Income Taxes
Income before income taxes includes the following components.
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| | | | | | | | | | | |
| Years Ended December 31, |
(dollars in thousands) | 2017 | | 2016 | | 2015 |
Domestic operations | $ | 337,704 |
| | $ | 288,905 |
| | $ | 323,954 |
|
Foreign operations | (250,409 | ) | | 341,015 |
| | 418,151 |
|
Income before income taxes | $ | 87,295 |
| | $ | 629,920 |
| | $ | 742,105 |
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Income tax expense (benefit) includes the following components.
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| | | | | | | | | | | |
| Years Ended December 31, |
(dollars in thousands) | 2017 | | 2016 | | 2015 |
Current: | | | | | |
Domestic | $ | (19,255 | ) | | $ | 57,916 |
| | $ | 44,406 |
|
Foreign | 29,882 |
| | 48,203 |
| | 118,235 |
|
Total current tax expense | 10,627 |
| | 106,119 |
| | 162,641 |
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Deferred: | | | | | |
Domestic | (222,427 | ) | | 19,991 |
| | 9,415 |
|
Foreign | (101,663 | ) | | 43,367 |
| | (19,093 | ) |
Total deferred tax expense (benefit) | (324,090 | ) | | 63,358 |
| | (9,678 | ) |
Income tax expense (benefit) | $ | (313,463 | ) | | $ | 169,477 |
| | $ | 152,963 |
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Foreign income tax expense includes U.S. income tax expense on foreign operations, which includes U.S. income tax on the Company's Bermuda-based operations, certain of which have elected to be taxed as domestic corporations for U.S. tax purposes.
State income tax expense is not material to the consolidated financial statements.
The Company made income tax payments of $70.2 million, $142.2 million and $132.5 million in 2017, 2016 and 2015, respectively. Income taxes payable were $51.3 million and $46.4 million at December 31, 2017 and 2016, respectively, and were included in other liabilities on the consolidated balance sheets. Income taxes receivable were $64.3 million and $5.4 million at December 31, 2017 and 2016, respectively, and were included in other assets on the consolidated balance sheets.
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (TCJA), which made significant modifications to U.S. federal income tax law, most of which are effective January 1, 2018. The TCJA, among other changes, (1) reduces the U.S. corporate tax rate from 35% to 21%, (2) imposes a one-time deemed repatriation tax on unremitted foreign earnings which were not previously subject to U.S. income tax, (3) moves the U.S. from a worldwide tax system towards a territorial tax system and (4) modifies the manner in which property and casualty insurance loss reserves are computed for federal income tax purposes. U.S. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. As a result, the Company recorded a one-time tax benefit of $339.9 million in the fourth quarter of 2017, a portion of which is considered provisional.
This one-time tax benefit from the TCJA is attributable to the remeasurement of the Company’s U.S. deferred tax assets and liabilities on temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases at the lower enacted U.S. corporate tax rate, as well as the tax on the deemed repatriation of foreign earnings, as follows:
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| | | |
| Year Ended |
(dollars in thousands) | December 31, 2017 |
Tax rate change on net unrealized gains on investments | $ | (401,538 | ) |
Tax rate change on other temporary differences - Markel Ventures (provisional) | (37,129 | ) |
Tax rate change on other temporary differences - Other operations (provisional) | 69,268 |
|
Tax on deemed repatriation of foreign earnings (provisional) | 29,500 |
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Total | $ | (339,899 | ) |
The impact of the tax rate change applied to temporary differences other than those related to net unrealized gains on investments is considered provisional because all the data necessary to calculate the underlying tax basis of certain temporary differences under the new tax law is not yet available and additional analysis is required. The largest provisional deferred tax component on other temporary differences is related to the Company’s unpaid losses and loss adjustment expenses. Other provisional deferred tax components are not significant. The tax on the deemed repatriation of foreign earnings is also considered provisional because a number of inputs to the calculation are incomplete, principally the earnings and profits of certain foreign subsidiaries which were not previously subject to U.S. income tax. There is also potential that authoritative clarification of technical issues associated with application of the TCJA, which are presently unclear, will be issued. The additional analysis required for provisional deferred tax components will be completed within the measurement period, which cannot exceed 12 months from the date of enactment, during preparation of the Company’s 2017 tax return. Once completed, any adjustments to these provisional deferred tax components will be reflected in income tax expense.
The following table presents a reconciliation of income taxes computed using the U.S. corporate tax rate to the Company's income tax expense (benefit).
