9. Income Taxes
The following table presents income tax expense (benefit) for 2017, 2016 and 2015:
| Federal | State | Foreign | Total | |||||||||||||
| ($ in millions) | ||||||||||||||||
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Year ended December 31, 2017 |
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Current |
$ | (41.3) | $ | 2.7 | $ | 41.0 | $ | 2.4 | ||||||||
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Deferred |
(66.6) | 0.6 | (0.2) | (66.2) | ||||||||||||
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| $ | (107.9) | $ | 3.3 | $ | 40.8 | $ | (63.8) | |||||||||
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Year ended December 31, 2016 |
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Current |
$ | 49.4 | $ | 4.9 | $ | 23.4 | $ | 77.7 | ||||||||
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Deferred |
109.6 | 0.3 | (0.5) | 109.4 | ||||||||||||
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| $ | 159.0 | $ | 5.2 | $ | 22.9 | $ | 187.1 | |||||||||
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Year ended December 31, 2015 |
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Current |
$ | 93.3 | $ | 3.1 | $ | 50.0 | $ | 146.4 | ||||||||
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Deferred |
49.2 | (0.4) | - | 48.8 | ||||||||||||
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| $ | 142.5 | $ | 2.7 | $ | 50.0 | $ | 195.2 | |||||||||
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(Losses) earnings before income taxes from domestic operations were ($132.7) million, $407.7 million and $376.7 million in 2017, 2016 and 2015, respectively. Earnings before income taxes from foreign operations was $169.4 million, $240.1 million and $380.7 million in 2017, 2016 and 2015, respectively. Foreign tax expense was primarily attributable to the U.K., Canada and France.
The following table presents the difference between the federal income tax rate and the effective income tax rate:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Federal income tax rate |
35.0 | % | 35.0 | % | 35.0 | % | ||||||
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Foreign tax credits |
(6.4 | ) | (0.6 | ) | (0.4 | ) | ||||||
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Income subject to dividends-received deduction |
(25.5 | ) | (1.6 | ) | (1.6 | ) | ||||||
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Tax-exempt interest |
(94.1 | ) | (6.5 | ) | (6.8 | ) | ||||||
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State taxes, net of federal tax benefit |
6.5 | 0.6 | 0.2 | |||||||||
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Prior period adjustment |
(3.3 | ) | 2.4 | (0.2 | ) | |||||||
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Tax benefit from sale of subsidiary |
(54.1 | ) | - | - | ||||||||
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Other, net |
(32.0 | ) | (0.4 | ) | (0.4 | ) | ||||||
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Effective tax rate |
(173.9 | )% | 28.9 | % | 25.8 | % | ||||||
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The effective tax rate in 2017 compared with 2016 primarily reflects income tax benefits from taxable losses arising from Hurricanes Harvey, Irma and Maria in 2017 and, to a lesser extent, a tax benefit associated with the December 31, 2017 sale of PacificComp, as well as prior period income tax expense adjustments in 2016, which include $16.1 million of out-of-period reductions to current and deferred TransRe tax assets recorded in 2016 that related primarily to periods prior to Alleghany’s merger with TransRe in 2012.
The Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law on December 22, 2017. Among other provisions, the Tax Act reduced the corporate federal income tax rate from 35.0 percent to 21.0 percent, effective January 1, 2018 for the 2018 tax year, and, as a consequence, the value of Alleghany’s deferred tax assets and liabilities as of December 31, 2017 was reduced. The net impact of this reduction to Alleghany’s consolidated 2017 tax expense was not material. There currently exists a degree of uncertainty as to how certain provisions in the Tax Act will be interpreted and implemented in practice in the future.
The increase in the effective tax rate in 2016 from 2015 primarily reflects larger prior period income tax expense adjustments, higher state income taxes and lower tax-exempt interest income arising from municipal bond securities. Prior period income tax expense adjustments for 2016 include $16.1 million of out-of-period reductions to current and deferred TransRe tax assets recorded in 2016 that relate primarily to periods prior to Alleghany’s merger with TransRe in 2012.
The following table presents the tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of December 31, 2017 and 2016:
| As of December 31, | ||||||||
| 2017 | 2016 | |||||||
| ($ in millions) | ||||||||
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Deferred tax assets: |
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Loss and LAE reserves |
$ | 114.2 | $ | 212.1 | ||||
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Minimum tax credit carry forward |
137.2 | 28.9 | ||||||
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Compensation accruals |
97.4 | 166.7 | ||||||
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Unearned premiums |
84.2 | 139.1 | ||||||
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OTTI losses |
9.6 | 19.5 | ||||||
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State net operating loss carry forward |
18.3 | 25.2 | ||||||
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Other |
73.7 | 173.3 | ||||||
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Gross deferred tax assets before valuation allowance |
534.6 | 764.8 | ||||||
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Valuation allowance |
(18.3) | (25.2) | ||||||
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Gross deferred tax assets |
516.3 | 739.6 | ||||||
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Deferred tax liabilities: |
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Net unrealized gains on investments |
227.5 | 125.8 | ||||||
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Deferred acquisition costs |
98.7 | 163.3 | ||||||
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Purchase accounting adjustments |
13.5 | 30.2 | ||||||
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Other |
40.1 | 65.4 | ||||||
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Gross deferred tax liabilities |
379.8 | 384.7 | ||||||
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Net deferred tax assets |
$ | 136.5 | $ | 354.9 | ||||
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A valuation allowance is provided against deferred tax assets when, in the opinion of management, it is more likely than not that a portion of the deferred tax asset will not be realized. As of December 31, 2017 and 2016, Alleghany recognized $18.3 million and $25.2 million, respectively, of deferred tax assets for certain state net operating and capital loss carryovers, and a valuation allowance of $18.3 million and $25.2 million, respectively, has been established against these deferred tax assets as Alleghany does not currently anticipate it will generate sufficient income in these states to absorb such loss carryovers.
The Internal Revenue Code provides for limits on the utilization of certain tax benefits following a corporate ownership change. Upon the closing of the merger with TransRe, TransRe was subject to an annual limitation on its ability to use its foreign tax credit carryforwards and its minimum tax credit carryforwards. The total amount of foreign tax credit carryforwards and minimum tax credit carryforwards that were available prior to the merger are not diminished by this provision. The limitation provides for an annual limit on the amount of the carryforwards that can be used each year. The unused carryovers are available to be used in subsequent years, subject to the annual limitation. The annual limitation is estimated at approximately $42.7 million.
Alleghany’s income tax returns are currently under examination by the Internal Revenue Service for the 2012, 2013 and 2014 tax years. TransRe’s income tax returns, which all relate to periods prior to the merger with Alleghany, are currently under examination by the Internal Revenue Service. The following table presents the tax years of Alleghany and TransRe tax returns that remain subject to examination by major tax jurisdictions as of December 31, 2017.
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Major Tax Jurisdiction |
Open Tax Years | |
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Australia |
2013 - 2016 | |
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Canada |
2013 - 2016 | |
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France |
2009 - 2010 and 2014 - 2016 | |
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Germany |
2013 - 2016 | |
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Hong Kong |
2014 - 2016 | |
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Japan |
2010 - 2016 | |
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Singapore |
2014 - 2017 | |
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Switzerland |
2016 | |
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U.K. |
2015 - 2016 | |
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U.S. |
2007 - 2016 |
Alleghany believes that, as of December 31, 2017, it had no material uncertain tax positions. Interest and penalties relating to unrecognized tax expenses (benefits) are recognized in income tax expense, when applicable. There were no material liabilities for interest or penalties accrued as of December 31, 2017.