of a trade or business in the United States (excluding Puerto Rico) and certain investment income derived from U.S. assets. Any such tax is creditable, with certain limitations, against Puerto Rico income taxes. Except for the operations of Doral Bank US and Doral Money, substantially all of the Company's operations are conducted through subsidiaries in Puerto Rico. Doral Bank US and Doral Money are U.S. corporations and are subject to U.S. income-tax on their income derived from all sources.

Until December 31, 2010, the maximum statutory corporate income tax rate in Puerto Rico was 39.00%. Under the 1994 Puerto Rico Internal Revenue Code, as amended (“1994 Code”), Corporations are not permitted to file consolidated returns with their subsidiaries and affiliates. Doral Financial is entitled to a 100% dividend received deduction on dividends received from Doral Bank PR or any other Puerto Rico subsidiary subject to tax under the Puerto Rico tax code.

On March 9, 2009, the Governor of Puerto Rico signed into law the Special Act Declaring a State of Fiscal Emergency and Establishing an Integral Plan of Fiscal Stabilization to Save Puerto Rico's Credit, Act No. 7 (the “Act”). Pursuant to the Act, Section 1020A was introduced to the Code to impose a 5.00% surtax over the total tax determined for corporations, partnerships, trusts, estates, as well as individuals whose combined gross income exceeds $100,000 or married individuals filing jointly whose gross income exceeds $150,000. This surtax is effective for tax years commenced after December 31, 2008 and before January 1, 2012. This increased the Company's income tax rate from 39.00% to 40.95% for tax years from 2009 through 2011.

On November 15, 2010, Act 171 was enacted into law (“Act 171”) generally providing, among other things: (1) an income tax credit equal to 7.00% of the “tax liability due” to corporations that paid the Christmas bonus required by local labor laws, and (2) extending to 10 years the carry forward term of net operating losses incurred for years commenced after December 31, 2004 and before December 31, 2012.

On January 31, 2011, the Governor signed into law the Internal Revenue Code of 2011 (“2011 Code”) making the 1994 Code largely ineffective, for years commenced after December 31, 2010. Under the provisions of the 2011 Code, the maximum statutory corporate income tax rate in 30.00% for years starting after December 31, 2010 and ending before January 1, 2014; if the government meets its income generation and expense control goals, for years started after December 31, 2013, the maximum corporate tax rate will be 25.00%. The 2011 Code eliminated the special 5.00% surtax on corporations for tax year 2011. In general, the 2011 Code maintains the extension in the carry forward periods for net operating losses from 7 to 10 years as provided for in Act 171; maintains the concept of the alternative minimum tax although it changed the way it is computed; allows limited liability companies to have flow-through treatment under certain circumstances; imposes additional restriction on the use of net operating loss carry forwards after certain types of reorganizations and/or changes in control; and specifies what types of auditors' report will be acceptable when audited financial statements are required to be filed with the income tax return. Additionally, the 2011 Code provides for changes in the implications of being in a controlled group of corporations and/or a group of related corporations. Notwithstanding the 2011 Code, a corporation may be subject to the provisions of the 1994 Code if it so elects by the time it files its income tax return for the first year commenced after December 31, 2010 and ending before January 1, 2012. If the election is made to remain subject to the provisions of the 1994 Code, such election will be effective that year and the next four succeeding years.

The Company is evaluating the impact of the tax reform on its results of operations including the election to be taxed under the 1994 Code. Nevertheless, the Company recorded its deferred tax assets estimated to reverse after 2015 at the 30.00% tax rate required for all taxable earnings beginning in 2016, which is the latest taxable year that it would be permitted to elect taxation under the 1994 Code. Puerto Rico deferred tax assets subject to the maximum statutory tax rate and estimated to reverse prior to 2016, together with any related valuation allowance, are recorded at the 39.00% tax rate pursuant to the 1994 Code. Upon determination of which alternative treatment will be followed, the Company will adjust its deferred tax assets for any required tax rate change, if applicable. Adoption of the 2011 Code as of June 30, 2011 would represent an additional deferred tax expense of $8.4 million.

		Quarters Ended				Six month periods ended
		June 30,				June 30,
(In thousands)		2011		2010		2011		2010
Current income tax expense - United States		$	3,101	$	3,615	$	5,475	$	3,890
Deferred income tax (benefit) expense:
	Puerto Rico		450		1,008		3,120		2,795
	United States		(680)		(136)		(627)		331
Total deferred income tax (benefit) expense			(230)		872		2,493		3,126
	Total income tax expense (benefit)	$	2,871	$	4,487	$	7,968	$	7,016

The current income tax expense of $3.1 million and $5.5 million for the quarter and six month periods ended June 30, 2011, respectively, was related to taxes on U.S. source income. The deferred tax benefit of $0.2 million and deferred tax expense of $2.5 million for the quarter and six month periods ended June 30, 2011 reflected reductions over the comparable periods in 2010 due to higher taxes recognized in 2010 related to U.S. source income, as well as the impact of tax rate change on the current period valuation allowance, partially offset by realization of operational deferred tax assets. The deferred income tax expense of $3.1 million for the six months ended June 30, 2011 was related to the net effect on the Company's deferred tax assets of (i) Puerto Rico tax legislation approved in January 2011 lowering the effective tax rate, resulting in a deferred tax expense of $18.8 million, (ii) the increased earnings expectation for profitable Puerto Rico entities which resulted in a deferred tax benefit of $17.4 million, and (iii) net amortization of deferred taxes of $1.7 million.

