Note 10. Income Taxes

The Company and its eligible subsidiaries file a consolidated federal income tax return. The Company has entered into a separate tax allocation agreement with CNA, a majority-owned subsidiary in which its ownership exceeds 80%. The agreement provides that the Company will: (i) pay to CNA the amount, if any, by which the Company’s consolidated federal income tax is reduced by virtue of inclusion of CNA in the Company’s return or (ii) be paid by CNA an amount, if any, equal to the federal income tax that would have been payable by CNA if it had filed a separate consolidated return. The agreement may be canceled by either of the parties upon thirty days written notice.

For 2013 through 2015, the Internal Revenue Service (“IRS”) has accepted the Company into the Compliance Assurance Process (“CAP”), which is a voluntary program for large corporations. Under CAP, the IRS conducts a real-time audit and works contemporaneously with the Company to resolve any issues prior to the filing of the tax return. The Company believes this approach should reduce tax-related uncertainties, if any. Although the outcome of tax audits is always uncertain, the Company believes that any adjustments resulting from audits will not have a material impact on its results of operations, financial position and cash flows. The Company and/or its subsidiaries also file income tax returns in various state, local and foreign jurisdictions. These returns, with few exceptions, are no longer subject to examination by the various taxing authorities before 2011.

Diamond Offshore, which is not included in the Company’s consolidated federal income tax return, files income tax returns in the U.S. federal, various state and foreign jurisdictions. Tax years that remain subject to examination by these jurisdictions include years 2009 to 2015. The 2013 federal income tax return is currently under examination.

The current and deferred components of income tax expense (benefit) are as follows:


Year Ended December 31	2015			2014			2013

(In millions)

Income tax expense (benefit):
Federal:
Current	$	79		$	370		$	705
Deferred		(234	)		(23	)		(232	)
State and city:
Current		21			12			19
Deferred		5			6			1
Foreign		86			92			163

Total	$	(43	)	$	457		$	656

The components of U.S. and foreign income before income tax and a reconciliation between the federal income tax expense at statutory rates and the actual income tax expense is as follows:


Year Ended December 31	2015			2014			2013
(In millions)

Income before income tax:
U.S.	$	543		$	1,499		$	1,945
Foreign		(299	)		311			332
Total	$	244		$	1,810		$	2,277


Income tax expense at statutory rate	$	86		$	633		$	797
Increase (decrease) in income tax expense resulting from:
Exempt investment income		(126	)		(121	)		(99	)
Foreign related tax differential		(18	)		(48	)		(117	)
Amortization of deferred charges associated with intercompany
rig sales to other tax jurisdictions		38			44			31
Taxes related to domestic affiliate		(10	)		14			19
Partnership earnings not subject to taxes		(38	)		(39	)		(38	)
Unrecognized tax benefit (expense)		1			(42	)		66
Other (a)		24			16			(3	)
Income tax expense (benefit)	$	(43	)	$	457		$	656

(a)	Includes state and local taxes, retroactive tax law changes, adjustments to prior year estimates and other non-deductible expenses.

Provision has been made for the expected U.S. federal income tax liabilities applicable to undistributed earnings of subsidiaries, except for certain subsidiaries for which the Company intends to invest the undistributed earnings indefinitely to finance foreign activities, or recover such undistributed earnings tax-free. The determination of the amount of the unrecognized deferred tax liability on approximately $2.0 billion of undistributed earnings related to foreign subsidiaries is not practicable.

A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding tax carryforwards and interest and penalties, is as follows:


Year Ended December 31	2015			2014			2013
(In millions)

Balance at January 1	$	57		$	91		$	67
Additions based on tax positions related to the current year		7			6			2
Additions for tax positions related to a prior year								31
Reductions for tax positions related to a prior year		(3	)		(35	)		(7	)
Lapse of statute of limitations		(7	)		(5	)		(2	)
Balance at December 31	$	54		$	57		$	91

At December 31, 2015, 2014 and 2013, $49 million, $51 million and $76 million of unrecognized tax benefits related to Diamond Offshore would affect the effective tax rate if recognized.

