Note 11: Income Taxes

Income (loss) from operations before provision (benefit) for income taxes consisted of:


	Years Ended December 31,
In millions	2012		2011		2010
Domestic	$	1,486	$	(2,231)	$	(146)
Foreign		112		(8)		51

Income (loss) before income taxes	$	1,598	$	(2,239)	$	(95)

The Company files a consolidated tax return that includes all of its U.S. subsidiaries and foreign branches. The Company also files tax returns in the United Kingdom (“U.K.”), France, Spain, and various state and local jurisdictions. Income tax expense (benefit) on income (loss) and shareholders’ equity consisted of:


	Years Ended December 31,
In millions	2012		2011		2010
Current taxes:
Federal	$	3	$	(1)	$	91
State		2		1		(17)
Foreign		(6)		15		(1)
Deferred taxes:
Federal		350		(919)		(239)
Foreign		15		(16)		18

Provision (benefit) for income taxes		364		(920)		(148)

Income taxes charged (credited) to shareholders’ equity related to:
Total adjustments due to the adoption of new accounting standards		—		—		(21)
Change in unrealized gains and losses on investments		75		119		112
Change in other-than-temporary impairment losses		42		3		(4)
Change in fair value of derivative instruments		11		3		(7)
Change in foreign currency translation		(2)		(1)		2
Share-based compensation		7		4		3

Total income taxes charged (credited) to shareholders’ equity		133		128		85

Total effect of income taxes	$	497	$	(792)	$	(63)

A reconciliation of the U.S. federal statutory tax rate of 35% to the Company’s effective income tax rate for the years ended December 31, 2012, 2011 and 2010 is presented in the following table:


	Years Ended December 31,
	2012		2011		2010
Federal income tax computed at the statutory rate		35.0%		35.0%		35.0%
Increase (reduction) in taxes resulting from:
Tax-exempt interest		(0.7)%		1.5%		40.2%
Mark-to-market on warrants		(0.7)%		0.3%		(11.2)%
Change in valuation allowance		(5.6)%		6.2%		119.4%
Change in uncertain tax positions		(0.1)%		(1.0)%		(22.3)%
State income tax, net of federal benefit		0.1%		0.0%		11.5%
Out-of-period adjustment		(3.8)%		0.0%		0.0%
Tax return and deferred inventory adjustments		(0.3)%		(0.2)%		(13.6)%
Foreign taxes		(1.2)%		0.1%		(1.8)%
Other		0.1%		(0.8)%		(1.4)%

Effective tax rate		22.8%		41.1%		155.8%

Deferred Tax Asset, Net of Valuation Allowance

The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on tax assets and liabilities is recognized in income in the period that includes the enactment date.

The tax effects of temporary differences that give rise to deferred tax assets and liabilities as of December 31, 2012 and 2011 are presented in the following table:


	As of December 31,
In millions	2012		2011
Deferred tax liabilities:
Unearned premium revenue	$	241	$	174
Loss and loss adjustment expense reserves		—		31
Deferral of cancellation of indebtedness income		114		119
Deferred acquisition costs		102		123
Investments in VIEs		—		154
Net unrealized gains in accumulated other comprehensive income		32		—
Other		64		—

Total gross deferred tax liabilities		553		601

Deferred tax assets:
Compensation and employee benefits		23		40
Loss and loss adjustment expense reserves		112		—
Net operating loss and tax credit carryforwards		441		330
Capital loss carryforward and other-than-temporary impairments		183		236
Net unrealized losses on insured derivatives		982		1,614
Net losses on financial instruments at fair value and foreign exchange		98		58
Net unrealized losses in accumulated other comprehensive income		—		105
Alternative minimum tax credit carryforward		19		22
Net deferred taxes on VIEs		40		73
Other		—		104

Total gross deferred tax assets		1,898		2,582

Valuation allowance		146		236

Net deferred tax asset	$	1,199	$	1,745

The Company establishes a valuation allowance against its deferred tax asset when it is more likely than not that all or a portion of the deferred tax asset will not be realized. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset ultimately depends, in part, on the existence of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carryforward period available under the tax law.

As of December 31, 2012, the Company reported a net deferred tax asset of $1.2 billion. The $1.2 billion net deferred tax asset is net of a $146 million valuation allowance. As of December 31, 2012, the Company had a valuation allowance against a portion of the deferred tax asset related to capital loss carryforwards and losses from asset impairments as these losses are considered capital losses, have a five-year carryforward period, once recognized, and can only offset capital gain income. The December 31, 2012 valuation allowance reflects a decrease of $90 million from the December 31, 2011 valuation allowance of $236 million. The decrease in the valuation allowance for the year ended December 31, 2012 was primarily due to the generation of capital gain income and the use of a tax planning strategy.

The Company has concluded that it is more likely than not that its net deferred tax asset will be realized. In its conclusion, the Company considered the following evidence (both positive and negative):

•

Due to the long-tail nature of the financial guarantee business, MBIA Inc.’s insurance subsidiaries, without regard to any new business, will have a steady stream of scheduled premium earnings with respect to the existing insured portfolio. Additionally, MBIA Corp.’s announcement in February 2008 of a suspension in writing new structured finance transactions and a permanent cessation with respect to insuring new CDS contracts, except in transactions related to the reduction of existing derivative exposure, would not have an impact on the expected earnings related to the existing insured portfolio.

