Income Taxes

6 Months Ended

Jun. 30, 2011

Income Taxes

Income Taxes

14. Income Taxes

Interim Tax Calculation Method

    In the first quarter of 2011, AIG began using the estimated annual effective tax rate method in computing its interim tax provisions. The recent stabilization of operations and expected financial results allow AIG to estimate the annual effective tax rate to be applied to year-to-date income.

    From the third quarter of 2008 through December 31, 2010, the discrete-period method was used to compute the interim tax provisions due to the significant variations in the customary relationship between income tax expense and pre-tax accounting income, which were partly due to the effects of AIG's asset disposition program and restructuring.

    The estimated annual effective tax rates for the three- and six-month periods ended June 30, 2011 reflect a full valuation allowance against the deferred tax asset of the U.S. consolidated income tax group, and statutory rates were used for computing the tax expense of foreign subsidiaries.

    Certain items, including those deemed to be unusual, infrequent or that cannot be reliably estimated, are excluded from the estimated annual effective tax rate. In these cases, the actual tax expense or benefit applicable to that item is treated discretely, and is reported in the same period as the related item. For the three- and six-month periods ended June 30, 2011, the tax effects of the loss on extinguishment of debt, other-than-temporary impairments, realized capital gains and losses, sale of MetLife securities, and divestiture gains or losses were treated as discrete items.

Interim Tax Expense (Benefit)

    For the three- and six-month periods ended June 30, 2011, the effective tax rates on pretax income from continuing operations were (15.9) and (114.6) percent, respectively. The effective tax rates were negative because AIG recorded a tax benefit on pre-tax income. The tax benefit was primarily due to a decrease in the valuation allowance attributable to the anticipated inclusion of ALICO SPV within the U.S. consolidated income tax group, tax effects associated with tax exempt interest income, investments in partnerships, and effective settlements of certain uncertain tax positions.

    For the three- and six-month periods ended June 30, 2010, the effective tax rate on pretax income from continuing operations were 66.9 percent and 17.8 percent, respectively. The effective tax rate for the three-month period ended June 30, 2010, attributable to continuing operations differs from the statutory rate of 35 percent primarily due to the change in investment in subsidiaries and the increase in the valuation allowance, partially offset by the tax benefit associated with tax exempt interest. The effective tax rate for the six-month period ended June 30, 2010, attributable to continuing operations differs from the statutory rate of 35 percent primarily due to the decrease in the deferred tax asset valuation allowance resulting from changes in the expected taxable gain on subsidiaries to be sold, the tax benefit associated with tax exempt interest, and the bargain purchase gain associated with the acquisition of Fuji, partially offset by the change in investment in subsidiaries which was principally related to changes in the estimated U.S. tax liability with respect to the potential sale of the subsidiaries.

Assessment of Deferred Tax Asset Valuation Allowances

    The evaluation of the recoverability of the deferred tax asset and the need for a valuation allowance requires AIG to weigh all positive and negative evidence to reach a conclusion that it is more likely than not that all or some portion of the deferred tax asset will not be realized. The weight given to the evidence is commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed.

    AIG's framework for assessing the recoverability of deferred tax assets weighs the sustainability of recent operating profitability, the predictability of future operating profitability of the character necessary to realize the deferred tax assets, and its emergence from cumulative losses in recent years. The framework requires AIG to consider all available evidence, including:

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  the sustainability of recent operating profitability of the AIG subsidiaries in various tax jurisdictions;

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  the predictability of future operating profitability of the character necessary to realize the deferred tax assets;

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  the nature, frequency, and severity of cumulative financial reporting losses in recent years;

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  the carryforward periods for the net operating loss, capital loss and foreign tax credit carryforwards;

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  the recognition of the gains and losses on business dispositions;

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  prudent and feasible tax planning strategies that would be implemented, if necessary, to protect against the loss of the deferred tax assets; and

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  the effect of reversing taxable temporary differences.

    Despite several favorable developments, including the completion of the Recapitalization in January 2011, the active wind-down of AIGFP's portfolios, and the sale of certain businesses, AIG's U.S. consolidated income tax group has experienced cumulative losses in recent years and volatility in sustainable operating profit. Based on this evidence at June 30, 2011, AIG cannot yet overcome this significant negative evidence to assert at this time that the U.S. consolidated income tax group deferred tax asset will be realized.

    However, AIG's U.S. consolidated income tax group has reported financial taxable income over the first half of 2011 and is currently projecting financial taxable income for the full year 2011. Additionally, AIG's U.S. consolidated income tax group expects to emerge from cumulative losses in recent years in the second half of 2011. These factors, if realized, would represent significant positive evidence. Therefore, if these factors were to be met, and based on the characteristics of the deferred tax assets, the valuation allowance could be released in large part during the fourth quarter of 2011, which would materially and favorably affect Net income and Other comprehensive income in the period. At December 31, 2010, the valuation allowance for AIG's U.S. consolidated income tax group was $23.8 billion.

Tax Examinations and Litigation

    On March 29, 2011, the U.S. District Court, Southern District of New York, ruled on a motion for partial summary judgment that AIG filed on July 30, 2010 related to the disallowance of foreign tax credits associated with cross border financing transactions. The court denied AIG's motion with leave to renew following the completion of discovery regarding certain transactions referred to in AIG's motion, which AIG believes may be significant to the outcome of the action.

Accounting for Uncertainty in Income Taxes

    At June 30, 2011 and December 31, 2010, AIG's unrecognized tax benefits, excluding interest and penalties, were $5.1 billion and $5.3 billion, respectively. At June 30, 2011 and December 31, 2010, AIG's unrecognized tax benefits were $1.4 billion and $1.7 billion, respectively, related to tax positions that if recognized would not affect the effective tax rate because they relate to the timing, rather than the permissibility, of the deduction. Accordingly, at June 30, 2011 and December 31, 2010, the amounts of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate were $3.7 billion and $3.6 billion, respectively.

    Interest and penalties related to unrecognized tax benefits are recognized in income tax expense. At June 30, 2011 and December 31, 2010, AIG accrued $845 million and $952 million, respectively, for the payment of interest (net of the federal benefit) and penalties. For the six-month periods ended June 30, 2011 and 2010, AIG recognized $(107) million and $78 million, respectively, of income tax expense (benefit) for interest (net of the federal benefit) and penalties.

    Although it is reasonably possible that a change in the balance of unrecognized tax benefits may occur within the next twelve months, at this time it is not possible to estimate the range of the change due to the uncertainty of the potential outcomes.