The Company's DTA consists primarily of the differential in the tax basis of IOs sold, net operating loss carry-forwards and other temporary differences arising from the daily operations of the Company.

The Company has entered into several agreements with the Puerto Rico Treasury Department related to the intercompany transfers of IOs (The “IO Tax Asset” or “IO”) and its tax treatment thereon. Under the agreements, the Company established the tax basis of all the IO transfers, clarified that for Puerto Rico income tax purpose, the IO Tax Asset is a stand-alone intangible asset subject to straight-line amortization based on a useful life of 15 years, and established that the IO Tax Asset could be transferred to any entity within the Doral Financial corporate group, including the Puerto Rico banking subsidiary. During the third quarter of 2009, the Company entered into an agreement with the Puerto Rico Treasury Department that granted the Company a two year moratorium of the amortization of the IO Tax Asset. This agreement resulted in a benefit of $11.2 million for the third quarter of 2009 and was effective for the taxable year beginning January 1, 2009. The realization of the deferred tax asset related to the differential in the tax basis of IOs sold is dependent upon the existence of, or generation of, taxable income during the remaining 12 year period (15 year original amortization period, 17 year original amortization period including the two year moratorium) in which the amortization of the IO Tax Asset is available. The IOs expire in 2022. Any IO amortization in excess of all legal entities' taxable income would become a NOL subject to the 7 or 10 year year carry-over period. Upon a business combination, which is not structured as a purchase of assets, the IOs should survive and be available to be used by the group's legal entities.

NOLs generated between 2005 and 2011 can be carried forward for a period of 10 years (there is no carry-back allowed in Puerto Rico). The NOLs creating deferred tax assets as of June 30, 2011, expire beginning in 2016 until 2021 for Puerto Rico entities and 2025 through 2029 for United States entities filing in New York. Since each legal entity files a separate income tax return, the NOLs can only be used to offset future taxable income of the entity that incurred it.

The Company evaluates its deferred tax asset for realizability, and the deferred tax asset is reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or all of the deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized.

In assessing the realization of deferred tax assets, the Company considers the expected reversal of its deferred tax assets and liabilities, projected future taxable income, cumulative losses in recent years, and tax planning strategies. The determination of a valuation allowance on deferred tax assets requires judgment based on the weight of all available evidence and considering the relative impact of negative and positive evidence.

As of June 30, 2011, the Company had two Puerto Rico entities which had incurred several consecutive years of losses. For purposes of assessing the realization of the DTAs, the loss position for these two entities is considered significant negative evidence that has caused management to conclude that the Company will not be able to fully realize the deferred tax assets related to these two entities in the future. Accordingly, as of June 30, 2011 and December 31, 2010, the Company determined that it was more likely than not that $441.2 million and $462.7 million, respectively, of its gross deferred tax asset would not be realized and maintained a valuation allowance for that amount.

As of June 30, 2011 and December 31, 2010, the Company's deferred tax assets were as follows:

(In thousands)		June 30, 2011		December 31, 2010
Deferred income tax asset resulting from:
	Differential in tax basis of IOs sold	$	207,797	$	237,912
	Net operating loss carry-forwards		226,509		193,322
	Allowance for loan and lease losses		36,868		48,635
	Capital loss carry-forward		18,227		26,783
	Reserve for losses on OREO		13,367		17,340
	Other		42,378		44,445
Gross deferred tax asset			545,146		568,437
	Valuation allowance		(441,188)		(462,725)
Net deferred tax asset		$	103,958	$	105,712

As of June 30, 2011 and December 31, 2010, the deferred tax asset valuation allowance off-set the following deferred tax assets:

The valuation allowance also includes $0.8 million and $1.3 million related to deferred taxes on unrealized losses on cash flow hedges as of June 30, 2011 and December 31, 2010, respectively.

Management did not establish a valuation allowance on the deferred tax assets generated on the unrealized gains and losses of its securities available for sale as of June 30, 2011 and December 31, 2010 because the Company had the positive intent and the ability to hold the securities until maturity or recovery of value.

