NOTE 12 – Income Taxes
The following is a summary of total income tax expense:
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Years ended December 31 (in millions) |
2017 | 2016 | 2015 | |||||||||
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Income tax expense applicable to pre-tax income |
$ | 129.9 | $ | 128.5 | $ | 130.4 | ||||||
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Deferred income tax expense (benefit) applicable to items reported in total other comprehensive income (loss) (note 16) |
8.3 | (10.6 | ) | (5.3 | ) | |||||||
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Total |
$ | 138.2 | $ | 117.9 | $ | 125.1 | ||||||
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The components of income tax expense applicable to pre-tax income are summarized as follows:
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Years ended December 31 (in millions) |
2017 | 2016 | 2015 | |||||||||
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Current tax expense: |
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Federal |
$ | 88.9 | $ | 109.7 | $ | 103.6 | ||||||
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State |
15.2 | 15.1 | 12.7 | |||||||||
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Total current tax expense |
104.1 | 124.8 | 116.3 | |||||||||
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Deferred tax expense (1) |
25.8 | 3.7 | 14.1 | |||||||||
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Total income tax expense |
$ | 129.9 | $ | 128.5 | $ | 130.4 | ||||||
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| (1) | Includes the effect of decreases in the valuation allowance for state deferred tax assets of $0.6 million, $1.3 million and $0.1 million in 2017, 2016 and 2015, respectively. |
The following is a reconciliation of expected income tax expense, computed at the U.S. federal statutory rate of 35%, to actual income tax expense:
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Years ended December 31 (dollars in millions) |
Amount | Rate | Amount | Rate | Amount | Rate | ||||||||||||||||||
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Expected income tax expense |
$ | 163.5 | 35.0 | % | $ | 143.3 | 35.0 | % | $ | 136.7 | 35.0 | % | ||||||||||||
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State income tax, net of federal tax effect |
12.2 | 2.6 | 10.0 | 2.5 | 9.3 | 2.4 | ||||||||||||||||||
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Tax-exempt interest |
(26.6 | ) | (5.7 | ) | (20.0 | ) | (4.9 | ) | (16.4 | ) | (4.2 | ) | ||||||||||||
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Federal income tax credits |
(11.6 | ) | (2.5 | ) | (5.3 | ) | (1.3 | ) | (0.4 | ) | (0.1 | ) | ||||||||||||
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Tax-exempt income from BOLI |
(2.2 | ) | (0.5 | ) | (2.0 | ) | (0.5 | ) | (1.6 | ) | (0.4 | ) | ||||||||||||
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Tax benefits realized in connection with: |
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Enactment of the Tax Cuts and Jobs Act |
(6.5 | ) | (1.4 | ) | — | — | — | — | ||||||||||||||||
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Equity-based compensation |
(1.1 | ) | (0.2 | ) | — | — | — | — | ||||||||||||||||
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Other, net |
2.2 | 0.5 | 2.5 | 0.6 | 2.8 | 0.7 | ||||||||||||||||||
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Actual income tax expense |
$ | 129.9 | $ | 128.5 | $ | 130.4 | ||||||||||||||||||
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Effective income tax rate |
27.8 | % | 31.4 | % | 33.4 | % | ||||||||||||||||||
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The Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The most significant provision of the Act applicable to the Company serves to reduce the U.S. federal corporate income tax rate, effective January 1, 2018, from 35% to 21%. In connection with its accounting for enactment of the Act, the Company recognized a one-time income tax benefit of $6.5 million during the quarter ended December 31, 2017. This benefit, which served to reduce income tax expense, reflects the revaluation of certain deferred tax assets ($105.7 million) and deferred tax liabilities ($112.2 million) based on the rates at which they are expected to reverse in the future (generally 21%). Forthcoming guidance, such as new regulations or technical corrections, could change how the Company interpreted certain provisions of the Act.
Under GAAP, the effect of a change in tax law is recorded discretely as a component of the income tax provision related to continuing operations in the period of enactment. This is true even if the deferred taxes being revalued were established through a financial statement component other than continuing operations (e.g. accumulated other comprehensive income). Adjusting the deferred taxes for temporary differences that arose from items of income or loss that were originally recorded in accumulated other comprehensive income through continuing operations may result in a disproportionate tax effect lodged in accumulated other comprehensive income. In other words, the original deferred tax amount recorded through accumulated other comprehensive income at the old tax rate will remain in accumulated other comprehensive income despite the fact that its related deferred tax asset/liability will be reduced through continuing operations to reflect the new tax rate. The amounts lodged in accumulated other comprehensive income are often referred to as “stranded tax effects.”
In February 2018, the FASB issued new accounting guidance providing entities with the option to reclassify, from accumulated other comprehensive income to retained earnings, certain stranded tax effects resulting from application of the Act. An entity that elects to reclassify these amounts must reclassify stranded tax effects related to the change in the U.S. federal corporate income tax rate for all items accounted for in other comprehensive income (e.g. available-for-sale securities, employee benefits, cumulative translation adjustments, hedging items). These entities can also elect to reclassify other stranded tax effects that relate to the Act but which do not directly relate to the change in the federal rate (e.g. state taxes). Tax effects that are stranded in other comprehensive income for other reasons (e.g. prior changes in tax law, a change in valuation allowance) may not be reclassified. The guidance, which is effective for all organizations for fiscal years beginning after December 15, 2018 (with early adoption permitted), also includes several related disclosure requirements (see Note 1).
Effective January 1, 2017, People’s United adopted new stock-based compensation accounting rules, which require the income tax effects of vestings and exercises be recognized in income tax expense. As a result, the Company realized windfall income tax benefits totaling $1.1 million for the year ended December 31, 2017. This amount, which was recognized as a discrete period income tax benefit, served to lower the Company’s 2017 effective income tax rate by 0.2% (see Note 1).