•

The Company performed taxable income projections over a twenty-year period to determine whether it will have sufficient income to offset its deferred tax asset that will generate future ordinary deductions. In this analysis, the Company concluded that premium earnings, even without regard to any new business, combined with investment income, less deductible expenses, will be sufficient to recover its net deferred tax asset. The Company’s taxable income projections used to assess the recoverability of its deferred tax asset include an estimate of future loss and LAE equal to the present value discount of loss reserves already recognized on the balance sheet and an estimate of LAE which is generally insignificant. The Company does not assume additional losses, with the exception of the accretion of its existing present value loss reserves, because the Company establishes case basis reserves on a present value basis based on an estimate of probable losses on specifically identified credits that have defaulted or are expected to default.

•

While the ratings downgrades by the rating agencies have significantly adversely impacted the Company’s ability to write new insurance business, the downgrades did not have a material impact on earnings from the existing insured portfolio, which the Company believes will be sufficient to absorb losses in the event that the cumulative unrealized losses become fully impaired.

•

With respect to installment policies, the Company generally does not have an automatic cancellation provision solely in connection with ratings downgrades. With regard to upfront policies, to the extent that the issuer chooses to terminate a policy, any unearned premium reserve with respect to that policy will be accelerated into earnings (i.e. refundings).

After reviewing all of the evidence available, both positive and negative, MBIA believes that it has appropriately valued the recoverability of its deferred tax assets, net of the valuation allowance, as of December 31, 2012. The Company continues to assess the adequacy of its valuation allowance as additional evidence becomes available. The Company’s recent financial results have been volatile which has impacted management’s ability to accurately project future taxable income. Continued volatility or losses beyond those projected may cause the Company to conclude that certain of the deferred tax assets within the total deferred tax assets of $1.2 billion as of December 31, 2012 may not be realizable. The Company performs an analysis every quarter to review its conclusion as to the ability to realize the deferred tax asset.

Out-of-Period Adjustment

During the fourth quarter of 2012, the Company completed a balance sheet focused analysis to enhance efficiency and accuracy with its deferred income tax balances, and as a result, identified errors to the current and deferred income tax balances. The Company evaluated the materiality of these errors in accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 99, Materiality, and SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, and concluded that these errors, individually and in the aggregate, were immaterial to the year ended December 31, 2012 and all prior periods to which these errors relate. Accordingly, the Company recorded these adjustments in its consolidated financial statements as of and for the year ended December 31, 2012 by increasing the deferred tax asset by $61 million, decreasing “Accumulated other comprehensive income (loss)” by $5 million, decreasing current tax receivable, included in “Other assets” by $6 million and increasing “Net income (loss)” by $60 million. For the years ended December 31, 2011 and 2010, this adjustment would have decreased “Net income (loss)” by $1 million and $22 million, respectively.

Treatment of Undistributed Earnings of Certain Foreign Subsidiaries—“Accounting for Income Taxes—Special Areas”

No U.S. deferred income taxes have been provided on the differences in the book and tax basis in the Company’s carrying value of MBIA UK Insurance Limited and other entities because of the Company’s practice and intent to permanently reinvest these earnings. The cumulative amounts of such differences were $139 million, $15 million and $3 million as of December 31, 2012, 2011 and 2010, respectively. The estimated tax liability with respect to this difference was $17 million as of December 31, 2012.

Accounting for Uncertainty in Income Taxes

The Company’s policy is to record and disclose any change in UTB and related interest and/or penalties to income tax in the consolidated statements of operations. In 2012, the total amount of UTB decreased as a result of settling the 2004-2009 Internal Revenue Service (“IRS”) examination and the 2005-2007 New York State examination, partially offset by a reserve for current year tax positions.


In millions
Unrecognized tax benefit as of January 1, 2010	$	10
The gross amount of the increase/(decrease) in the UTB as a result of tax positions taken:
During a prior year		21
The amounts of decreases in the UTB as a result of the applicable statute of limitations		(5)

Unrecognized tax benefit as of December 31, 2010	$	26
The gross amount of the increase/(decrease) in the UTB as a result of tax positions taken:
During a prior year		21

Unrecognized tax benefit as of December 31, 2011	$	47
The gross amount of the increase/(decrease) in the UTB as a result of tax positions taken:
During the current year		26
The amounts of decreases in the UTB related to settlements with taxing authorities		(26)

Unrecognized tax benefit as of December 31, 2012	$	47

MBIA’s major tax jurisdictions include the U.S. and the U.K. MBIA and its U.S. subsidiaries file a U.S. consolidated federal income tax return. The IRS has concluded its field work with respect to the examination of tax years 2004 through 2009 and on January 12, 2012, the Joint Committee on Taxation notified the Company that the results of the IRS field examination were reviewed and accepted.

The U.K. tax authorities are currently auditing tax years 2005 through 2011. On February 5, 2013, HM Revenue & Customs notified the Company of their request for a meeting to discuss the progress of the audit.

As of December 31, 2012, the Company had a capital loss carryforward of $162 million, which will expire from tax years 2013 through 2017, a NOL carryforward of $1.4 billion, which will expire from tax years 2029 through 2032, and an alternative minimum tax credit carryforward of $19 million, which has an unlimited carryforward period.