Income Taxes

9 Months Ended

Sep. 30, 2011

Income Taxes

Income Taxes

12.  Income Taxes

The Company’s effective tax rate on income from continuing operations was 32.5% and 29.7% for the three months ended September 30, 2011 and 2010, respectively. The Company’s effective tax rate on income from continuing operations was 27.8% and 20.7% for the nine months ended September 30, 2011 and 2010, respectively.

The Company is required to establish a valuation allowance for any portion of the deferred tax assets that management believes will not be realized. Included in deferred tax assets is a significant deferred tax asset relating to capital losses that have been recognized for financial statement purposes but not yet for tax return purposes. Under current U.S. federal income tax law, capital losses generally must be used against capital gain income within five years of the year in which the capital losses are recognized for tax purposes. Significant judgment is required in determining if a valuation allowance should be established, and the amount of such allowance if required. Factors used in making this determination include estimates relating to the performance of the business including the ability to generate capital gains. Consideration is given to, among other things in making this determination, (i) future taxable income exclusive of reversing temporary differences and carryforwards, (ii) future reversals of existing taxable temporary differences, (iii) taxable income in prior carryback years, and (iv) tax planning strategies. Based on analysis of the Company’s tax position, management believes it is more likely than not that the results of future operations and implementation of tax planning strategies will generate sufficient taxable income to enable the Company to utilize all of its deferred tax assets. Accordingly, no valuation allowance for deferred tax assets has been established as of September 30, 2011 and December 31, 2010.

Included in the Company’s deferred income tax assets are tax benefits related to capital loss carryforwards of $30 million which will expire beginning December 31, 2015 and tax credits of $103 million which will expire beginning December 31, 2027. As a result of the Company’s ability to file a consolidated U.S. federal income tax return including the Company’s life insurance subsidiaries starting in 2010, as well as the expected level of taxable income, management believes the Company’s capital loss carryforwards and tax credit carryforwards will be utilized before they expire.

As of September 30, 2011 and December 31, 2010, the Company had $168 million and $75 million, respectively, of gross unrecognized tax benefits. If recognized, approximately $44 million and $54 million, net of federal tax benefits, of unrecognized tax benefits as of September 30, 2011 and December 31, 2010, respectively, would affect the effective tax rate.

The Company recognizes interest and penalties related to unrecognized tax benefits as a component of the income tax provision. The Company recognized nil and $65 million of interest and penalties for the three months and nine months ended September 30, 2011, respectively. The Company recognized a net reduction of nil and $20 million of interest and penalties for the three months and nine months ended September 30, 2010, respectively. At September 30, 2011 and December 31, 2010, the Company had a payable of $36 million and a receivable of $29 million, respectively, related to accrued interest and penalties.

It is reasonably possible that the total amounts of unrecognized tax benefits will change in the next 12 months. Based on the current audit position of the Company, it is estimated that the total amount of gross unrecognized tax benefits may decrease by $130 million to $140 million in the next 12 months.

The Company or one or more of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 1997. The Internal Revenue Service (“IRS”) completed its field examination of the Company’s U.S. income tax returns for 2005 through 2007 during the third and fourth quarters of 2010. The IRS had previously completed its field examination of the 1997 through 2004 tax returns in recent years as part of the overall examination of the American Express Company consolidated returns. However, for federal income tax purposes these years continue to remain open as a consequence of certain unagreed issues. In the fourth quarter of 2010, the IRS commenced an examination of the Company’s U.S income tax returns for 2008 and 2009. The Company’s or certain of its subsidiaries’ state income tax returns are currently under examination by various jurisdictions for years ranging from 1999 through 2009.

On September 25, 2007, the IRS issued Revenue Ruling 2007-61 in which it announced that it intends to issue regulations with respect to certain computational aspects of the Dividends Received Deduction (“DRD”) related to separate account assets held in connection with variable contracts of life insurance companies. Any regulations that the IRS ultimately proposes for issuance in this area will be subject to public notice and comment, at which time insurance companies and other members of the public will have the opportunity to raise legal and practical questions about the content, scope and application of such regulations. As a result, the ultimate timing and substance of any such regulations are unknown at this time, but they may result in the elimination of some or all of the separate account DRD tax benefit that the Company receives.