People’s United holds ownership interests in limited partnerships formed to develop and operate affordable housing units for lower income tenants throughout its franchise area. The underlying partnerships, which are considered VIEs, are not consolidated into the Company’s Consolidated Financial Statements. These investments have historically played a role in enabling the Bank to meet its Community Reinvestment Act requirements while, at the same time, providing federal income tax credits.
Affordable housing investments, including all legally binding commitments to fund future investments, are included in other assets in the Consolidated Statements of Condition ($250.7 million and $195.2 million at December 31, 2017 and 2016, respectively). Included in other liabilities in the Consolidated Statements of Condition is a liability for all legally binding unfunded commitments to fund future investments ($99.6 million and $92.5 million at those dates). The cost of the Company’s investments is amortized on a straight-line basis over the period during which the related federal income tax credits are realized (generally ten years). Amortization expense, which is included as a component of income tax expense in the Consolidated Statements of Income, totaled $16.7 million, $12.6 million and $12.6 million for the years ended December 31, 2017, 2016 and 2015, respectively.
In 1998, the Bank formed a passive investment company, People’s Mortgage Investment Company (“PMIC”), in accordance with Connecticut tax laws, which permit transfers of mortgage loans to such subsidiaries on or after January 1, 1999. The related earnings of PMIC, and any dividends it pays to the Bank, are not subject to Connecticut income tax. As a result of the exclusion of such earnings and dividends from Connecticut taxable income beginning in 1999, the Bank has established a valuation allowance for the full amount of its Connecticut deferred tax asset attributable to net temporary differences and state net operating loss carryforwards. Connecticut tax net operating loss carryforwards totaled $1.4 billion at December 31, 2017 and expire between 2020 and 2032.
The tax effects of temporary differences that give rise to People’s United’s deferred tax assets and liabilities are as follows:
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As of December 31 (in millions) |
2017 | 2016 | ||||||
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Deferred tax assets: |
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Leasing activities |
$ | 93.4 | $ | 122.2 | ||||
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State tax net operating loss carryforwards, net of federal tax effect |
80.9 | 66.3 | ||||||
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Allowance for loan losses and non-accrual interest |
61.0 | 90.2 | ||||||
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Equity-based compensation |
12.4 | 19.0 | ||||||
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Unrealized loss on securities available-for-sale |
9.2 | 18.7 | ||||||
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Unrealized loss on securities transferred to held-to-maturity |
6.2 | 10.2 | ||||||
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Pension and other postretirement benefits |
3.7 | 10.9 | ||||||
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Other deductible temporary differences |
21.3 | 37.1 | ||||||
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Total deferred tax assets |
288.1 | 374.6 | ||||||
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Less: valuation allowance for state deferred tax assets |
(79.8 | ) | (66.7 | ) | ||||
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Total deferred tax assets, net of the valuation allowance |
208.3 | 307.9 | ||||||
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Deferred tax liabilities: |
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Tax over book depreciation |
(165.1 | ) | (207.1 | ) | ||||
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Acquisition-related deferred tax liabilities |
(21.0 | ) | (35.3 | ) | ||||
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Book over tax income recognized on consumer loans |
(13.0 | ) | (18.4 | ) | ||||
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Mark-to-market and original issue discounts for tax purposes |
(9.0 | ) | (16.0 | ) | ||||
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Temporary differences related to merchant services joint venture |
(3.9 | ) | (6.3 | ) | ||||
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Deferred cancellation-of-indebtedness income |
(3.0 | ) | (9.0 | ) | ||||
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Other taxable temporary differences |
(4.6 | ) | (6.4 | ) | ||||
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Total deferred tax liabilities |
(219.6 | ) | (298.5 | ) | ||||
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Net deferred tax (liability) asset |
$ | (11.3 | ) | $ | 9.4 | |||
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Based on People’s United’s recent historical and anticipated future pre-tax earnings and the reversal of taxable temporary differences, management believes it is more likely than not that People’s United will realize its total deferred tax assets, net of the valuation allowance.
People’s United’s current income tax receivable at December 31, 2017 and 2016 totaled $68.7 million and $29.9 million, respectively.
The following is a reconciliation of the beginning and ending balances of People’s United’s unrecognized income tax benefits related to uncertain tax positions:
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Years ended December 31 (in millions) |
2017 | 2016 | 2015 | |||||||||
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Balance at beginning of year |
$ | 2.8 | $ | 2.7 | $ | 3.0 | ||||||
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Additions for tax positions taken in prior years |
0.1 | 0.1 | 0.1 | |||||||||
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Reductions for tax positions taken in prior years |
— | — | — | |||||||||
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Reductions attributable to audit settlements/lapse of statute of limitations |
(0.2 | ) | — | (0.4 | ) | |||||||
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Balance at end of year |
$ | 2.7 | $ | 2.8 | $ | 2.7 | ||||||
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If recognized, the unrecognized income tax benefits at December 31, 2017 would minimally affect People’s United’s annualized income tax rate. Accrued interest expense related to the unrecognized income tax benefits totaled $0.8 million and $0.7 million at December 31, 2017 and 2016, respectively. People’s United recognizes accrued interest related to unrecognized income tax benefits and penalties, if incurred, as components of income tax expense in the Consolidated Statements of Income. The amount of total unrecognized income tax benefits is not expected to change significantly within the next twelve months. People’s United files a consolidated U.S. federal income tax return and various state income tax returns and is no longer subject to federal or state income tax examinations through 2011.