NOTE 9. INCOME TAXES

Our Company is subject to the tax laws and regulations of the 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 the Syndicate’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 the Syndicate 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. Our Company’s undistributed foreign earnings are intended to be permanently reinvested. As a result of the Tax Act’s one-time Transition Tax on the earnings of foreign subsidiaries, as of December 31, 2017 our Company expects the unrecognized deferred tax liability attributable to indefinitely reinvested earnings to be immaterial.

On December 22, 2017, the President signed the Tax Act. The Tax Act, among other things, lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. Consequently, we revalued our net deferred tax assets as of December 31, 2017 by $17.1 million to reflect the estimated impact of the Tax Act. As a result of the Tax Act we are subject to the Transition Tax and we anticipate incurring a one-time adjustment of approximately $2.6 million due to the tax on previously untaxed accumulated and current earnings and profits on certain foreign subsidiaries. In computing taxable income, P&C insurers reduce underwriting income by loss and loss adjustment expenses incurred. The deduction for losses incurred is discounted for tax at the interest rates and for the loss payment patterns prescribed by the U.S. Treasury. The Tax Act changes the prescribed interest rates to rates based on corporate bond yield curves and extends the applicable time periods for the loss payment pattern. These changes are effective for tax years beginning after 2017 and are subject to a transition rule that spreads the additional tax payment from the amount determined by applying these changes over the subsequent eight years beginning in 2018. This item is a taxable temporary difference and has no direct impact on total tax expense for 2017 and future years. While we have substantially completed our provisional analysis of the income tax effects of the Tax Act and recorded a reasonable estimate of such effects, including but not limited to, the re-measurement of deferred tax assets (liabilities), future discounting for loss reserves and the Transition Tax, the net one-time charge related to the Tax Act may differ, possibly materially, due to further refinement of our calculations, changes in interpretations and assumptions that we have made, additional guidance that may be issued by the U.S. Government, and actions and related accounting policy decisions we may take as a result of the Tax Act. We will complete our analysis over a one-year measurement period, as described in SAB 118, and any adjustments during this measurement period will be included in net earnings from continuing operations as an adjustment to income tax expense in the reporting period when such adjustments are determined.

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

	Years Ended December 31,
amounts in thousands	2017			2016			2015
Current Income Tax Expense (Benefit):
Federal and Foreign	$	42,427		$	39,900		$	27,937
State and Local		764			638			1,476
Subtotal	$	43,191		$	40,538		$	29,413
Deferred Income Tax Expense (Benefit):
Federal and Foreign	$	(8,879	)	$	(5,755	)	$	7,004
State and local		—			—			—
Subtotal	$	(8,879	)	$	(5,755	)	$	7,004
Total Income Tax Expense (Benefit)	$	34,312		$	34,783		$	36,417

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:

	Years Ended December 31,
amounts in thousands	2017					2016						2015
Computed Expected Tax Expense	$	26,182		35.0	%	$	41,128			35.0	%	$	41,116			35.0	%
Tax-Exempt Interest		(5,394	)	(7.2	%)		(4,559	)		(3.9	%)		(4,987	)		(4.2	%)
Dividends Received Deduction		(4,689	)	(6.3	%)		(3,812	)		(3.2	%)		(2,086	)		(1.8	%)
Proration of DRD and Tax-Exempt Interest		1,512		2.0	%		1,256			1.1	%		1,061			0.9	%
Current State and Local Income Taxes, Net of Federal Income Tax Deduction		497		0.7	%		415			0.4	%		959			0.8	%
Stock Compensation Fair Market Value		(5,027	)	(6.7	%)	N/A			N/A			N/A			N/A
Change in Valuation Allowance		1,182		1.6	%		—			—			—			—
Deferred Tax Expense due to Tax Law Changes		17,107		22.9	%	N/A			N/A			N/A			N/A
Transition Tax		2,587		3.5	%	N/A			N/A			N/A			N/A
Other		355		0.4	%		355			0.2	%		354			0.3	%
Actual Tax Expense and Rate	$	34,312		45.9	%	$	34,783			29.6	%	$	36,417			31.0	%

N/A - Not applicable

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

	December 31,
amounts in thousands	2017			2016
Deferred Tax Assets:
Loss Reserve Discount	$	20,425		$	25,420
Unearned Premiums		24,352			33,886
Compensation Related		8,462			15,288
Lloyd's Year of Account Deferral		9,400			—
State and Local Net Deferred Tax Assets		616			699
Net Currency Translation Adjustments		2,084			5,363
Other		152			3,618
Total Gross Deferred Tax Assets	$	65,491		$	84,274
Less: Valuation Allowance		(1,798	)		(699	)
Total Deferred Tax Assets	$	63,693		$	83,575
Deferred Tax Liabilities:
Loss Reserve Discount - (Transition Rule)	$	(5,066	)	$	—
Net Unrealized Gains/Losses on Securities		(8,708	)		(10,142	)
Deferred Acquisition Costs		(20,670	)		(29,401	)
Lloyd's Year of Account Deferral		—			(15,471	)
Net Unrealized Foreign Exchange		(3,782	)		(3,575	)
Other		(3,196	)		(4,048	)
Total Deferred Tax Liabilities	$	(41,422	)	$	(62,637	)
Net Deferred Income Tax Asset (Liability)	$	22,271		$	20,938

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, 2017, 2016 and 2015. Our Company did not incur any interest or penalties related to unrecognized tax benefits for the years ended December 31, 2017, 2016 and 2015. Our Company is currently under examination by the IRS for tax years 2014 and 2015. In addition, our Company is generally subject to state or local or foreign tax examinations by tax authorities for open tax years in the respective locations.

Our Company had state and local deferred tax assets amounting to potential future tax benefits of $0.6 and $0.7 million as of December 31, 2017 and 2016, respectively. Included in the deferred tax assets are minimal state and local net operating loss carry-forwards. 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, 2017 expire from 2027 to 2035. Additionally, our Company has established a valuation allowance of $1.2 million for our deferred tax asset on our foreign operations in the U.K. Net operating losses were incurred as a result of the catastrophe losses incurred during the third quarter of 2017 and their significance to the 2017 financial results of our Company’s international operations. U.K. net operating losses have the ability to be carried forward without expiration. However, upon evaluation, management determined that a valuation allowance was necessary for a portion of the deferred tax assets where it was more likely than not that the deferred tax assets would not be utilized in future periods.

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, 2017, net of any valuation allowance.