Income Taxes

Total income taxes were as follows:



Year Ended December 31,	2013			2012			2011
	(in millions)
Provision (benefit) for income taxes related to continuing operations	$	325		$	(1,406	)	$	(1,431	)
Income taxes related to adjustments included in common shareholder’s equity:
Unrealized gains (losses) on securities available-for-sale, not other-than-temporarily impaired, net	(62		)	7			13
Unrealized gains on other-than-temporarily impaired debt securities available-for-sale	(1		)	1			3
Unrealized gains on cash flow hedging instruments	143			75			52
Changes in funded status of postretirement benefit plans	8			(8		)	(6		)
Foreign currency translation adjustments	(10		)	1			(1		)
Total	$	403		$	(1,330	)	$	(1,370	)

Provisions (benefits) for income taxes related to our continuing operations all of which were in the United States were:



Year Ended December 31,	2013			2012			2011
	(in millions)
Current benefit	$	(917	)	$	(958	)	$	(772	)
Deferred provision (benefit)	1,242			(448		)	(659		)
Total income provision (benefit)	$	325		$	(1,406	)	$	(1,431	)

The significant components of deferred provisions (benefits) attributable to income from continuing operations were:



Year Ended December 31,	2013			2012			2011
	(in millions)
Deferred income tax provision (benefit) (excluding the effects of other components)	$	1,443		$	(597	)	$	(602	)
Increase in Federal operating loss carryforwards	(141		)	—			—
(Decrease) increase in State valuation allowance	(51		)	323			(65		)
Decrease (increase) in State operating loss carryforwards and credits	11			(296		)	(65		)
(Increase) decrease in foreign and general business tax credits	(20		)	122			73
Deferred income tax provision (benefit)	$	1,242		$	(448	)	$	(659	)

The decrease in state operating loss carryforwards and corresponding decrease in valuation allowance in the table above pertain mainly to states with net operating losses that were utilized against 2012 taxable income on returns filed in 2013.

A reconciliation of income tax expense (benefit) compared with the amounts at the U.S. federal statutory rates was as follows:



Year Ended December 31,	2013					2012					2011
	(dollars are in millions)
Tax provision (benefit) at the U.S. federal statutory income tax rate	$	363		35.0	%	$	(1,334	)	(35.0	)%	$	(1,315	)	(35.0	)%
Increase (decrease) in rate resulting from:
State and local taxes, net of Federal benefit	9			.9		(19		)	(.5	)	(19		)	(.5	)
Adjustment with respect to tax for prior periods⁽¹⁾	11			1.1		(51		)	(1.3	)	5			.1
Adjustment of tax rate used to value deferred taxes	(5		)	(.5	)	(7		)	(.2	)	—			—
Change in valuation allowance and reserves⁽²⁾	(11		)	(1.1	)	15			.4		(130		)	(3.5	)
Uncertain tax adjustments⁽³⁾	(10		)	(1.0	)	(15		)	(.4	)	—			—
Other non-deductible/non-taxable items⁽⁴⁾	(29		)	(2.8	)	—			—		29			.8
Other	(3		)	(.3	)	5			.1		(1		)	—
Total income tax benefit	$	325		31.3	%	$	(1,406	)	(36.9	)%	$	(1,431	)	(38.1	)%


⁽¹⁾	For 2013, 2012 and 2011, the amount relates to corrections to current and deferred tax balance sheet accounts and changes in estimates as a result of filing the Federal and state income tax returns.


⁽²⁾	For 2013 and 2012, the amounts relate to changes in valuation allowance in states with net operating loss carryforward periods of 12 to 20 years. For 2011, the amount relates mainly to the release of a valuation allowance previously established on foreign tax credits.


⁽³⁾	For 2013 and 2012, the amounts primarily relate to the conclusion of state audits and expiration of state statutes of limitations.


⁽⁴⁾	For 2013, the amount includes a change in the estimated deductibility of accrued costs for certain regulatory matters that were accrued during 2011.

