Income Tax

Total income tax expense (benefit) is allocated as follows:



	Year Ended December 31
	2012			2011			2010
	(in millions of dollars)
Net Income	$	355.1		$	49.1		$	441.2
Stockholders' Equity - Additional Paid-in Capital
Stock-Based Compensation	3.5			(3.3		)	(2.7		)
Stockholders' Equity - Accumulated Other Comprehensive Income (Loss)
Change in Net Unrealized Gains on Securities Not Other-Than Temporarily Impaired	467.7			799.4			519.1
Change in Net Unrealized Gains and Losses on Securities Other-Than Temporarily Impaired	—			(1.1		)	(0.5		)
Change in Net Gain on Cash Flow Hedges	(4.3		)	25.2			(5.0		)
Change in Adjustment to Reserves for Future Policy and Contract Benefits, Net of Reinsurance and Other	(325.6		)	(701.5		)	(499.6		)
Change in Foreign Currency Translation Adjustment	—			—			0.6
Change in Unrecognized Pension and Postretirement Benefit Costs	(68.0		)	(67.4		)	(12.7		)
Total	$	428.4		$	100.4		$	440.4

A reconciliation of the income tax expense (benefit) attributable to income from operations before income tax, computed at U.S. federal statutory tax rates, to the income tax expense (benefit) as included in our consolidated statements of income, is as follows. Certain prior year amounts have been reclassified to conform to current year reporting.



	Year Ended December 31
	2012		2011		2010
Statutory Income Tax	35.0	%	35.0	%	35.0	%
Prior Year Taxes	(0.9	)	(11.0	)	0.4
Foreign Items	(2.0	)	(0.3	)	(1.3	)
Tax Credits	(2.7	)	(5.9	)	(0.6	)
Other Items, Net	(1.0	)	(3.1	)	(0.1	)
Effective Tax	28.4	%	14.7	%	33.4	%

Our deferred income tax asset and liability consists of the following:



	December 31
	2012		2011
	(in millions of dollars)
Deferred Tax Liability
Deferred Acquisition Costs	$	62.8	$	35.6
Unrealized Gains and Losses	643.9		512.7
Other	252.0		138.2
Gross Deferred Tax Liability	958.7		686.5

Deferred Tax Asset
Invested Assets	373.5		349.8
Employee Benefits	315.2		262.3
Other	0.6		29.7
Gross Deferred Tax Asset	689.3		641.8

Total Net Deferred Tax Liability	$	269.4	$	44.7

Note 6 - Income Tax - Continued

Our consolidated statements of income include amounts subject to both domestic and foreign taxation. The income and related tax expense (benefit) are as follows:



	Year Ended December 31
	2012			2011			2010
	(in millions of dollars)
Income Before Tax
United States - Federal	$	1,128.4		$	160.5		$	1,113.1
Foreign	121.1			172.8			206.8
Total	$	1,249.5		$	333.3		$	1,319.9

Current Tax Expense
United States - Federal	$	164.4		$	218.4		$	246.9
Foreign	42.2			12.1			54.1
Total	206.6			230.5			301.0

Deferred Tax Expense (Benefit)
United States - Federal	173.5			(203.4		)	144.5
Foreign	(25.0		)	22.0			(4.3		)
Total	148.5			(181.4		)	140.2

Total	$	355.1		$	49.1		$	441.2

During 2010, the U.K. government enacted an income tax rate reduction, with additional enactments occurring during 2011 and 2012. The ultimate goal is to reduce the rate from 28 percent to 21 percent by 2014. Although the rate reductions in each instance became or will become effective during the following year, we are required to adjust deferred tax assets and liabilities through income on the date of enactment of a rate change. As a result, we recorded income tax benefits of $9.3 million and $6.8 million, respectively, for the two percent tax rate reductions enacted during each of the years 2012 and 2011 and $2.7 million for the one percent rate reduction enacted during 2010.

We consider the unremitted earnings of our foreign operations to be permanently invested and therefore have not provided U.S. deferred taxes on the cumulative earnings of our non-U.S. affiliates. Deferred taxes are provided for earnings of non-U.S. affiliates when we plan to remit those earnings. As of December 31, 2012, we have not made a provision for U.S. taxes on approximately $992.2 million of the excess of the carrying amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration. The determination of a deferred tax liability related to investments in these foreign subsidiaries is not practicable.

