GENWORTH FINANCIAL INC

(13) Income Taxes

Income (loss) from continuing operations before income taxes included the following components for the years ended December 31:


(Amounts in millions)	2017		2016			2015
Domestic	$	397	$	(283	)	$	(468	)
Foreign		332		603			453

Income (loss) from continuing operations before income taxes	$	729	$	320		$	(15	)

The total provision (benefit) for income taxes was as follows for the years ended December 31:


(Amounts in millions)	2017			2016		2015
Current federal income taxes	$	(32	)	$	55	$	1
Deferred federal income taxes		(274	)		115		(199	)

Total federal income taxes		(306	)		170		(198	)

Current state income taxes		1			1		—
Deferred state income taxes		6			2		4

Total state income taxes		7			3		4

Current foreign income taxes		192			183		186
Deferred foreign income taxes		(100	)		2		(1	)

Total foreign income taxes		92			185		185

Total provision (benefit) for income taxes	$	(207	)	$	358	$	(9	)

Our current income tax payable was $28 million and $36 million as of December 31, 2017 and 2016, respectively.

The reconciliation of the federal statutory tax rate to the effective income tax rate was as follows for the years ended December 31:


(Amounts in millions)	2017					2016					2015
Pre-tax income (loss)	$	729				$	320				$	(15	)

Statutory U.S. federal income tax rate	$	255		35.0	%	$	112		35.0	%	$	(5	)	35.0	%
Increase (reduction) in rate resulting from:
State income tax, net of federal income tax effect		5		0.7			3		1.0			2		(18.0	)
Tax favored investments		(3	)	(0.4	)		(4	)	(1.3	)		(14	)	93.3
Effect of foreign operations		—		—			(5	)	(1.6	)		(20	)	129.2
Net impact of repatriating foreign earnings		—		—			9		2.8			—		—
Non-deductible expenses		2		0.3			1		0.3			(3	)	22.0
Stock-based compensation		3		0.4			5		1.6			5		(31.7	)
Loss on sale of business		—		—			(1	)	(0.3	)		—		—
Other, net		7		0.9			5		1.6			1		(6.8	)
Valuation allowance		(258	)	(35.4	)		233		72.8			25		(165.0	)
TCJA, impact from change in tax rate		(154	)	(21.1	)		—		—			—		—
TCJA, impact on foreign operations		(64	)	(8.8	)		—		—			—		—

Effective rate	$	(207	)	(28.4	)%	$	358		111.9	%	$	(9	)	58.0	%

For the year ended December 31, 2017, the decrease in the effective tax rate was primarily related to changes in U.S. tax legislation under the TCJA. We released $258 million of our valuation allowance principally from the TCJA and improvements in business performance, mostly in our U.S. mortgage insurance business, as well as lower operating earnings volatility in our U.S. life insurance businesses. In addition, under the TCJA, corporate tax rates decreased which reduced the tax rate applied to the overall U.S. jurisdiction deferred tax asset. The decrease from the TCJA related to foreign operations was principally driven by the release of shareholder liability taxes, partially offset by higher taxes associated with the transition tax.

For the year ended December 31, 2016, the increase in the effective tax rate was primarily related to a $258 million valuation allowance recorded on deferred tax assets related to foreign tax credits that we did not expect to realize. The effective tax rate for the year ended December 31, 2016 was also impacted by the reversal of a deferred tax valuation allowance related to our mortgage insurance business in Europe due to taxable gains supporting the recognition of these deferred tax assets in 2016.

The components of the net deferred income tax liability were as follows as of December 31:


(Amounts in millions)	2017			2016
Assets:
Foreign tax credit carryforwards	$	603		$	690
Net operating loss carryforwards		499			906
State income taxes		347			329
Accrued commission and general expenses		127			208
Investments		27			—
Insurance reserves		146			—
Other		34			58

Gross deferred income tax assets		1,783			2,191
Valuation allowance		(363	)		(601	)

Total deferred income tax assets		1,420			1,590

Liabilities:
Investments		—			2
Net unrealized gains on investment securities		325			644
Net unrealized gains on derivatives		28			18
Insurance reserves transition adjustment		134			—
Insurance reserves		—			58
DAC		396			748
PVFP and other intangibles		38			55
Investment in foreign subsidiaries		—			48
Other		22			70

Total deferred income tax liabilities		943			1,643

Net deferred income tax asset (liability)	$	477		$	(53	)

The above valuation allowances of $363 million and $601 million as of December 31, 2017 and 2016, respectively, related to state deferred tax assets, foreign net operating losses and a specific federal separate tax return net operating loss deferred tax asset. The state deferred tax assets related primarily to the future deductions

associated with the Section 338 elections and non-insurance net operating loss (“NOL”) carryforwards. As of December 31, 2016, the valuation allowance also included the impact of foreign tax credits that we did not expect to realize. The decrease in the valuation allowance in 2017 was primarily related to judgments regarding the future realization of certain foreign tax credits, for which a valuation allowance was established in 2016. In light of our latest financial projections, which include the impact of changes in U.S. tax law under the TCJA, we believe that it is more likely than not that the benefits of these foreign tax credits will be realized and have released this portion of the valuation allowance.

