NOTE 10 - INCOME TAXES

Income tax expense from continuing operations consists of the following:

Austin Taylor Communications, Ltd. operates in the United Kingdom (U.K.) and is subject to U.K. rather than U.S. income taxes. Austin Taylor had pretax losses of $1,474,000, $1,119,000 and $1,252,000 in 2011, 2010 and 2009 respectively. At the end of 2011, Austin Taylor's net operating loss carry-forward was $6,986,000. $56,000 of the 2011 pretax loss will provide group relief to Patapsco, a U.K. company acquired by Communications Systems, Inc. during 2011. The Company remains uncertain that it will be able to generate the future income needed to realize the tax benefit of the carry-forward. Accordingly, the Company has continued to maintain its deferred tax valuation allowance against the potential carry-forward benefit.

In 2007, Transition Networks China began operations in China and is subject to Chinese taxes rather than U.S. income taxes. Transition Networks China had pretax income of $24,000 in 2011 and pretax losses of $115,000 and $190,000 in 2010 and 2009 respectively. At the end of 2011, Transition Networks China's net operating loss carry-forward was $1,730,000. Due to the history of losses in China the Company remains uncertain that it will be able to generate the future income needed to realize the tax benefit of the carry-forward. Accordingly, the Company has continued to maintain its deferred tax valuation allowance against the potential carry-forward benefit.

Suttle Costa Rica, S.A. operates in Costa Rica and is subject to Costa Rica income taxes. In 2005, the Board of Directors of Suttle Costa Rica S. A. declared a dividend in the amount of $3,500,000 payable to the Company. The dividend and related "dividend reinvestment plan" qualify under Internal Revenue Code Sec. 965, which allows the Company to receive an 85% dividend received deduction if the amount of the dividend is reinvested in the United States pursuant to a domestic reinvestment plan. The Company made the required qualified capital expenditures in 2006. It is the Company's intention to maintain the remaining undistributed earnings in its Costa Rica subsidiary to support continued operations there. No deferred taxes have been provided for the undistributed earnings.

Suttle Costa Rica had pretax income of $155,000 and $80,000 in 2011 and 2010 respectively and pretax loss of $519,000 in 2009. At the end of 2011, Suttle Costa Rica's net operating loss carry-forward was $519,000. The Costa Rican tax authorities may allow losses to be carried forward to future periods at their discretion. The Company believes that it is unlikely that the Costa Rican tax authorities would grant the request to defer the prior years' net operating losses to future periods. Therefore, the Company has placed a deferred tax valuation allowance against the potential carry-forward benefit.

The provision for income taxes for continuing operations varied from the federal statutory tax rate as follows:

Deferred tax assets and liabilities as of December 31 related to the following:

As part of previous acquisitions, the Company purchased net operating loss carry-forwards in the amount of $3,790,000. At December 31, 2011, the Company had $531,000 remaining net operating loss carry-forwards for income tax purposes which expire in 2014. Utilization of net operating loss carry-forwards is limited to $228,000 per year in future years.

The Company assesses uncertain tax positions in accordance with ASC 740. Under this method, the Company must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. The Company's practice is to recognize interest and penalties related to income tax matters in income tax expense.

Changes in the Company's unrecognized tax benefits are summarized as follows:

Included in the balance of unrecognized tax benefits at December 31, 2011 are $342,000 of tax benefits that if recognized would affect the tax rate. The Company's unrecognized tax benefits could be reduced by $81,000 in the next twelve months due to statute of limitations expirations. The Company's income tax liability accounts included accruals for interest and penalties of $172,000 at December 31, 2011. The Company's 2011 income tax expense was decreased by $236,000 due to net decreases for accrued interest and penalties.

The Company's federal and state tax returns and tax returns it has filed in Costa Rica and the United Kingdom are open for review going back to the 2008 tax year. Puerto Rico has no statute of limitations on tax returns.