Temporary differences which gave rise to a significant portion of deferred tax assets and liabilities were as follows:



	December 31, 2013			December 31, 2012
	(in millions)
Deferred Tax Assets:
Credit loss reserves	$	1,220		$	1,678
Receivables held for sale	101			921
Federal and state unused tax benefit carryforwards	1,080			930
Market value adjustment related to derivatives and long-term debt carried at fair value	392			624
Interests in Real Estate Mortgage Investment Conduits ⁽¹⁾	394			505
Accrued expenses not currently deductible	199			183
Other	271			280
Total deferred tax assets	3,657			5,121
Valuation allowance	(931		)	(982		)
Total deferred tax assets net of valuation allowance	2,726			4,139
Deferred Tax Liabilities:
Fee income	82			105
Other	64			145
Total deferred tax liabilities	146			250
Net deferred tax asset	$	2,580		$	3,889

⁽¹⁾

Real Estate Mortgage Investment Conduits ("REMIC") are investment vehicles that hold commercial and residential mortgages in trust and issue securities representing an undivided interest in these mortgages. We hold portfolios of noneconomic residual interests in a number of REMICs through one of our subsidiaries. This item represents the tax basis in such interests which has accumulated as a result of tax rules requiring the recognition of income related to such noneconomic residuals.

The deferred tax valuation allowance is attributed to the following deferred tax assets that based on the available evidence it is more-likely-than-not that the deferred tax asset will not be realized:



	December 31, 2013		December 31, 2012
	(in millions)
State unused tax benefit carryforwards	$	875	$	926
Deferred capital loss on sale to affiliates	49		49
Other	7		7
Total	$	931	$	982

The state deferred tax assets against which a valuation allowance is maintained primarily relate to unused tax benefits associated with our run off business for which recovery is highly unlikely.

A reconciliation of the beginning and ending amount of unrecognized tax benefits related to uncertain tax positions is as follows:



	2013			2012			2011
	(in millions)
Balance at beginning of year	$	165		$	153		$	164
Additions based on tax positions related to the current year	—			8			4
Additions for tax positions of prior years	3			49			60
Reductions for tax positions of prior years	(41		)	(27		)	(19		)
Settlements	(8		)	(18		)	(42		)
Reductions for lapse of statute of limitations	(8		)	—			(14		)
Balance at end of year	$	111		$	165		$	153

The total amount of unrecognized tax benefits related to uncertain tax positions that, if recognized, would affect the effective tax rate was $73 million, $113 million and $96 million at December 31, 2013, December 31, 2012 and December 31, 2011, respectively. Included in the unrecognized tax benefits are some items the recognition of which would not affect the effective tax rate, such as the tax effect of temporary differences and the amount of state taxes that would be deductible for U.S. federal purposes. It is reasonably possible that there could be a change in the amount of our unrecognized tax benefits within the next 12 months due to settlements or statutory expirations in various state and local tax jurisdictions.

It is our policy to recognize accrued interest related to uncertain tax positions in interest income in the consolidated statement of income (loss) and to recognize penalties, if any, related to uncertain tax positions as a component of other servicing and administrative expenses in the consolidated statement of income (loss). We had accruals for the payment of interest and penalties associated with uncertain tax positions of $28 million and $42 million at December 31, 2013 and December 31, 2012, respectively. We decreased our accrual for the payment of interest and penalties associated with uncertain tax positions by $14 million during 2013 and $46 million during 2012.

HSBC North America Consolidated Income Taxes We are included in HSBC North America's consolidated Federal income tax return and in various combined state income tax returns. As such, we have entered into a tax allocation agreement with the HNAH Group entities included in the consolidated returns which govern the current amount of taxes to be paid or received by the various entities included in the consolidated return filings. As a result, we have looked at the HNAH Group's consolidated deferred tax assets and various sources of taxable income, including the impact of HSBC and HNAH Group tax planning strategies, in reaching conclusions on recoverability of deferred tax assets. Where a valuation allowance is determined to be necessary at the HSBC North America consolidated level, such allowance is allocated to the principal subsidiaries within the HNAH Group as described below in a manner that is systematic, rational and consistent with the broad principles of accounting for income taxes.