Note 6 - Income Tax - Continued

Our consolidated statements of income include the following changes in unrecognized tax benefits:



	December 31
	2012			2011			2010
	(in millions of dollars)
Balance at Beginning of Year	$	86.9		$	138.9		$	146.8
Tax Positions Taken During Prior Years
Additions	13.3			4.4			3.6
Subtractions	(0.6		)	(11.8		)	(11.5		)
Settlements with Tax Authorities	(23.5		)	(44.6		)	—
Lapses of Statute of Limitations	(61.1		)	—			—
Tax Positions Taken During Current Year	2.5			—			—
Balance at End of Year	17.5			86.9			138.9
Less Tax Attributable to Temporary Items Included Above	(15.0		)	(86.9		)	(123.7		)
Total Unrecognized Tax Benefits that if Recognized Would Affect the Effective Tax Rate	$	2.5		$	—		$	15.2

Included in the balances at December 31, 2012, 2011, and 2010 are $15.0 million, $86.9 million, and $123.7 million, respectively, of unrecognized tax benefits for tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Other than potential interest and penalties, the disallowance of the shorter deductibility period would not affect our results of operations but would accelerate the payment of cash to the taxing authority.

We recognize interest expense and penalties, if applicable, related to unrecognized tax benefits in tax expense net of federal income tax. We recognized a reduction of interest expense associated with unrecognized tax benefits of $10.4 million and $13.1 million for 2012 and 2011, respectively. We recognized an increase in interest expense related to unrecognized tax expense of $5.5 million during 2010. The total amounts of accrued interest and penalties related to unrecognized tax benefits in our consolidated balance sheets as of December 31, 2012, 2011, and 2010 were $1.9 million, $12.3 million, and $25.4 million, respectively. It is reasonably possible that unrecognized tax benefits could decrease within the next 12 months by $0 to $10.0 million as a result of additional Internal Revenue Service (IRS) settlements, advance payments of taxes, and claims for refund.

We file federal and state income tax returns in the United States and in foreign jurisdictions. We are under continuous examination by the IRS with regard to our U.S. federal income tax returns. The IRS audit of our 2009 and 2010 years commenced in 2012. During 2012, we also finalized all issues with the IRS related to our 2007 and 2008 years and recognized a reduction of our federal income taxes of $11.0 million. During 2011, the Congressional Joint Committee on Taxation approved our final settlement with the IRS for tax years 1996 to 2004. The settlement resulted from our administrative appeal of audit adjustments relating primarily to insurance tax reserves and losses incurred by foreign subsidiaries. As a result of the settlement, we recognized in our 2011 operating results a reduction in our federal income taxes of $41.3 million as well as interest income of $17.5 million before tax and $11.4 million after tax. We received a cash refund of taxes and interest under this settlement of $60.4 million in 2012.

During 2010, the IRS completed its examination of tax years 2005 and 2006 and issued a revenue agent's report (RAR). In 2011, we filed a protest to the RAR with respect to all significant adverse proposed adjustments. In 2012, we reached a tentative settlement with IRS Appeals for these years and expect to receive final approval of the settlement in 2013, with no material impact on our results of operations or financial condition.

Tax years subsequent to 2008 remain subject to examination by tax authorities in the U.S. and tax years subsequent to 2009 remain subject to examination in major foreign jurisdictions. We believe sufficient provision has been made for all potential adjustments for years that are not closed by the statute of limitations in all major tax jurisdictions, and that any such adjustments would not have a material adverse effect on our financial position, liquidity, or results of operations.

Note 6 - Income Tax - Continued

In January 2013, the American Taxpayer Relief Act retroactively reinstated the active financing income exemption which affects the amount of earnings from foreign subsidiaries that is taxed annually, regardless of whether foreign earnings are repatriated. Our 2012 income tax expense reflects the taxation of all active financing income from our foreign subsidiaries, the amount of which was immaterial. In the first quarter of 2013, our income tax expense will reflect reinstatement of the exemption of active financing income, and we will reverse the amounts recorded in 2012.

In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 were signed into law. Among other things, the legislation reduced the tax benefits available to an employer that receives a postretirement prescription drug coverage subsidy from the federal government under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Under the legislation, to the extent our future postretirement prescription drug coverage expenses are reimbursed under the subsidy program, the expenses covered by the subsidy will no longer be tax deductible after 2012. Employers that receive the subsidy were required to recognize the deferred tax effects relating to the future postretirement prescription drug coverage in the period the legislation was enacted. Our income tax expense for the year ended December 31, 2010 includes a non-cash tax charge of $10.2 million to reflect the impact of the tax law change.

As of December 31, 2012, we had no net operating loss carryforward for U.S. income taxes. We record a valuation allowance to reduce deferred tax assets to the amount that is more likely than not to be realized. As of December 31, 2012, we had no valuation allowance. In 2011, as part of an IRS settlement, we released a $4.1 million valuation allowance related to basis differences in foreign subsidiaries and net operating loss carryforwards in foreign jurisdictions for which we previously believed we would not realize a tax benefit.

Total income taxes paid net of refunds during 2012, 2011, and 2010 were $185.0 million, $303.5 million, and $273.0 million, respectively.