The Company recognizes interest accrued related to: (i) unrecognized tax benefits in Interest expense and (ii) tax refund claims in Other revenues on the Consolidated Statements of Income. The Company recognizes penalties in Income tax expense on the Consolidated Statements of Income. Interest amounts recorded by the Company were insignificant for the years ended December 31, 2015, 2014 and 2013. The Company recorded income tax expense of $2 million and $38 million for the years ended December 31, 2015 and 2013 and income tax benefit of $22 million for the year ended December 31, 2014 related to penalties.

During 2013, Diamond Offshore received notification from the Egyptian tax authorities proposing a $1.2 billion increase in taxable income for the years 2006 to 2008. In December of 2013, Diamond Offshore accrued an additional $57 million of expense for uncertain tax positions in Egypt for all open years. During the first quarter of 2014, Diamond Offshore settled certain disputes for the years 2006 through 2008 with the Egyptian tax authorities, resulting in a net reduction to income tax expense of $17 million. One issue for the 2006 through 2008 period remains open, which Diamond Offshore appealed. The court case is scheduled to occur in the first quarter of 2016. Diamond Offshore has sought assistance from an agency of the U.S. Treasury Department, pursuant to international tax treaties and continues to believe that its position will, more likely than not, be sustained. However, if Diamond Offshore’s position is not sustained, tax expense and related penalties would increase by approximately $53 million related to this issue for the 2006 through 2008 tax years as of December 31, 2015.

During the third quarter of 2014, Diamond Offshore reversed $36 million of reserves for uncertain tax positions, including $6 million for interest and $11 million for penalties, related to a favorable court decision in Brazil resulting in the closure of the 2004 and 2005 tax years, approval from Malaysian tax authorities for the settlement of tax liabilities and penalties for the years 2003 through 2008 and the expiration of the statute of limitations in Mexico for the 2008 tax year.

Due to the 2015 expiration of the statute of limitations in Mexico for the 2009 tax year for one of Diamond Offshore’s subsidiaries operating in Mexico, Diamond Offshore reversed an $11 million accrual for an uncertain tax position of which $4 million is interest and $1 million is penalty.

The following table summarizes deferred tax assets and liabilities:


December 31	2015			2014
(In millions)

Deferred tax assets:
Insurance reserves:
Property and casualty claim and claim adjustment expense reserves	$	178		$	265
Unearned premium reserves		230			187
Receivables		30			37
Employee benefits		419			432
Life settlement contracts		48			46
Deferred retroactive reinsurance benefit		84			61
Net operating loss carryforwards		245			321
Tax credit carryforwards		131			93
Basis differential in investment in subsidiary		19			21
Other		282			209
Total deferred tax assets		1,666			1,672
Valuation allowance		(147	)		(48	)
Net deferred tax assets		1,519			1,624

Deferred tax liabilities:
Deferred acquisition costs		(117	)		(226	)
Net unrealized gains		(166	)		(469	)
Property, plant and equipment		(998	)		(1,132	)
Basis differential in investment in subsidiary		(428	)		(472	)
Other liabilities		(173	)		(204	)
Deferred tax liabilities		(1,882	)		(2,503	)

Net deferred tax liability (a)	$	(363	)	$	(879	)

(a)	Includes $19 and $14 of deferred tax assets reflected in Other assets in the Consolidated Balance Sheets at December 31, 2015 and 2014.

Federal net operating loss carryforwards of $138 million expire in 2034 and 2035. Net operating loss carryforwards in foreign tax jurisdictions of $66 million expire between 2020 and 2025 and $32 million can be carried forward indefinitely. Federal tax credit carryforwards of $83 million have indefinite lives and $46 million of foreign tax credit carryforwards expire in 2024 and 2025.

Although realization of deferred tax assets is not assured, management believes it is more likely than not that the recognized deferred tax assets will be realized through recoupment of ordinary and capital taxes paid in prior carryback years and through future earnings, reversal of existing temporary differences and available tax planning strategies.

The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013. The act extended, through 2013, several expired or expiring temporary business provisions, commonly referred to as “extenders,” which were retroactively extended to the beginning of 2012. As required by GAAP, the effects of new legislation are recognized when signed into law. The Company reduced 2013 tax expense by $28 million as a result of recognizing the 2012 effect of the extenders.