Income Taxes

Beginning in 2018, the statutory tax rate is 21%. Due to the reduced statutory tax rate under the New Tax Act, we were required to remeasure our deferred tax assets and liabilities using the lower rate at December 22, 2017, the date of enactment. This re-measurement resulted in a reduction of net deferred tax assets of $35.7 million, which includes a $4.7 million benefit related to deferred taxes previously recognized in accumulated other comprehensive income. In accordance with the SEC's Staff Accounting Bulletin No. 118 ("SAB 118"), the Company recorded provisional amounts related to the impacts of the New Tax Act as of December 31, 2017, including but not limited to the change in corporate tax rate and immediate expensing of certain capital assets. During 2018, the provisional amounts were adjusted during the measurement period allowed by SAB 118 and had an immaterial impact on the 2018 income tax expense.

CICA Ltd., a wholly-owned subsidiary of Citizens, is considered a controlled foreign corporation for federal tax purposes. As a result, the insurance activity of CICA Ltd. is subject to Subpart F of the IRC and is included in Citizens’s taxable income. As of December 31, 2018, the Subpart F income inclusion generated $18.4 million of federal income tax expense and this amount was largely driven by the impact of the novation transaction. The novation transaction also resulted in somewhat offsetting adjustments to the current tax liability for CICA, notably an increased amortization of DAC under Section 848 of the IRC, a reduction of premium income and a release of the $50.8 million uncertain tax position related to tax reserves on product qualification issues.

Our federal income tax expense was $13.1 million, $35.1 million and $3.5 million in 2018, 2017 and 2016, respectively. This represents effective tax rates of 652.6%, (1,176.9)% and 64.1%, respectively. The high positive rate in 2018 was primarily due to the large Subpart F income inclusion following the novation transaction. The high negative effective tax rate in 2017 was primarily related to remeasurement of deferred income taxes under the New Tax Act reform which went into effect on December 22, 2017. The high effective rate in 2016 was primarily due to the effect of our uncertain tax position and the nondeductible costs to remediate our tax compliance issues.

The Company holds no valuation allowance in other comprehensive income at December 31, 2018 or 2017.

A reconciliation of federal income tax expense computed by applying the federal income tax rate of 21% in 2018 and 35% in 2017 and 2016 to income (loss) before federal income tax expense is as follows:



	Years Ended December 31,
	2018					2017					2016
	Amount			%		Amount			%		Amount			%
	(In thousands)
Expected tax expense (benefit)	$	420		21.0	%	$	(1,045	)	35.0	%	$	1,919		35.0	%
Foreign income tax rate differential	(8,133		)	(406.3	)	—			—		—			—
Taxable stock sales	—			—		—			—		263			4.8
Tax-exempt interest and dividends-received deduction	(227		)	(11.3	)	(360		)	12.1		(553		)	(10.1	)
Adjustment of prior year taxes	113			5.6		68			(2.3	)	29			0.5
Effect of graduated rates	—			—		(140		)	4.7		(57		)	(1.0	)
Effect of uncertain tax position	2,612			130.5		(355		)	11.9		1,672			30.5
Nondeductible costs to remediate tax compliance issue	(366		)	(18.3	)	(384		)	12.9		241			4.4
Subpart F income	18,403			919.2		—			—		—			—
Tax reform re-measurement	68			3.4		35,718			(1,196.2	)	—			—
Goodwill impairment	—			—		1,621			(54.3	)	—			—
Other	174			8.8		18			(0.7	)	—			—
Total income tax expense	$	13,064		652.6	%	$	35,141		(1,176.9	)%	$	3,514		64.1	%

Income tax expense consists of:



	Years Ended December 31,
	2018			2017	2016
	(In thousands)
Current	$	(49,569	)	14,454	13,348
Deferred	62,633			20,687	(9,834	)
Total income tax expense	$	13,064		35,141	3,514

The components of deferred federal income taxes are as follows:



	December 31,
	2018			2017
	(In thousands)
Deferred tax assets:
Future policy benefit reserves	$	2,795		78,372
Net operating and capital loss carryforwards	191			485
Accrued expenses	30			65
Investments	1,841			6,002
Deferred intercompany loss	5,190			—
Other	309			276
Total gross deferred tax assets	10,356			85,200
Deferred tax liabilities:
Deferred policy acquisition costs, cost of customer relationships acquired and intangible assets	(8,745		)	(25,518	)
Unrealized gains on investments available-for-sale	(1,968		)	(8,297	)
Accrued policyholder dividends	—			(441	)
Tax reserves transition liability	(4,864		)	—
Other	(488		)	(147	)
Total gross deferred tax liabilities	(16,065		)	(34,403	)
Net deferred tax asset (liability)	$	(5,709	)	50,797

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



	December 31,
	2018			2017
	(In thousands)
Deferred federal and state income taxes:
Balance January 1,	$	50,797		76,869
Deferred tax benefit	(62,633		)	(20,687	)
Investments available-for-sale	6,153			(5,570	)
Effects of unrealized gains on DAC, CCRA and reserves	(26		)	(103	)
Reclassification of MGLIC NOL from current taxes payable	—			288
Balance December 31,	$	(5,709	)	50,797

MGLIC, an entity that is not eligible to join the Company's consolidated tax return until 2020, had a $0.9 million net operating loss carryforward at December 31, 2018, which will begin expiring in 2031.

The Company and our subsidiaries had no capital loss carryforwards at December 31, 2018.

At December 31, 2018 and 2017, we determined that as a result of our taxable income in carryback periods, tax planning strategies, and the expected reversal of existing deferred tax liabilities, it was more likely than not that the deferred tax assets would be realized.

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:



	Years ended December 31,
	2018			2017	2016
	(In thousands)

Balance at January 1,	$	95,831		85,762	78,079
Additions based on tax positions related to the current year	—			7,384	3,546
Additions for tax positions of prior years	2,268			2,685	4,706
Reductions for tax positions of prior years	(53,258		)	—	(569	)
Balance December 31,	$	44,841		95,831	85,762

This unrecognized tax benefit is reported net in current federal income tax payable in the Consolidated Statements of Financial Position. Included in these amounts is $8.8 million, $6.5 million and $5.7 million of interest expense with respect to unrecognized tax benefit as of December 31, 2018, 2017 and 2016, respectively.

The Company’s unrecognized tax benefits at December 31, 2018 would affect the effective tax rate if recognized. The Company does not believe there is a reasonable possibility the total amount of uncertain tax benefits will significantly increase or decrease in the next twelve months.

The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense. In the Consolidated Statements of Comprehensive Income (Loss), the amount of interest expense recorded was $2.3 million, $0.8 million and $2.2 million for the years ended December 31, 2018, 2017 and 2016, respectively.

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

Magnolia Guaranty Life Insurance Company files its Federal income tax return on a stand-alone basis as it is not eligible to join the consolidated group until 2020. CICA Ltd. is subject to separate tax reporting.

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. None of our subsidiaries are subject to examination by U.S. tax authorities for years prior to 2015.