Note 7.

Income Taxes

Our Company is subject to the tax laws and regulations of the United States (“U.S.”) and the foreign countries in which it operates. Our Company files a consolidated U.S. Federal tax return, which includes all domestic subsidiaries and the U.K. Branch. The income from the foreign operations is designated as either U.S. connected income or non-U.S. connected income. Lloyd’s is required to pay U.S. income tax on U.S. connected income written by Lloyd’s syndicates. Lloyd’s and the Internal Revenue Service (“IRS”) have entered into an agreement whereby the amount of tax due on U.S. connected income is calculated by Lloyd’s and remitted directly to the IRS. These amounts are then charged to the corporate member in proportion to its participation in the relevant syndicates. Our Company’s corporate member is subject to this agreement and receives U.K. tax credits in the U.K. for any U.S. income tax incurred up to the U.K. income tax charged on the U.S. connected income. The non-U.S. connected insurance income would generally constitute taxable income under the Subpart F income section of the U.S. Internal Revenue Code (“Subpart F”) since less than 50% of Syndicate 1221’s premiums are derived within the U.K. and would therefore be subject to U.S. taxation when the Lloyd’s year of account closes. Taxes are accrued at a 35% rate on our Company’s foreign source insurance income and foreign tax credits, where available, are utilized to offset U.S. tax as permitted. Our Company’s effective tax rate for Syndicate 1221 taxable income could substantially exceed 35% to the extent our Company is unable to offset U.S. taxes paid under Subpart F tax regulations with U.K. tax credits on future underwriting year distributions. U.S. taxes are not accrued on the earnings of our Company’s foreign agencies as these earnings are subject to the active financing exception and are not includable as Subpart F income. Certain provisions of Subpart F expired for years after December 31, 2014; therefore, these earnings will be taxable in the U.S. at the 35% tax rate beginning January 1, 2015.

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


	Year Ended December 31,
In thousands	2014		2013		2012
Current income tax expense (benefit):
Federal and foreign	$	27,290	$	23,703	$	39,242
State and local		1,036		446		146

Subtotal		28,326		24,149		39,388

Deferred income tax expense (benefit):
Federal and foreign		16,881		4,658		(11,414	)
State and local		—		—		—

Subtotal		16,881		4,658		(11,414	)

Total income tax expense (benefit)	$	45,207	$	28,807	$	27,974

A reconciliation of total income taxes applicable to pre-tax operating income and the amounts computed by applying the federal statutory income tax rate to the pre-tax operating income were as follows:


	Year Ended December 31,
In thousands	2014					2013					2012
Computed expected tax expense	$	49,187		35.0	%	$	32,299		35.0	%	$	32,109		35.0	%
Tax-exempt interest		(4,771	)	-3.4	%		(3,839	)	-4.2	%		(4,443	)	-4.8	%
Dividends received deduction		(1,257	)	-0.9	%		(897	)	-1.0	%		(799	)	-0.9	%
Proration of DRD and Tax-exempt interest		904		0.6	%		710		0.8	%		786		0.9	%
Current state and local income taxes, net of federal income tax deduction		674		0.5	%		290		0.3	%		95		0.1	%
Other		470		0.3	%		244		0.3	%		226		0.2	%

Actual tax expense and rate	$	45,207		32.2	%	$	28,807		31.2	%	$	27,974		30.5	%

The tax effects of temporary differences that give rise to federal, foreign, state and local deferred tax assets and deferred tax liabilities were as follows:


	December 31,
In thousands	2014			2013
Deferred tax assets:
Loss reserve discount	$	24,820		$	27,822
Unearned premiums		29,080			25,706
Compensation related		10,586			6,782
State and local net deferred tax assets		777			555
Other		1,834			3,889

Total gross deferred tax assets		67,097			64,754
Less: Valuation allowance		(777	)		(555	)

Total deferred tax assets	$	66,320		$	64,199

Deferred tax liabilities:
Net unrealized gains/losses on securities		(24,832	)		(9,119	)
Deferred acquisition costs		(22,120	)		(19,258	)
Lloyd’s year of account deferral		(13,578	)		(4,381	)
Net unrealized foreign exchange		(4,470	)		(3,516	)
Other		(2,787	)		(4,119	)

Total deferred tax liabilities	$	(67,787	)	$	(40,393	)

Net deferred income tax asset (liability)	$	(1,467	)	$	23,806

Our Company has not provided for U.S. income taxes on approximately $22.6 million of undistributed earnings of its non-U.S. subsidiaries since it is intended that those earnings will be reinvested indefinitely in those subsidiaries. If a future determination is made that those earnings no longer are intended to be reinvested indefinitely in those subsidiaries, U.S. income taxes of approximately $2.3 million, assuming all foreign tax credits are realized, would be included in the tax provision at that time and would be payable if those earnings were distributed to our Company.

Unrecognized tax benefits are differences between tax positions taken in the tax returns and benefits recognized in the financial statements. Our Company has no unrecognized tax benefits as of December 31, 2014 and 2013. Our Company did not incur any interest or penalties related to unrecognized tax benefits for the years ended December 31, 2014 and 2013. Our Company currently is under examination by the IRS for taxable years 2010, 2011, and 2012 and generally is subject to U.S. Federal, state or local or foreign tax examinations by tax authorities for 2009 and subsequent years.

Our Company recorded income tax expense of $45.2 million for the year ended December 31, 2014 compared to $28.8 million for the same period in 2013, resulting in an effective tax rate of 32.2% for the year ended December 31, 2014 and 31.2% for the comparable periods in 2013.

Our Company had state and local deferred tax assets amounting to potential future tax benefits of $0.8 million and $0.6 million as of December 31, 2014 and 2013, respectively. Included in the deferred tax assets are state and local net operating loss carry-forwards of $0.0 million as of December 31, 2014 and $0.1 million for December 31, 2013. A valuation allowance was established for the full amount of these potential future tax benefits due to the uncertainty associated with their realization. Our Company’s state and local tax carry-forwards as of December 31, 2014 expire from 2024 to 2032.

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that, the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, tax planning strategies and anticipated future taxable income in making this assessment and believes it is more likely than not that our Company will realize the benefits of its deductible differences as of December 31, 2014, net of any valuation allowance.