12.

INCOME TAXES

As of December 31, 2011 and 2010, the Company's gross unrecognized tax benefits totaled $0.3 million, which includes approximately $0.03 million of interest and penalties. The Company estimates that the unrecognized tax benefits will not change significantly within the next year.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


	2011		2010			2009
Balance at January 1,	$	265	$	645		$	349
Additions based on tax positions related to the current year		—		—			31
Additions for tax positions of prior years				—			265
Reductions for tax positions of prior years		—		(380	)		—
Settlements		—		—			—

Balance at December 31,	$	265	$	265		$	645

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The table below summarizes the open tax years and ongoing tax examinations in major jurisdictions as of December 31, 2011:


Jurisdiction	Open Years		Examination in Process
United States - Federal Income Tax		2005, 2008 - 2011		2009
United States - various states		2006 - 2011		N/A
Germany		2004 - 2011		2004 - 2007
Switzerland		2011		N/A
Singapore		2006 - 2011		N/A

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in tax expense. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $0.3 million. FARO does not currently anticipate that the total amount of unrecognized tax benefits will result in material changes to its financial position. The Company is subject to income taxes at the federal, state and foreign country level. The Company's tax returns are subject to examination at the U.S. federal level from 2005 forward and at the state level subject to a three to five year statute of limitations.

The United States Internal Revenue Service ("IRS") commenced an examination of the Company's 2009 income tax returns in June 2011 that is currently in process. The IRS completed an examination of the Company's 2005 to 2007 income tax returns in late 2009. This examination resulted in an assessment of approximately $2.6 million related to the valuation of certain intangible assets contributed to a foreign subsidiary of the Company under a R&D Cost Sharing Arrangement entered into in 2001. This assessment was paid in January 2010 and included in income tax expense for the year ended December 31, 2009. The Company does not expect this assessment will have a prospective impact on its global effective tax rate. The Company believes that it has provided appropriately for any uncertain tax positions that may arise.

The effective income tax rate for 2011, 2010, and 2009 includes a reduction in the statutory corporate tax rates for the Company's operations in Switzerland. The favorable tax rate ruling requires the Company to maintain a certain level of manufacturing operations in Switzerland. The aggregate dollar effect of this favorable tax rate was approximately $0.9 million, or $0.05 per share, in the year ended December 31, 2011, $0.2 million, or $0.01 per share, in the year ended December 31, 2010, and $1.2 million, or $0.07 per share, in the year ended December 31, 2009.

In 2005, the Company opened a regional headquarters and began to manufacture its products in Singapore. In the third quarter of 2006, the Company received confirmation of a tax holiday for its operations from the Singapore Economic Development Board for a period of four years commencing January 1, 2006 and an additional six-year extension at a favorable tax rate subject to certain terms and conditions including employment, spending, and capital investment. The aggregate dollar effect of this favorable tax rate was approximately $0.3 million, or $0.02 per share, during the year ended December 31, 2011, $0.7 million, or $0.04 per share, in the year ended December 31, 2010 and $1.1 million, or $0.07 per share, during the year ended December 31, 2009.

At December 31, 2011 and 2010, the Company's domestic entities had deferred income tax assets in the amount of $4,957 and $4,564, respectively.

At December 31, 2011 and 2010, the Company's foreign subsidiaries had deferred income tax assets relating to net operating loss carry forwards, some of which expire in 5 to 15 years and others which can be carried forward indefinitely, of $14,939 and $14,084, respectively. For financial reporting purposes, a valuation allowance of $11,760 and $11,148, respectively, has been recognized to offset the deferred tax assets relating to net operating losses. The Company maintains a valuation allowance on net operating losses in jurisdictions for which it does not have a history of earnings over the last three years and where the Company believes that the deferred tax assets are not more-likely-than-not to be realized based upon two-year projections of taxable income. The Company released a valuation allowance of approximately $1.2 million in the year ended December 31, 2010 related to net operating losses of a subsidiary in Germany as a result of being included in a group consolidated tax filing with net taxable earnings.

The Company has not recognized any U.S. tax expense on undistributed international earnings, as it intends to reinvest the earnings outside the U.S. for the foreseeable future. The Company's net undistributed international earnings were approximately $50.8 million and $38.4 million at December 31, 2011 and 2010, respectively.

Significant judgment is required in determining the Company's worldwide provision for income taxes. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. The Company reviews its tax contingencies on a regular basis and makes appropriate accruals as necessary.

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


	Years ended December 31,
	2011		2010		2009
Domestic	$	14,268	$	4,921	$	(7,239	)
Foreign		17,437		9,294		(2,919	)

Income (loss) before income taxes	$	31,705	$	14,215	$	(10,158	)

The components of the income tax expense are as follows:


	Years ended December 31,
	2011			2010			2009
Current:
Federal	$	4,356		$	1,008		$	(1,369	)
State		423			98			(133	)
Foreign		4,195			2,633			(60	)

		8,974			3,739			(1,562	)

Deferred:
Federal		(400	)		150			1,199
State		(40	)		15			116
Foreign		(206	)		(757	)		671

		(646	)		(592	)		1,986

	$	8,328		$	3,147		$	424

Income tax expense for the years ended December 31, 2011, 2010, and 2009 differs from the amount computed by applying the federal statutory corporate rate to income before income taxes. The differences are reconciled as follows:


	Years ended December 31,
	2011			2010			2009
Tax expense (benefit) at statutory rate of 35%	$	11,097		$	4,975		$	(3,555	)
State income taxes, net of federal benefit		471			162			(239	)
Foreign tax rate difference		(2,910	)		(1,866	)		(1,977	)
Research and development credit		(418	)		(518	)		(123	)
Change in valuation allowance		612			545			2,486
IRS settlement		—			—			2,628
Equity based compensation		(91	)		479			828
Tax expense related to uncertain tax positions		—			(380	)		265
Tax exempt interest income		—			—			(39	)
Manufacturing credit		(474	)		(167	)		—
Other		41			(83	)		150

Total income tax expense	$	8,328		$	3,147		$	424

The components of the Company's net deferred income tax asset are as follows:


	December 31,
	2011			2010
Net deferred income tax asset - Current
Intercompany profit in inventory	$	1,482		$	1,504
Warranty costs		291			248
Bad debt reserve		120			112
Inventory reserve		727			655
Unearned service revenue		1,997			1,787
Other		679			149

Net deferred income tax asset - Current	$	5,297		$	4,455

Net deferred income tax asset - Non-current
Depreciation	$	(779	)	$	(186	)
Goodwill amortization		(1,508	)		(1,342	)
Product design costs		(87	)		(61	)
Employee stock options		426			202
Unearned service revenue		1,065			973
Loss carryforwards		14,939			14,084

Deferred income tax asset - Non-current		14,056			13,670

Valuation Allowance		(11,760	)		(11,148	)

Net deferred income tax asset - Non-current	$	2,296		$	2,522

Net deferred income tax liability - Non-current
Intangible assets	$	(1,148	)	$	(1,161	)