We recognize the current and deferred tax consequences of all transactions that have been recognized in the financial statements using the provisions of the enacted tax laws. Current income tax expense represents our estimated taxes to be paid or refunded for the current period and includes income tax expense related to our uncertain tax positions, as well as tax-related interest and penalties. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. We record the effect of remeasuring deferred tax assets and liabilities due to a change in tax rates or laws as a component of income tax expense related to continuing operations for the period in which the change is enacted. Income tax benefits are recognized when, based on their technical merits, they are more likely than not to be sustained upon examination. The amount recognized is the largest amount of benefit that is more likely than not to be realized upon settlement.
The amounts as of and for the year ended December 31, 2017 include the estimated impacts of the Tax Act. Those impacts consist of:
| |
• | $1.6 billion due to the revaluation of our net deferred tax assets reflecting the reduction in the U.S. corporate tax rate from 35% to 21%; |
| |
• | $125 million related to the deemed repatriation of our undistributed foreign earnings; and |
| |
• | $76 million associated with the revaluation of our investments in affordable housing projects. |
The impacts of the Tax Act recorded are considered to be reasonable estimates that are provisional in nature and are subject to potential adjustment during the measurement period ending no later than December 2018. The initial accounting is incomplete as certain information was not yet available or our analysis was not yet completed due to the close proximity of the date the Tax Act was signed into law to the filing date of this Report. The additional information needed includes, but is not limited to, tax-related information pertaining to certain of our partnership investments, final computations of tax depreciation, final calculations of undistributed foreign earnings and the related foreign taxes including the filing of 2017 tax returns in foreign jurisdictions, final tax calculations for certain loan and investment adjustments, and information related to certain payment accruals that is not expected to be available until later in 2018.
The following table presents significant components of the provision for income taxes attributable to continuing operations:
Table 16.1: Significant Components of the Provision for Income Taxes Attributable to Continuing Operations |
| | | | | | | | | | | | |
| | Year Ended December 31, |
(Dollars in millions) | | 2017 | | 2016 | | 2015 |
Current income tax provision: | | | | | | |
Federal taxes | | $ | 1,585 |
| | $ | 2,087 |
| | $ | 1,991 |
|
State taxes | | 223 |
| | 209 |
| | 207 |
|
International taxes | | 133 |
| | 104 |
| | 73 |
|
Total current provision | | $ | 1,941 |
| | $ | 2,400 |
| | $ | 2,271 |
|
Deferred income tax provision (benefit): | | | | | | |
Federal taxes | | $ | 1,509 |
| | $ | (621 | ) | | $ | (368 | ) |
State taxes | | (69 | ) | | (63 | ) | | (39 | ) |
International taxes | | (6 | ) | | (2 | ) | | 5 |
|
Total deferred provision (benefit) | | 1,434 |
| | (686 | ) | | (402 | ) |
Total income tax provision | | $ | 3,375 |
| | $ | 1,714 |
| | $ | 1,869 |
|
The international income tax provision is related to pre-tax earnings from foreign operations of approximately $410 million, $287 million and $288 million in 2017, 2016 and 2015, respectively.
Total income tax provision does not reflect the tax effects of items that are included in accumulated other comprehensive income, which include a tax benefit of $134 million in 2017 and tax provisions of $24 million and $19 million in 2016 and 2015, respectively. See “Note 11—Stockholders’ Equity ”for additional information. In addition, total income tax provision does not reflect tax effects associated with our employee stock-based compensation plan, which decreased our additional paid-in capital by $33 million in 2016 and increased our addition paid-in capital by $7 million in 2015. No income tax provision was recorded in additional paid-in capital in 2017 as a result of our adoption of the new accounting guidance related to employee share-based payments. See “Note 1—Summary of Significant Accounting Policies” for additional information.
The following table presents the reconciliation of the U.S. federal statutory income tax rate to effective income tax rate applicable to income from continuing operations for the years ended December 31, 2017, 2016 and 2015:
Table 16.2: Effective Income Tax Rate |
| | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Income tax at U.S. federal statutory tax rate | | 35.0 | % | | 35.0 | % | | 35.0 | % |
Impacts of the Tax Act | | 32.2 |
| | N/A |
| | N/A |
|
State taxes, net of federal benefit | | 2.2 |
| | 1.9 |
| | 1.9 |
|
Low-income housing, new markets and other tax credits | | (5.8 | ) | | (4.9 | ) | | (4.0 | ) |
Tax-exempt interest and other nontaxable income | | (1.5 | ) | | (1.4 | ) | | (1.3 | ) |
Other, net | | (0.6 | ) | | 0.7 |
| | 0.2 |
|
Effective income tax rate | | 61.5 | % | | 31.3 | % | | 31.8 | % |
The following table presents significant components of our deferred tax assets and liabilities as of December 31, 2017 and 2016. The valuation allowance below represents the adjustment of certain state deferred tax assets and net operating loss carryforwards to the amount we have determined is more likely than not to be realized.