The increase in the 2016 valuation allowance related primarily to judgments regarding the future realization of certain deferred tax assets. In light of our 2016 financial projections, including the projected impact to current and future earnings associated with higher expected claim costs in our long-term care insurance business as a result of our annual claim reserves review in the third quarter of 2016 and sustained low interest rates, we recorded a valuation allowance related to foreign tax credits that we did not expect to realize in 2016. We also recorded a reversal of a deferred tax valuation allowance, established in 2015, related to our mortgage insurance business in Europe.

Based on our analysis, we believe it is more likely than not that the results of future operations and reversal of taxable temporary differences will generate sufficient taxable income to enable us to realize the deferred tax assets for which we have not established valuation allowances.

U.S. federal NOL carryforwards amounted to $2.3 billion as of December 31, 2017, and, if unused, will expire beginning in 2021. Foreign tax credit carryforwards amounted to $603 million as of December 31, 2017, and, if unused will begin to expire in 2022.

Although we had net income available to Genworth Financial, Inc.’s common stockholders of $817 million in 2017, we are currently in a three-year cumulative pre-tax loss position in our U.S. jurisdiction as of December 31, 2017. A cumulative loss position is considered significant negative evidence in assessing the realizability of our deferred tax assets. Our ability to realize our deferred tax assets of $477 million, which includes deferred tax assets of $1.1 billion related to NOL carryforwards and foreign tax credit carryforwards, is primarily dependent upon generating sufficient taxable income in future years. Management has concluded that there is sufficient positive evidence to overcome this negative evidence for the NOL carryforwards and the foreign tax credit carryforwards. This positive evidence includes the fact that: (i) our three-year cumulative pre-tax loss position includes significant charges that are not expected to recur in the future, including a loss on the sale of our lifestyle protection insurance business in 2015 and a loss recorded in 2015 related to the sale of our mortgage insurance business in Europe; (ii) our profitable U.S. operating forecasts which include in-force premium rate actions already obtained in our long-term care insurance business, favorable development in interest rates, improvements in business performance; driven mostly by our U.S. mortgage insurance business, as well as lower operating earnings volatility in our U.S. life insurance businesses, and changes in U.S. tax legislation under the TCJA; which are expected to impact utilization of foreign tax credits, including the changes to policyholder reserves and capitalized policy acquisition expenses; (iii) an anticipated change in the timing of tax deductions for life insurance reserves on GLIC which is expected to generate significant increases to taxable income over the next five years; and (iv) overall domestic losses that we have incurred are now, under the TCJA, allowed to be reclassified as foreign source income to the extent of 100% of domestic source income produced in subsequent years, and such resulting foreign source income is sufficient to cover the foreign tax credits being carried forward. After consideration of all available evidence, we released $258 million of our valuation allowance previously recorded to offset our foreign tax credits and state them at net realizable value. If our actual results do not validate the current projections of pre-tax income, we may be required to record an additional valuation allowance that could have a material impact on our consolidated financial statements in future periods.

As a consequence of our separation from GE and our joint election with GE to treat that separation as an asset sale under Section 338 of the Internal Revenue Code, we became entitled to additional tax deductions in post IPO periods. We are obligated, pursuant to our Tax Matters Agreement with GE, to make fixed payments to GE over the next six years on an after-tax basis and subject to a cumulative maximum of $640 million, which is 80% of the projected tax savings associated with the Section 338 deductions. We recorded net interest expense of $7 million, $10 million and $11 million for the years ended December 31, 2017, 2016 and 2015, respectively, reflecting accretion of our liability at the Tax Matters Agreement rate of 5.72%. As of December 31, 2017 and 2016, we have recorded the estimated present value of our remaining obligation to GE of $119 million and $173 million, respectively, as a liability in our consolidated balance sheets. Both our IPO-related deferred tax assets and our obligation to GE are estimates that are subject to change.

A reconciliation of the beginning and ending amount of unrecognized tax benefits was as follows:


(Amounts in millions)	2017			2016		2015
Balance as of January 1	$	34		$	28	$	49
Tax positions related to the current period:
Gross additions		2			6		5
Gross reductions		(1	)		—		—
Tax positions related to the prior years:
Gross additions		13			—		—
Gross reductions		(6	)		—		(26	)

Balance as of December 31	$	42		$	34	$	28

The total amount of unrecognized tax benefits was $42 million as of December 31, 2017, which if recognized would affect the effective rate on continuing operations by $30 million. These unrecognized tax benefits included the impact of foreign currency translation from our international operations.

