Annual report pursuant to Section 13 and 15(d)

Income Taxes (Notes)

v2.4.0.6
Income Taxes (Notes)
 12 Months Ended
Dec. 31, 2011
Income Taxes [Abstract]  
Income Taxes
Income Taxes
For the years ended December 31, 2011 and 2010, the Company qualified to be taxed as a REIT under the Code for U.S. federal income tax purposes. As long as the Company qualifies as a REIT, the Company generally will not be subject to U.S. federal income taxes on its taxable income to the extent it annually distributes its net taxable income to stockholders, does not engage in prohibited transactions, and maintains its intended qualification as a REIT. The majority of states also recognize the Company's REIT status. The Company also owns taxable REIT subsidiaries (TRS),
Capitol and TH TRS Corp., which file separate tax returns and are fully taxed as standalone U.S. C-Corporations. The tables below reflect the net taxes accrued at the TRS level and the tax attributes included in the consolidated financial statements. It is assumed that the Company will retain its REIT status and will incur no REIT level taxation as it intends to comply with the REIT regulations and annual distribution requirements.
Certain activities the Company performs may produce income which will not be qualifying income for REIT purposes. These activities include holding swaptions, credit default swaps, TBAs, and other risk-management instruments. The Company has designated Capitol to engage in such activities. The Company intends to purchase and sell mortgage loans through the secondary whole loan market and/or securitization market. The Company has designated TH TRS Corp. to engage in these activities.
The following table summarizes the tax (benefit) provision recorded at the taxable subsidiary level for the years ended December 31, 2011, 2010 and 2009:
 
 
Year Ended December 31,
(in thousands)
 
2011
 
2010
 
2009
Current tax provision (benefit):
 
 
 
 
 
 
Federal
 
$
4,731

 
$
(6
)
 
$
(442
)
State
 
—

 
—

 
—

Total current tax provision (benefit)
 
4,731

 
(6
)
 
(442
)
Deferred tax (benefit) provision
 
(5,837
)
 
(678
)
 
124

Total benefit from income taxes
 
$
(1,106
)
 
$
(684
)
 
$
(318
)


The Company's taxable income before dividend distributions differs from its GAAP pre-tax net income primarily due to unrealized gains and losses, the recognition of credit losses for GAAP but not tax, differences in timing of income recognition due to market discount, and original issue discount and the calculations surrounding each, and a distribution paid by Capitol to Two Harbors which is classified as a taxable dividend. These book to tax differences in the REIT are not reflected in the financial statements as the Company believes it will retain its REIT status.
The following is a reconciliation of the statutory federal and state rates to the effective rates, for the years ended December 31, 2011, 2010 and 2009:
 
 
Year Ended December 31,
 
 
2011
 
2010
 
2009
(dollars in thousands)
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
Computed income tax expense at federal rate
 
$
42,951

 
34
 %
 
$
11,924

 
34
 %
 
$
(3,081
)
 
(34
)%
State taxes, net of federal benefit, if applicable
 
—

 
—
 %
 
—

 
—
 %
 
—

 
—
 %
Permanent differences in taxable income from GAAP income (loss)
 
2,731

 
2
 %
 
(5
)
 
—
 %
 
4,012

 
44
 %
Dividends paid deduction
 
(46,788
)
 
(37
)%
 
(12,602
)
 
(36
)%
 
(1,249
)
 
(14
)%
Benefit from income taxes/Effective Tax Rate(1)
 
$
(1,106
)
 
(1
)%
 
$
(683
)
 
(2
)%
 
$
(318
)
 
(4
)%

____________________
(1)
The benefit from income taxes is recorded at the taxable subsidiary level.

The Company's consolidated balance sheet, as of December 31, 2011 and 2010, contains the following current and deferred tax assets and liabilities, recorded at the taxable subsidiary level:
(in thousands)
 
December 31, 2011
 
December 31, 2010
Current tax
 
 
 
 
Federal income tax payable
 
$
(3,898
)
 
$
(1
)
Current taxes receivable
 
157

 
—

State and local income tax payable
 
—

 
—

Current tax payable, net
 
(3,741
)
 
(1
)
Deferred tax assets (liabilities)
 
 
 
 
Deferred tax asset
 
9,710

 
723

Deferred tax liability
 
(3,319
)
 
(169
)
Deferred tax asset, net
 
6,391

 
554

Total tax assets and liabilities, net
 
$
2,650

 
$
553



Deferred Tax Assets and Liabilities
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting and tax purposes. Components of the Company's deferred tax assets and liabilities as of December 31, 2011 and 2010 are as follows:
 
 
December 31,
(in thousands)
 
2011
 
2010
Unrealized loss on derivative assets
 
$
7,429

 
$
392

Unrealized (gain) loss on trading securities
 
(1,038
)
 
162

Total net deferred tax assets
 
$
6,391

 
$
554



At December 31, 2011 and December 31, 2010, the Company has not recorded a valuation allowance for any portion of its deferred tax assets as it does not believe, at a more likely than not level, that any portion of its deferred tax assets will not be realized. The Company estimates, based on existence of sufficient evidence, the ability to realize the remainder of its deferred tax assets. Any adjustments to such estimates will be made in the period such determination is made.
Based on the Company's evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company's financial statements of a contingent tax liability for uncertain tax positions. Additionally, there were no amounts accrued for penalties or interest as of or during the periods presented in these consolidated financial statements.