The HNAH Group evaluates deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical financial performance, projections of future taxable income, future reversals of existing taxable temporary differences, tax planning strategies and any available carryback capacity.

In evaluating the need for a valuation allowance, the HNAH Group estimates future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC necessary as part of such plans and strategies. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period.

Market conditions have created losses in the HNAH Group in recent periods and volatility in our pre-tax book income. As a consequence, our current analysis of the recoverability of the deferred tax assets significantly discounts any future taxable income expected from continuing operations and relies on continued capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. HSBC has indicated it remains fully committed and has the capacity and willingness to provide capital as needed to the HNAH Group to run operations, maintain sufficient regulatory capital, and fund certain tax planning strategies.

Only those tax planning strategies that are both prudent and feasible, and which management has the ability and intent to implement, are incorporated into our analysis and assessment. The primary and most significant strategy is HSBC's commitment to reinvest excess HNAH Group capital to reduce debt funding or otherwise invest in assets to ensure that it is more likely than not that the deferred tax assets will be utilized.

Currently, it has been determined that the HNAH Group's primary tax planning strategy, in combination with other tax planning strategies, provides support for the realization of the net deferred tax assets recorded for the HNAH Group. Such determination is based on HSBC North America 's business forecasts and assessment as to the most efficient and effective deployment of HSBC capital, most importantly including the length of time such capital will need to be maintained in the U.S. for purposes of the tax planning strategy.

Notwithstanding the above, the HNAH Group has valuation allowances against certain state deferred tax assets and certain Federal tax loss carryforwards for which the aforementioned tax planning strategies do not provide appropriate support.

HNAH Group valuation allowances are allocated to the principal subsidiaries, including us. The methodology allocates the valuation allowance to the principal subsidiaries based primarily on the entity's relative contribution to the growth of the HSBC North America consolidated deferred tax asset against which the valuation allowance is being recorded.

If future results differ from the HNAH Group's current forecasts or the tax planning strategies were to change, a valuation allowance against some or all of the remaining net deferred tax assets may need to be established which could have a material adverse effect on our results of operations, financial condition and capital position. The HNAH Group will continue to update its assumptions and forecasts of future taxable income, including relevant tax planning strategies, and assess the need for such incremental valuation allowances.

Absent the capital support from HSBC and implementation of the related tax planning strategies, the HNAH Group, including us, would be required to record a valuation allowance against the remaining deferred tax assets.

HSBC Finance Corporation Income Taxes We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits and net operating and other losses. Our net deferred tax assets, including deferred tax liabilities and valuation allowances, totaled $2,580 million and $3,889 million as of December 31, 2013 and December 31, 2012, respectively.

The Internal Revenue Service ("IRS") concluded its examination of our 2006 through 2009 income tax returns in the third quarter of 2013. The IRS forwarded the Revenue Agents' Report ("RAR") to the Joint Committee of Taxation ("JCT") for approval in the fourth quarter of 2013. We expect the RAR to be approved by the JCT in the first half of 2014. The final impact is not expected to significantly affect our financial statements.

We remain subject to state and local income tax examinations for years 2003 and forward. We are currently under audit by various state and local tax jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law and the closing of statute of limitations. Such adjustments are reflected in the tax provision.

At December 31, 2013, for Federal tax purposes, we had net operating loss carryforwards of $403 million.which expire in 2033; foreign tax credits of $12 million which expire in 2018; and general business credits of $8 million which expire in 2029.

At December 31, 2013, for state tax purposes, we had net operating loss carryforwards of $15,325 million for which we have valuation allowances totaling $14,126 million. These state net operating loss carryforwards expire as follows: $502 million in 2014 - 2018; $1,017 million in 2019 - 2023; $4,374 million in 2024 - 2028; and $9,432 million in 2029 and forward.

At December 31, 2013, for state tax purposes, we had general business tax credit carryforwards of $12 million of which $9 million expire in 2014 - 2018 and $3 million have no expiration period.