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| | | | | | | | | | | | | | | | | |
| | Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Income taxes at U.S. corporate tax rate | $ | 30,553 |
| 35 | % | | $ | 220,472 |
| 35 | % | | $ | 259,737 |
| 35 | % |
Increase (decrease) resulting from: | | | | | | | | |
TCJA | (339,899 | ) | (389 | ) | | — |
| — |
| | — |
| — |
|
Tax-exempt investment income | (41,565 | ) | (48 | ) | | (39,710 | ) | (6 | ) | | (40,483 | ) | (5 | ) |
Tax credits | (10,236 | ) | (12 | ) | | (13,294 | ) | (2 | ) | | (56,409 | ) | (8 | ) |
Stock based compensation | (9,001 | ) | (10 | ) | | (5,411 | ) | (1 | ) | | — |
| — |
|
Foreign operations | 54,920 |
| 63 |
| | 4,672 |
| 1 |
| | (10,766 | ) | (1 | ) |
Other | 1,765 |
| 2 |
| | 2,748 |
| — |
| | 884 |
| — |
|
Income tax expense (benefit) | $ | (313,463 | ) | (359 | )% | | $ | 169,477 |
| 27 | % | | $ | 152,963 |
| 21 | % |
The following table presents the components of domestic and foreign deferred tax assets and liabilities.
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| | | | | | | |
| December 31, |
(dollars in thousands) | 2017 | | 2016 |
Assets: | | | |
Unpaid losses and loss adjustment expenses | $ | 144,761 |
| | $ | 181,303 |
|
Life and annuity benefits | 77,945 |
| | 135,075 |
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Unearned premiums recognized for income tax purposes | 74,282 |
| | 121,852 |
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Tax credit carryforwards | 48,938 |
| | 23,037 |
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Net operating loss carryforwards | 29,252 |
| | 26,743 |
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Accrued incentive compensation | 23,167 |
| | 67,719 |
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Other differences between financial reporting and tax bases | 60,995 |
| | 64,177 |
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Total gross deferred tax assets | 459,340 |
| | 619,906 |
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Less valuation allowance | (25,225 | ) | | (18,781 | ) |
Total gross deferred tax assets, net of allowance | 434,115 |
| | 601,125 |
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Liabilities: | | | |
Investments | 603,523 |
| | 664,950 |
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Amortization of goodwill and other intangible assets | 171,681 |
| | 102,631 |
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Deferred policy acquisition costs | 90,826 |
| | 128,302 |
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Other differences between financial reporting and tax bases | 73,664 |
| | 35,727 |
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Total gross deferred tax liabilities | 939,694 |
| | 931,610 |
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Net deferred tax liability | $ | 505,579 |
| | $ | 330,485 |
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The net deferred tax liability at December 31, 2017 and 2016 was included in other liabilities on the consolidated balance sheets.
At December 31, 2017, the Company had tax credit carryforwards of $48.9 million. The earliest any of these credits will expire is 2024.
At December 31, 2017, the Company also had net operating losses of $15.1 million that can be used to offset other future taxable income in the U.S. The Company's ability to use these losses expires between the years 2028 and 2030. At December 31, 2017, certain branch operations in Europe and a wholly owned subsidiary in Brazil had net operating losses of $105.2 million that can be used to offset future income in their local jurisdictions. The Company's ability to use $26.9 million of these losses expires between the years 2020 and 2026. The remaining losses are not subject to expiration. As discussed below, the deferred tax assets related to losses at the Company's European branches and Brazilian subsidiary are offset by valuation allowances.
The Company believes that it is more likely than not that it will realize $434.1 million of gross deferred tax assets, including net operating losses at December 31, 2017, through generating taxable income or the reversal of existing temporary differences attributable to the gross deferred tax liabilities. As a result of cumulative net operating losses in certain jurisdictions, the Company has a valuation allowance of $25.2 million at December 31, 2017 that offsets the deferred tax assets primarily related to losses incurred at European branches of one of the Company's wholly owned United Kingdom subsidiaries and at one of the Company's Brazilian subsidiaries.
At December 31, 2017, the Company did not have any material unrecognized tax benefits. The Company does not currently anticipate any changes in unrecognized tax benefits during 2018 that would have a material impact on the Company's income tax provision.
The Company is subject to income tax in the U.S. and in foreign jurisdictions. With few exceptions, the Company is no longer subject to income tax examination by tax authorities for years ended before January 1, 2014.
Following the enactment of the TCJA and as a result of the tax on the deemed repatriation of foreign earnings, the Company’s net foreign earnings have now been subjected to tax in the U.S. However, the Company continues to be indefinitely reinvested in its foreign subsidiaries, with the exception of certain Bermuda-based subsidiaries, and no provision for deferred U.S. income taxes has been recorded on the basis differences attributable to those subsidiaries. The Company's largest basis difference is attributable to net unrealized gains on investments held by the Company’s foreign insurance operations, which totaled $630.0 million at December 31, 2017. This amount has not been subjected to the 21% U.S. corporate tax rate.
While the Company's tax expense for the year ended December 31, 2017 is based upon an assertion that it is indefinitely reinvested in its foreign subsidiaries, the Company's plans for its foreign operations may change upon completion of an assessment of the impact of the TCJA on capital in the Company's foreign subsidiaries. A change in the Company's indefinite reinvestment assertion for some or all of its foreign subsidiaries could result in recognition of additional income tax expense.