Income Taxes

The following is a reconciliation of income taxes at the statutory rate of 35% to the provision for income taxes as shown in the Statement of Earnings (in millions):



	2013					2012					2011
	Amount			% of EBT		Amount			% of EBT		Amount			% of EBT
Earnings before income taxes (“EBT”)	$	689				$	537				$	558

Income taxes at statutory rate	$	241		35	%	$	188		35	%	$	195		35	%
Effect of:
Tax exempt interest	(21		)	(3	%)	(23		)	(4	%)	(23		)	(4	%)
Losses of managed investment entities	9			1	%	34			6	%	9			2	%
Subsidiaries not in AFG’s tax return	2			—	%	(1		)	—	%	5			1	%
Tax case and settlement of open tax years	—			—	%	(67		)	(13	%)	—			—	%
Change in valuation allowance	1			—	%	3			1	%	44			8	%
Other	4			1	%	1			—	%	9			1	%
Provision for income taxes as shown in the Statement of Earnings	$	236		34	%	$	135		25	%	$	239		43	%

A decision in favor of AFG from litigation with the IRS regarding the calculation of tax reserves for certain annuity liabilities became final in August 2012. As a result, during the third quarter of 2012, AFG recorded net earnings of approximately $28 million, which included the expected refund of $17 million of tax and interest paid to the IRS in 2005 and 2006 as well as a decrease in the liability for uncertain tax positions. In December 2012, AFG reached an agreement with the IRS to close subsequent years held open by the tax case. As a result, AFG decreased its tax liabilities by approximately $39 million in the fourth quarter of 2012.

AFG’s 2008 — 2013 tax years remain subject to examination by the IRS.

Total earnings before income taxes include income subject to tax in foreign jurisdictions of $12 million in 2013 compared to losses of $3 million in 2012 and $26 million in 2011.

The total income tax provision (credit) consists of (in millions):



	2013			2012			2011
Current taxes:
Federal	$	308		$	146		$	186
State	5			6			4
Deferred taxes:
Federal	(77		)	(17		)	22
Foreign	—			—			27
Provision for income taxes	$	236		$	135		$	239

For income tax purposes, AFG and its subsidiaries had the following carryforwards available at December 31, 2013 (in millions):



	Expiring	Amount
Operating Loss – U.S.	2014 - 2020	$	74
	2021 - 2025	71
Operating Loss – United Kingdom	indefinite	137

Deferred income tax assets and liabilities reflect temporary differences between the carrying amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. The significant components of deferred tax assets and liabilities included in the Balance Sheet at December 31 were as follows (in millions):



	2013			2012
Deferred tax assets:
Federal net operating loss carryforwards	$	51		$	51
Foreign underwriting losses	50			46
Insurance claims and reserves	558			528
Employee benefits	98			91
Other, net	51			36
Total deferred tax assets before valuation allowance	808			752
Valuation allowance against deferred tax assets	(103		)	(101		)
Total deferred tax assets	705			651
Deferred tax liabilities:
Subsidiaries not in AFG’s tax return (*)	(60		)	(58		)
Investment securities	(443		)	(753		)
Deferred policy acquisition costs	(234		)	(91		)
Total deferred tax liabilities	(737		)	(902		)
Net deferred tax liability	$	(32	)	$	(251	)

(*) Related to National Interstate Corporation, a 52%-owned subsidiary.

AFG’s net deferred tax liability at December 31, 2013 and 2012 is included in other liabilities in AFG’s Balance Sheet.

The likelihood of realizing deferred tax assets is reviewed periodically; any adjustments required to the valuation allowance are made in the period during which developments requiring an adjustment become known.

“Foreign underwriting losses” in the table above include the net operating loss carryforward and other deferred tax assets related to the Marketform Lloyd’s insurance business, which resulted primarily from underwriting losses in its run-off Italian public hospital medical malpractice business that has not been written since 2008. Due to uncertainty concerning the realization of the deferred tax benefits associated with these losses, AFG recorded a $44 million valuation allowance against the deferred tax assets related to the Lloyd’s insurance business in 2011, approximately $34 million of which related to prior year losses. AFG will be able to reduce this valuation allowance in future periods when income is generated by the Lloyd’s business.

In addition to the valuation allowance related to the Marketform Lloyd’s insurance business discussed above, the gross deferred tax asset has also been reduced by a $50 million valuation allowance related to a portion of AFG’s net operating loss carryforwards (“NOL”) that is subject to the separate return limitation year (“SRLY”) tax rules. A SRLY NOL can be used only by the entity that created it and only in years that the consolidated group has taxable income.

The changes in the deferred tax liabilities related to investment securities and deferred policy acquisition costs at year end 2013 compared to 2012 are due primarily to the decrease in unrealized gains on fixed maturity securities.

AFG increased its liability for uncertain tax positions by $1 million in 2013, $3 million in 2012 and $7 million in 2011, exclusive of interest, to reflect uncertainty as to the timing of tax return inclusion of income related to certain securities. Because the ultimate recognition of income with respect to these securities is highly certain, any adjustments to this liability will result in offsetting adjustments to AFG’s deferred tax liability. Accordingly, the ultimate resolution of this item will not impact AFG’s annual effective tax rate but could accelerate the payment of taxes. During 2012, AFG also increased its liability for uncertain tax positions by $2 million related to the deductibility of certain financing expenses.

The resolution of the tax case and closure of subsequent tax years during 2012 (discussed above) reduced AFG’s liability for uncertain tax positions by $36 million and the related liability for interest by $14 million. Additionally, the IRS issued new guidance during the third quarter of 2012 that brought certainty to the timing of investment deductions, which caused AFG to reduce its liability for uncertain tax positions by $10 million. Because this was solely a timing issue, the reduction in AFG’s liability for uncertain tax positions for this item was offset by an increase in AFG’s deferred tax liability with no overall impact on income tax expense.

A progression of the liability for uncertain tax positions, excluding interest and penalties, follows (in millions):



	2013		2012			2011
Balance at January 1	$	18	$	59		$	52
Reductions for tax positions of prior years	—		(46		)	—
Additions for tax positions of current year	1		5			7
Balance at December 31	$	19	$	18		$	59

As a result of discussions with the IRS Appeals Office during the third quarter of 2013, AFG believes it is reasonably possible that its liability for uncertain tax positions may be reduced by up to the full $19 million balance due to a settlement with the IRS that is expected to become final in 2014. The majority of the reduction in this liability would result in offsetting adjustments to AFG’s deferred tax liability. The total unrecognized tax benefits and related interest that, if recognized, would impact the effective tax rate is $4 million at December 31, 2013. AFG’s provision for income taxes included an expense of $1 million in 2013, a benefit of $14 million in 2012 and an expense of $3 million in 2011 of interest (net of federal benefit or expense). AFG’s liability for interest related to unrecognized tax benefits was $1 million at both December 31, 2013 and December 31, 2012 (net of federal benefit); no penalties were accrued at those dates.

Cash payments for income taxes, net of refunds, were $204 million, $277 million and $157 million for 2013, 2012 and 2011, respectively.