As of June 30, 2011 and December 31, 2010, the deferred tax asset by legal entity was as follows:

		As of June 30, 2011
(In thousands)		Doral Financial Corporation		Doral Bank PR		Doral Mortgage LLC		Doral Insurance Agency		Doral Money		Doral Bank FSB		Total

Differential in tax basis of IOs sold	$	207,797	$	-	$	-	$	-	$	-	$	-	$	207,797
Net operating loss carry-forwards		48,544		171,832		5,030		-		-		1,103		226,509
Allowance for loan and lease losses		4,178		29,983		-		-		2,194		513		36,868
Capital loss carry-forward		849		17,375		-		-		-		3		18,227
Reserve for losses on OREO		3,278		10,043		-		-		-		46		13,367
Unrealized gains on investment securities available for sale		474		-		-		-		-		-		474
Other		15,109		25,352		172		2,905		221		278		44,037
Deferred tax assets		280,229		254,585		5,202		2,905		2,415		1,943		547,279
Unrealized gains on investment securities available for sale		-		(1,095)		-		-		-		-		(1,095)
Other		(549)		(324)		(120)		-		(45)		-		(1,038)
Deferred tax liabilities		(549)		(1,419)		(120)		-		(45)		-		(2,133)
Valuation allowance		(186,927)		(254,261)		-		-		-		-		(441,188)
Net deferred tax asset (liability)	$	92,753	$	(1,095)	$	5,082	$	2,905	$	2,370	$	1,943	$	103,958

		As of December 31, 2010
(In thousands)		Doral Financial Corporation		Doral Bank PR		Doral Mortgage LLC		Doral Insurance Agency		Doral Money		Doral Bank FSB		Total

Differential in tax basis of IOs sold	$	237,912	$	-	$	-	$	-	$	-	$	-	$	237,912
Net operating loss carry-forwards		46,634		139,813		5,963		83		-		829		193,322
Allowance for loan and lease losses		3,554		42,396		-		-		2,098		587		48,635
Capital loss carry-forward		6,776		20,003		-		-		-		4		26,783
Reserve for losses on OREO		4,903		12,391		-		-		-		46		17,340
Other		14,887		29,403		178		2,935		14		100		47,517
Deferred tax assets		314,666		244,006		6,141		3,018		2,112		1,566		571,509
Unrealized gains on investment securities available for sale		-		(1,889)		-		-		-		-		(1,889)
Other		(700)		(299)		(135)		-		(49)		-		(1,183)
Deferred tax liabilities		(700)		(2,188)		(135)		-		(49)		-		(3,072)
Valuation allowance		(219,017)		(243,708)		-		-		-		-		(462,725)
Net deferred tax asset (liability)	$	94,949	$	(1,890)	$	6,006	$	3,018	$	2,063	$	1,566	$	105,712

Puerto Rico deferred tax assets subject to the maximum statutory tax rate and estimated to reverse prior to 2016, together with any related valuation allowance, are recorded at the tax rate in effect under the 1994 Code, 39.00% or 40.95% as applicable. As of June 30, 2011, DTAs totalling $457.7 million were at the higher rates with a valuation allowance of $422.3 million. DTAs of $62.4 million were at the 30.00% tax rate while DTAs of $25.1 million with a valuation allowance of $18.9 million, were at other tax rates (and would not be impacted by the change in the tax code). If the Company elects to adopt the 2011 Code, DTAs would be $439.4 million with a valuation allowance of $343.7 million for a net DTA of $95.7 million.

For Puerto Rico taxable entities with positive core earnings, a valuation allowance on deferred tax assets has not been recorded since they are expected to continue to be profitable. At June 30, 2011, the net deferred tax asset associated with these two companies was $8.0 million, compared to $9.0 million at December 31, 2010. In addition, approximately, $92.3 million of the IO tax asset maintained at the holding company would be realized through these entities. In management's opinion, for these companies, the positive evidence of profitable core earnings outweighs any negative evidence.

Failure to achieve sufficient projected taxable income in the entities and deferred tax assets where a valuation allowance has not been established, might affect the ultimate realization of the net deferred tax assets.

Management assesses the realization of its deferred tax assets at each reporting period. To the extent that earnings improve and the deferred tax assets become realizable, the Company may be able to reduce the valuation allowance through earnings.

As of June 30, 2011, the Company did not have unrecognized tax benefits and had accrued interest of $0.8 million on previously unrecognized tax benefits. The Company classifies all interest related to tax uncertainties as income tax expense.

The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the expiration of statutes of limitation, changes in management's judgment about the level of uncertainty, status of examinations, litigation and legislative activity, and the addition or elimination of uncertain tax positions. During the third quarter of 2010, the Company settled its uncertain tax positions. As of June 30, 2011, the following years remain subject to examination: U.S. Federal jurisdictions – 2004 through 2008 and Puerto Rico – 2005 through 2008.

During the six months ended June 30, 2011, the Company did not identify any additional uncertain tax position.