Table 16.3: Significant Components of Deferred Tax Assets and Liabilities |
| | | | | | | | |
(Dollars in millions) | | December 31, 2017 | | December 31, 2016 |
Deferred tax assets: | | | | |
Allowance for loan and lease losses | | $ | 1,768 |
| | $ | 2,350 |
|
Rewards programs | | 936 |
| | 1,348 |
|
Security and loan valuations | | 424 |
| | 869 |
|
Net operating loss and tax credit carryforwards | | 244 |
| | 188 |
|
Compensation and employee benefits | | 208 |
| | 276 |
|
Goodwill and intangibles | | 201 |
| | 294 |
|
Unearned income | | 130 |
| | 186 |
|
Net unrealized losses on derivatives | | 104 |
| | 35 |
|
Representation and warranty reserve | | 8 |
| | 234 |
|
Other assets | | 278 |
| | 270 |
|
Subtotal | | 4,301 |
| | 6,050 |
|
Valuation allowance | | (226 | ) | | (179 | ) |
Total deferred tax assets | | 4,075 |
| | 5,871 |
|
| | | | |
|
| | | | | | | | |
(Dollars in millions) | | December 31, 2017 | | December 31, 2016 |
Deferred tax liabilities: | | | | |
Original issue discount | | 703 |
| | 1,012 |
|
Fixed assets and leases | | 168 |
| | 221 |
|
Loan fees and expenses | | 68 |
| | 84 |
|
Mortgage servicing rights | | 57 |
| | 67 |
|
Other liabilities | | 215 |
| | 177 |
|
Total deferred tax liabilities | | 1,211 |
| | 1,561 |
|
Net deferred tax assets | | $ | 2,864 |
| | $ | 4,310 |
|
Our federal net operating loss carryforwards were $15 million and $19 million as of December 31, 2017 and 2016, respectively. These operating loss carryforwards were attributable to prior acquisitions and will expire from 2018 to 2035. Under IRS rules, our ability to utilize these losses against future income is limited. Our net tax values for state operating loss carryforwards were $241 million and $182 million as of December 31, 2017 and 2016, respectively, and they will expire from 2018 to 2037.
We recognize accrued interest and penalties related to income taxes as a component of income tax expense. We recognized a $5 million expense for 2017, a $5 million benefit for 2016 and a $3 million benefit for 2015.
The following table presents the accrued balance of tax, interest and penalties related to unrecognized tax benefits:
Table 16.4: Reconciliation of the Change in Unrecognized Tax Benefits |
| | | | | | | | | | | | |
(Dollars in millions) | | Gross
Unrecognized
Tax Benefits | | Accrued
Interest and
Penalties | | Gross Tax,
Interest and
Penalties |
Balance as of January 1, 2015 | | $ | 107 |
| | $ | 36 |
| | $ | 143 |
|
Additions for tax positions related to prior years | | 38 |
| | 8 |
| | 46 |
|
Reductions for tax positions related to prior years due to IRS and other settlements | | (15 | ) | | (11 | ) | | (26 | ) |
Balance as of December 31, 2015 | | 130 |
| | 33 |
| | 163 |
|
Additions for tax positions related to prior years | | 0 |
| | 6 |
| | 6 |
|
Reductions for tax positions related to prior years due to IRS and other settlements | | (45 | ) | | (15 | ) | | (60 | ) |
Balance as of December 31, 2016 | | 85 |
| | 24 |
| | 109 |
|
Additions for tax positions related to prior years | | 5 |
| | 7 |
| | 12 |
|
Reductions for tax positions related to prior years due to IRS and other settlements | | (4 | ) | | (2 | ) | | (6 | ) |
Balance as of December 31, 2017 | | $ | 86 |
| | $ | 29 |
| | $ | 115 |
|
Portion of balance at December 31, 2017 that, if recognized, would impact the effective income tax rate | | $ | 68 |
| | $ | 23 |
| | $ | 91 |
|
We are subject to examination by the IRS and other tax authorities in certain countries and states in which we operate. The tax years subject to examination vary by jurisdiction. During 2017, the IRS completed its examination of our federal income tax returns for the tax years 2014, 2015 and 2016.
The Company entered into the IRS Compliance Assurance Process (“CAP”) for the Company’s 2014 federal income tax return. The examinations of the Company’s 2014 and 2015 returns were completed in 2017 with no adjustments proposed by the IRS. The IRS also completed its review of the Company’s 2016 return prior to filing the return in 2017 and proposed no adjustments. The Company continued in the CAP examination process for the 2017 tax year during 2017, with a similar expectation that the IRS examination will be completed prior to the filing of its 2017 federal income tax return in 2018. The Company has been accepted into CAP for 2018. The Company has a refund claim for the taxable years 2012 and 2013 pending at the IRS Office of Appeals with respect to the proper timing for the recognition of its credit card rewards costs.
It is reasonably possible that further adjustments to the Company’s unrecognized tax benefits may be made within 12 months of the reporting date as a result of future judicial or regulatory interpretations of existing tax laws. At this time, an estimate of the potential change to the amount of unrecognized tax benefits cannot be made.
The Tax Act requires that all unremitted earnings of subsidiaries operating outside the U.S. are deemed to be repatriated as of December 31, 2017. As such, a liability of $125 million has been accrued for the deemed repatriation of $1.5 billion of undistributed foreign earnings. The amount will be payable on our 2017 and 2018 tax returns. No actual distributions of these earnings have been made as of the balance sheet date. In accordance with the guidance for accounting for income taxes in special areas, these earnings are considered by management to be invested indefinitely. Upon repatriation of these earnings, there would be no additional U.S. income taxes, but certain jurisdictions may have withholding taxes payable on actual distributions.
As of December 31, 2017, U.S. income taxes of $69 million have not been provided for approximately $287 million of previously acquired thrift bad debt reserves created for tax purposes as of December 31, 1987. These amounts, acquired as a result of previous mergers and acquisitions, are subject to recapture in the unlikely event that CONA, as successor to the merged and acquired entities, makes distributions in excess of earnings and profits, redeems its stock or liquidates.