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 2016 through 2018, 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 or 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 2014.

Diamond Offshore, which is not included in the Company’s consolidated federal income tax return, files income tax returns in the U.S. federal and various state and foreign jurisdictions. Tax years that remain subject to examination by these jurisdictions include years 2006 to 2017.

On December 22, 2017, H.R.1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” previously known as “The Tax Cuts and Jobs Act” was signed into law (the “Tax Act”).

The Securities and Exchange Commission Staff Accounting Bulletin No. 118 (“SAB 118”) allowed companies to report the income tax effects of the Tax Act as a provisional amount based on a reasonable estimate, subject to adjustment during a reasonable measurement period, not to exceed twelve months, until the accounting and analysis under ASC 740 is complete. Although further guidance and clarification from the relevant authorities is expected to continue into 2019, in accordance with SAB 118’s twelve month measurement period, we have completed our analysis of the income tax effect of the Tax Act including: (i) the amount of deferred tax assets and liabilities subject to the income tax rate change from 35% to 21%, including, but not limited to, the calculation of the mandatory deemed repatriation aspect of the Tax Act and the state tax effect of adjustments made to federal temporary differences, (ii) the ability to more likely than not realize the benefit of deferred tax assets, including net operating losses and foreign tax credits, (iii) the effect of re-computing CNA’s insurance reserves and the transition adjustment from existing law, the effects of which had no impact on the effective tax rate and (iv) the special accounting method provisions for recognizing income for U.S. federal income tax purposes no later than financial accounting purposes and the transition adjustment from existing law, which also had no impact on the effective tax rate.

The Company recorded a one-time non-cash provisional $200 million increase to net income (net of noncontrolling interests) for the year ended December 31, 2017 related to the Tax Act. This increase included a $268 million income tax benefit due to the adjustment of net deferred tax assets and liabilities related to the reduction of the U.S. federal corporate income tax rate from 35% to 21% partially offset by a $78 million charge mostly related to the one-time mandatory repatriation of previously deferred earnings of certain of Diamond Offshore’s non-U.S. subsidiaries inclusive of the utilization of certain tax attributes offset by a provisional liability for uncertain tax positions related to such attributes. Due to the timing of the enactment of the Tax Act, there has been and continues to be a significant amount of uncertainty as to the appropriate application of a number of the underlying provisions, pending further guidance and clarification from the relevant authorities. In 2018, the U.S. Department of the Treasury and Internal Revenue Service issued additional guidance which the Company believes clarified certain of our tax positions taken in 2017 and, consequently, during 2018, the Company recorded a $6 million reduction to net income (net of noncontrolling interests).

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


Year Ended December 31	2018		2017			2016

(In millions)

Income tax expense (benefit):
Federal:
Current	$	6	$	157		$	71
Deferred		85		(63	)		102
State and city:
Current		15		22			13
Deferred		9		17			13
Foreign		13		37			21

Total	$	128	$	170		$	220

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 (benefit) is as follows:


Year Ended December 31	2018			2017			2016
(In millions)

Income before income tax:
U.S.	$	775		$	1,322		$	1,207
Foreign		59			260			(271	)

Total	$	834		$	1,582		$	936



Income tax expense at statutory rate	$	175		$	554		$	328
Increase (decrease) in income tax expense resulting from:
Effect of the Tax Act		(6	)		(190	)
Exempt investment income		(64	)		(134	)		(126	)
Foreign related tax differential		1			(36	)		40
Taxes related to domestic affiliate		(7	)		1			(14	)
Partnership earnings not subject to taxes		(14	)		(51	)		(52	)
Valuation allowance		12			7			62
Unrecognized tax positions, settlements and adjustments relating to prior years		2			(8	)		(42	)
State taxes		20			23			18
Other		9			4			6

Income tax expense (benefit)	$	128		$	170		$	220

The deferred foreign earnings of certain international subsidiaries were deemed to be repatriated under the Tax Act and consequently the Company will no longer permanently reinvest earnings of its foreign subsidiaries. The Company has not provided income tax on the outside basis difference of its foreign subsidiaries since there is no intention to dispose of these subsidiaries and structuring alternatives exist to mitigate any potential liability. The potential unrecorded liability associated with the outside basis difference is approximately $116 million.

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	2018			2017			2016

(In millions)

Balance at January 1	$	84		$	35		$	54
Additions for tax positions related to the current year		3			51			4
Additions for tax positions related to a prior year		20			5			1
Reductions for tax positions related to a prior year		(48	)		(1	)		(20	)
Lapse of statute of limitations		(1	)		(6	)		(4	)

Balance at December 31	$	58		$	84		$	35

The 2018 addition to prior year tax positions is primarily due to recent proposed regulations on the offsetting of the deemed repatriation with certain tax attributes and the reduction for prior year tax positions is due to clarification issued by the Internal Revenue Service regarding tax attributes available to offset the deemed repatriation. The $51 million addition to current year tax positions for 2017 is attributable to a provisional liability associated with the use of tax attributes on the deemed, mandatory repatriation of the Tax Act. In 2016, the $20 million in reductions for tax positions related to a prior year, is primarily from the devaluation of the Egyptian pound. At December 31, 2018, 2017 and 2016, $82 million, $102 million and $36 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 Operating revenues and other 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, 2018, 2017 and 2016. The Company recorded income tax expense of $1 million for the year ended December 31, 2018 and a benefit of $2 million and $23 million for the years ended December 31, 2017 and 2016 related to penalties.

The following table summarizes deferred tax assets and liabilities:


December 31	2018			2017
(In millions)

Deferred tax assets:
Insurance reserves:
Property and casualty claim and claim adjustment expense reserves	$	108		$	74
Unearned premium reserves		108			142
Receivables		13			13
Employee benefits		222			243
Deferred retroactive reinsurance benefit		79			68
Net operating loss carryforwards		251			169
Tax credit carryforwards		101			199
Net unrealized losses		24
Basis differential in investment in subsidiary		8			15
Other		197			211
Total deferred tax assets		1,111			1,134
Valuation allowance		(175	)		(169	)
Net deferred tax assets		936			965

Deferred tax liabilities:
Deferred acquisition costs		(78	)		(77	)
Net unrealized gains					(263	)
Property, plant and equipment		(840	)		(765	)
Basis differential in investment in subsidiary		(586	)		(364	)
Other liabilities		(236	)		(220	)
Total deferred tax liabilities		(1,740	)		(1,689	)

Net deferred tax liabilities (a)	$	(804	)	$	(724	)

(a)	Includes $37 and $25 of deferred tax assets reflected in Other assets in the Consolidated Balance Sheets at December 31, 2018 and 2017.

Federal net operating loss carryforwards of $83 million expire between 2034 and 2038 and $35 million can be carried forward indefinitely. Net operating loss carryforwards in foreign tax jurisdictions of $37 million expire between 2021 and 2028 and $83 million can be carried forward indefinitely. Federal tax credit carryforwards of $57 million can be utilized to offset future current tax liabilities or will ultimately be refundable no later than 2021. Foreign tax credit carryforwards of $43 million will expire in 2020 and 2024 to 2027.

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. As of December 31, 2018, Diamond Offshore recorded a valuation allowance of $175 million related to net operating losses of $98 million, foreign tax credits of $45 million, and other deferred tax assets of $32 million.