Income Taxes

Our federal income tax expense was $3.7 million, $2.1 million and $1.5 million in 2014, 2013 and 2012, respectively. This represents effective tax rates of (134.0)%, 30.8% and 25.0%, respectively. The current year impact is the result of costs to remediate the tax compliance issue we identified in 2015 which impacted our current year effective tax rate negatively by approximately $3.5 million due to approximately $10.0 million of these costs not being deductible for tax. The Company previously had a valuation allowance related to OTTI writedowns on stocks and stock mutual funds in 2008. Due to the sale of these mutual funds in 2009 and 2010, the valuation allowance was released in its entirety in 2009 and 2010. Part of this valuation allowance was released to other comprehensive income ("OCI") in 2009 due to the increase in fair value of mutual funds and stocks still owned. As the stocks and mutual funds have been disposed of since 2009, this valuation allowance has been released as reductions of tax expense. During 2014, 2013 and 2012, $21,000, and $20,000 and $188,000 has been released as a reduction of tax expense, respectively.

The table below summarizes the changes in the valuation allowance.



	Deferred Tax Liability		Other Comprehensive Income		Goodwill	Income Tax Expense (Benefit)
	(In thousands)
Balance at December 31, 2011	$	—	(271	)	1,058	(787	)
Release of valuation allowance in 2012	—		188		—	(188	)
Balance at December 31, 2012	—		(83	)	1,058	(975	)
Release of valuation allowance in 2013	—		20		—	(20	)
Balance at December 31, 2013	—		(63	)	1,058	(995	)
Release of valuation allowance in 2014	—		21		—	(21	)
Balance at December 31, 2014	$	—	(42	)	1,058	(1,016	)

A reconciliation of federal income tax expense computed by applying the federal income tax rate of 35% in 2014, 2013 and 2012 to income (loss) before federal income tax expense is as follows:



	Years Ended December 31,
	2014			2013		2012
	2014			2013		2012
	(In thousands)
Expected tax expense (benefit)	$	(973	)	2,426		2,113
Release of valuation allowance previously held in other comprehensive income	(21		)	(20	)	(188	)
Taxable intercompany stock sales	—			143		182
Tax-exempt interest and dividends-received deduction	(862		)	(397	)	(364	)
Change in fair value of options and warrants	—			—		(158	)
Adjustment of prior year taxes	1			60		—
Effect of graduated rates	(89		)	(100	)	(100	)
Effect of uncertain tax position	2,136			—		—
Nondeductible costs to remediate tax compliance issue	3,514			—		—
Other	19			26		22
Total income tax expense	$	3,725		2,138		1,507

Income tax expense (benefit) consists of:



	Years Ended December 31,
	2014			2013		2012
	2014			2013		2012
	(In thousands)
Current	$	82,900		5,871		3,666
Deferred	(79,175		)	(3,733	)	(2,159	)
Total income tax expense	$	3,725		2,138		1,507

Deferred tax benefit is comprised of $79.2 million deferred tax benefit and $21,000 tax benefit released from OCI.

The components of deferred federal income taxes are as follows:



	Years Ended December 31,
	2014			2013
	(In thousands)
Deferred tax assets:
Future policy benefit reserves	$	123,058		39,345
Net operating and capital loss carryforwards	16			2,632
Due and accrued dividends and expenses	1,349			1,318
Investments	1,047			1,805
State income tax credits	125			128
Other	389			219
Total gross deferred tax assets	125,984			45,447
Valuation allowance	—			—
Total gross deferred tax assets net of valuation allowance	125,984			45,447
Deferred tax liabilities:
Deferred policy acquisition costs, cost of customer relationships acquired and intangible assets	(45,398		)	(42,948	)
Unrealized gains on investments available-for-sale	(14,123		)	(3,741	)
Other	(194		)	(462	)
Total gross deferred tax liabilities	(59,715		)	(47,151	)
Net deferred tax asset (liability)	$	66,269		(1,704	)

A summary of the changes in the components of deferred federal and state income taxes is as follows:



	At December 31,
	2014			2013
	(In thousands)
Deferred federal and state income taxes:
Balance January 1,	$	(1,704	)	(17,301	)
Deferred tax benefit	79,154			3,713
Acquisition of MGLIC	$	(909	)	—
Investments available-for-sale	(10,382		)	12,282
Effects of unrealized gains on DAC, CCRA and reserves	110			(398	)
Balance December 31,	$	66,269		(1,704	)

The Company and our subsidiaries had net operating losses at December 31, 2014 available to offset future taxable income of approximately $47,000, expiring at various times through 2024. A portion of the net operating loss carryforward is subject to limitations under Section 382 of the Internal Revenue Code. At December 31, 2014 and 2013, we determined that as a result of our historical income, projected future income, tax planning strategies, and the nature of the items from which the deferred tax assets are derived, other than assets for which OTTI was recorded, it was more likely than not that the deferred tax assets would be realized. The Company has sufficient unrealized gains in its available-for-sale portfolio so as not to need a valuation allowance for OTTI writedowns.

The Company and our subsidiaries had no capital loss carry-forwards at December 31, 2014.

At December 31, 2014, the Company had accumulated approximately $3.3 million in our "policyholders' surplus account." This is a special memorandum tax account into which certain amounts not previously taxed, under prior tax laws, were accumulated. No new additions are expected to be made to this account. Federal income taxes will become payable thereon at the then current tax rate (a) when and if distributions to shareholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income; or (b) when a company ceases to be a life insurance company as defined by the Internal Revenue Code and such termination is not due to another life insurance company acquiring its assets in a nontaxable transaction. We do not anticipate any transactions that would cause any part of this amount to become taxable. However, should the balance at December 31, 2014 become taxable, the tax computed at present rates would be approximately $1.2 million.

The Company recognizes only the impact of tax positions that, based on their technical merits, are more likely than not to be sustained upon an audit by the taxing authority.

A reconciliation of unrecognized tax benefits is as follows:



	At December 31,
	2014			2013
	(In thousands)

Balance at January 1,	$	1,539		—
Additions based on tax positions related to the current year	10,132			896
Additions for tax positions of prior years	71,327			643
Reductions for tax positions of prior years	(1,539		)	—
Balance December 31,	$	81,459		1,539

None of the Company’s unrecognized tax benefits at December 31, 2014 would affect the effective tax rate if recognized. There is a reasonable possibility that the unrecognized tax benefit relative to reserve deductions will decrease by $81.5 million within the next twelve months based upon the filing of an accounting method change in 2015.

The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense. The Company has recorded a material interest expense uncertainty of $3.1 million, net of tax, with respect to an unrecognized tax benefit as of December 31, 2014.

The Company's Federal income tax return is filed on a consolidated basis with the following entities:

Citizens, Inc.

CICA Life Insurance Company of America

Security Plan Life Insurance Company

Security Plan Fire Insurance Company

Computing Technology, Inc.

Insurance Investors, Inc.

Citizens National Life Insurance Company

The method of allocation among companies is subject to a written tax sharing agreement, approved by the Board of Directors, whereby allocation is made primarily on a separate return basis with current credit for any net operating losses or other items utilized in the consolidated tax return. Intercompany tax balances are settled quarterly.

The Company and our subsidiaries file income tax returns in the U.S. Federal jurisdiction and various U.S. states. Most of our subsidiaries are not subject to examination by U.S. tax authorities for years prior to 2011. Some of our subsidiaries have open tax years going back as far as 2005 due to net operating loss carry-forwards.