INCOME TAXES AND TAX-RELATED ITEMS

The provision for income taxes is calculated as the sum of income taxes due for the current year and deferred taxes. Income taxes due for the current year is computed by applying federal and state tax statutes to income before income taxes as reported in the consolidated financial statements. Deferred taxes arise from temporary differences between the income tax basis and financial accounting basis of assets and liabilities. Tax-related interest and penalties and foreign taxes are then added to the tax provision.

The current and deferred components of the provision for income taxes for continuing operations were as follows:



(in millions)
December 31	2012		2011		2010
Current:
Federal	$	7	$	42	$	239
Foreign	6		9		6
State and local	18		7		12
Total current	31		58		257
Deferred:
Federal	152		73		(202		)
State and local	6		6		—
Total deferred	158		79		(202		)
Total	$	189	$	137	$	55

Income from continuing operations before income taxes of $710 million for the year ended December 31, 2012 included $21 million of foreign-source income.

Income from discontinued operations, net of tax, included a provision for income taxes on discontinued operations of $10 million for the year ended December 31, 2010. There was no income from discontinued operations for the years ended December 31, 2012 and 2011. The income tax provision on securities transactions was $4 million, $5 million and $1 million for the years ended December 31, 2012, 2011 and 2010, respectively.

A reconciliation of expected income tax expense at the federal statutory rate to the Corporation’s provision for income taxes for continuing operations and effective tax rate follows:



(dollar amounts in millions)	2012					2011					2010
Years Ended December 31	Amount			Rate		Amount			Rate		Amount			Rate
Tax based on federal statutory rate	$	249		35.0	%	$	185		35.0	%	$	110		35.0	%
State income taxes	14			2.0		9			1.6		7			2.4
Affordable housing and historic credits	(56		)	(7.8	)	(51		)	(9.7	)	(49		)	(15.6	)
Bank-owned life insurance	(15		)	(2.1	)	(14		)	(2.7	)	(15		)	(4.9	)
Other changes in unrecognized tax benefits	1			0.2		17			3.2		2			0.6
Tax-related interest and penalties	—			—		(7		)	(1.3	)	3			1.0
Other	(4		)	(0.7	)	(2		)	(0.2	)	(3		)	(1.0	)
Provision for income taxes	$	189		26.6	%	$	137		25.9	%	$	55		17.5	%

The Corporation recognized no expense in 2012 for tax-related interest and penalties included in “provision for income taxes” on the consolidated statements of income, compared to a benefit of $7 million in 2011 and an expense of $3 million in 2010. Included in “accrued expenses and other liabilities” on the consolidated balance sheets was a $4 million liability for tax-related interest and penalties at December 31, 2012, compared to a receivable of $8 million December 31, 2011.

In the ordinary course of business, the Corporation enters into certain transactions that have tax consequences. From time to time, the Internal Revenue Service (IRS) may review and/or challenge specific interpretive tax positions taken by the Corporation with respect to those transactions. The Corporation believes that its tax returns were filed based upon applicable statutes, regulations and case law in effect at the time of the transactions. The IRS, an administrative authority or a court, if presented with the transactions, could disagree with the Corporation’s interpretation of the tax law.

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



(in millions)	2012			2011			2010
Balance at January 1	$	20		$	10		$	—
Increases as a result of tax positions taken during a prior period	33			22			10
Decrease related to settlements with tax authorities	(11		)	(12		)	—
Balance at December 31	$	42		$	20		$	10

The Corporation anticipates that it is reasonably possible that settlements of federal and state tax issues will result in a decrease in net unrecognized tax benefits of $30 million within the next twelve months.

The increase in unrecognized tax benefits in 2012 was primarily the result of the recognition of federal and state audit adjustments, partially offset by a decrease in unrecognized tax benefits primarily resulting from the Corporation finalizing a settlement with the IRS regarding the repatriation of foreign earnings on a structured investment transaction. After consideration of the effect of the federal tax benefit available on unrecognized state tax benefits, the total amount of unrecognized tax benefits that, if recognized, would affect the Corporation’s effective tax rate was approximately $2 million at December 31, 2012.

The following tax years for significant jurisdictions remain subject to examination as of December 31, 2012:



Jurisdiction	Tax Years
Federal	2008-2011
California	2001-2011

Based on current knowledge and probability assessment of various potential outcomes, the Corporation believes that current tax reserves are adequate, and the amount of any potential incremental liability arising is not expected to have a material adverse effect on the Corporation’s consolidated financial condition or results of operations. Probabilities and outcomes are reviewed as events unfold, and adjustments to the reserves are made when necessary.

The principal components of deferred tax assets and liabilities were as follows:



(in millions)
December 31	2012			2011
Deferred tax assets:
Allowance for loan losses	$	220		$	255
Deferred compensation	134			142
Defined benefit plans	113			147
Loan purchase accounting adjustments	38			73
Deferred loan origination fees and costs	30			29
Foreign tax credit	1			14
Other tax credits	39			54
Other temporary differences, net	34			52
Total deferred tax assets	609			766
Deferred tax liabilities:
Lease financing transactions	(241		)	(262		)
Net unrealized gains on investment securities available-for-sale	(86		)	(73		)
Allowance for depreciation	(28		)	(36		)
Total deferred tax liabilities	(355		)	(371		)
Net deferred tax asset	$	254		$	395

Included in deferred tax assets at December 31, 2012 were $40 million of federal tax credits, the majority of which will expire in 2032 if not utilized. Deferred tax assets at December 31, 2012 also included net state tax credit carryforwards of $7 million, which will expire in 2027 if not utilized. At December 31, 2012, the Corporation determined that no valuation allowance was necessary on federal or state deferred tax assets. This determination was based on sufficient taxable income in the carry-back period and anticipated future events to absorb a significant portion of the deferred tax assets. The remaining deferred tax assets will be absorbed by future reversals of existing taxable temporary differences. For further information on the Corporation’s valuation policy for deferred tax assets, refer to Note 1.