We believe it is reasonably possible that in 2018 due to the potential resolution of certain potential settlements and other administrative and statutory proceedings and limitations, up to approximately $25 million unrecognized tax benefits will be recognized. These tax benefits are mainly related to certain insurance and non-insurance deductions and other tax benefits in the U.S. and also in foreign jurisdictions.

We recognize accrued interest and penalties related to unrecognized tax benefits as components of income tax expense. We recorded less than $1 million of benefits, in each respective year, related to interest and penalties for 2017, 2016 and 2015.

Our companies have elected to file a single U.S. consolidated income tax return (the “life/non-life consolidated return”). All companies domesticated in the United States and our former Bermuda and Guernsey subsidiaries, which elected to be taxed as U.S. domestic companies, are included in the life/non-life consolidated return as allowed by the tax law and regulations. We have a tax sharing agreement in place and all intercompany balances related to this agreement are settled at least annually. With possible exceptions, we are no longer subject to U.S. federal tax examinations for years through 2012. Potential state and local examinations for those years are generally restricted to results that are based on closed U.S. federal examinations. Our Australia mortgage insurance businesses are generally no longer subject to examinations by the Australian Tax Office (“ATO”) for years prior to 2013. In November 2017, the ATO completed a risk review of Genworth Mortgage Insurance Australia Limited for the years 2013-2015. The outcome of their review was a low risk rating for those years. Our Canada mortgage insurance businesses generally are no longer subject to examination by Canadian Revenue Agency and provincial taxing authorities for years prior to 2013. There are no significant ongoing audits with respect to Canadian or Australian taxing authorities at this time.

Due to the complexities involved in accounting for the recently enacted TCJA, the U.S. Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) 118, which requires companies to include in its financial statements a reasonable estimate of the impact of the TCJA on earnings to the extent such reasonable estimate has been determined. For specific effects of the TCJA for which a reasonable estimate cannot be made, SAB 118 provides that no amount should be recorded as a provisional amount in current year earnings and companies should continue to apply the tax law in effect just before the enactment date of the TCJA on December 22, 2017.

Accordingly, we recorded the following reasonable estimates of the tax impact under the TCJA in our 2017 earnings. These amounts are considered to be provisional as we continue to assess available tax methods and elections and refine our computations and estimates.

Deferred tax assets and liabilities

We remeasured certain deferred tax assets and liabilities based on the federal rate at which we expected to reverse in the future, which is generally 21%. However, the Internal Revenue Service has indicated that additional guidance will be forthcoming with respect to several technical areas within the TCJA, which could affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded in 2017 that related to the re-measurement of our deferred tax assets and liabilities was a tax benefit of $154 million.

Foreign tax effects

The one-time transition tax is based on total post-1986 earnings and profits (“E&P”) that were previously deferred from U.S. income taxes. We recorded our best estimate of the provisional amount for the one-time transition tax liability for all of our foreign subsidiaries resulting in an increase in income tax expense of $63 million in 2017. However, we have not yet completed our calculation of the total post-1986 E&P for these foreign subsidiaries. Further, the transition tax is based, in part, on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation of our post-1986 foreign E&P previously deferred from U.S. federal taxation and finalize the amounts held in cash or other specified assets.

Insurance reserve transition adjustment

We have recorded a provisional reclassification in deferred tax assets and liabilities in the amount of $134 million related to the transition adjustment required under the TCJA with respect to life insurance policyholder reserves. Under the TCJA this transition adjustment is to be taken into account ratably over eight taxable years. This provisional amount had no impact on income (loss), however, the reclassification amount may change as we continue to refine our insurance reserve calculations and apply the new reserving rules under the TCJA on a product level basis. Future changes similarly are not expected to have an impact on income from continuing operations.

We have identified the following areas for which a reasonable estimate cannot be made.

Foreign Tax Effects

We have not completed our accounting for the income tax effects of the new Global Intangible Low Taxed Income (“GILTI”) and Base Erosion Anti-Abuse (“BEAT”) taxes. A policy election can be made to either account for taxes on GILTI as incurred or recognize deferred taxes when basis differences exist that are expected to affect the amount of GILTI inclusion upon reversal. Due to the complexity of these new tax rules, we are continuing to evaluate these provisions of the TCJA and whether such taxes are recorded as a current period expense when incurred or whether such amounts should be factored into a measurement of our deferred taxes. As a result, we have not included an estimate of the tax expense (benefit) related to these items for the year ended December 31, 2017, nor have we made a policy election with respect to accounting for the GILTI tax.

State tax effects

Certain areas of state income taxes, including treatment of the one-time transition tax, have not been analyzed and accordingly, no estimate of the impact of these provisions on state income taxes has been recorded for the year ended December 31, 2017.

Further regulatory guidance related to the TCJA is expected to be issued in 2018 which may result in changes to our current estimates. Any revisions to the estimated impacts of the TCJA will be recorded quarterly until the computations are complete which is expected no later than the fourth quarter of 2018.