Income Taxes

The following table is an analysis of the difference between effective rates based on the total income tax provision attributable to pretax income and the statutory U.S. Federal income tax rate.



	2013					2012
	(dollars are in millions)
Three Months Ended June 30, 2013
Tax expense at the U.S. federal statutory income tax rate	$	80		35.0	%	$	(84	)	(35.0	)%
Increase (decrease) in rate resulting from:
State and local taxes, net of federal benefit	13			5.7		16			6.6
Non-deductible expense accrual related to certain regulatory matters⁽¹⁾	—			—		245			101.2
Non-deductible goodwill related to branch sale⁽¹⁾	—			—		106			43.8
Other non-deductible / non-taxable items⁽²⁾	(12		)	(5.2	)	(3		)	(1.2	)
Items affecting prior periods⁽³⁾	(12		)	(5.2	)	33			13.6
Uncertain tax adjustments⁽⁴⁾	4			1.7		49			20.2
Impact of foreign operations	1			.4		35			14.5
Low income housing tax credits	(22		)	(9.7	)	(31		)	(12.8	)
Other	(3		)	(1.3	)	(15		)	(5.9	)
Total income tax expense	$	49		21.4	%	$	351		145.0	%

Six Months Ended June 30, 2013
Tax expense at the U.S. federal statutory income tax rate	$	181		35.0	%	$	(50	)	(35.0	)%
Increase (decrease) in rate resulting from:
State and local taxes, net of federal benefit	30			5.8		22			15.3
Adjustment of tax rate used to value deferred taxes	—			—		(10		)	(6.9	)
Non-deductible expense accrual related to certain regulatory matters⁽¹⁾	—			—		245			170.1
Non-deductible goodwill related to branch sale⁽¹⁾	—			—		106			73.6
Other non-deductible / non-taxable items⁽²⁾	(9		)	(1.7	)	(8		)	(5.6	)
Items affecting prior periods⁽³⁾	(22		)	(4.3	)	33			22.9
Uncertain tax adjustments⁽⁴⁾	18			3.5		65			45.1
Impact of foreign operations	4			.8		21			14.6
Low income housing tax credits	(43		)	(8.3	)	(42		)	(29.2	)
Other	(6		)	(1.1	)	(13		)	(8.6	)
Total income tax expense	$	153		29.7	%	$	369		256.3	%


⁽¹⁾	Relates to non-deductible expense related to certain regulatory matters and non-deductible goodwill related to the branches sold to First Niagara in 2012.


⁽²⁾	Mainly relates to a change in the assessment of the deductibility of certain amounts accrued for certain regulatory matters.


⁽³⁾	Relates to corrections to current and deferred tax balance sheet accounts.


⁽⁴⁾	Reflects changes in state uncertain tax positions which no longer meet the more likely than not requirement for recognition.

It is reasonably possible that there could be a change in the amount of our unrecognized tax benefits within the next 12 months due to settlements or statutory expirations in various tax jurisdictions. The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate is $332 million and $314 million at June 30, 2013 and December 31, 2012, respectively.

It is our policy to recognize accrued interest related to unrecognized tax positions in interest expense in the consolidated statement of income (loss) and to recognize penalties, if any, related to unrecognized tax positions as a component of other operating expenses in the consolidated statement of income (loss). We had accruals for the payment of interest associated with uncertain tax positions of $182 million and $159 million at June 30, 2013 and December 31, 2012, respectively. We have no penalty accruals recorded as of June 30, 2013.

HSBC North America Consolidated Income Taxes We are included in HSBC North America's consolidated Federal income tax return and in various combined state income tax returns. As such, we have entered into a tax allocation agreement with HSBC North America and its subsidiary entities (the “HNAH Group”) included in the consolidated returns which govern the current amount of taxes to be paid or received by the various entities included in the consolidated return filings. As a result, we have looked at the HNAH Group's consolidated deferred tax assets and various sources of taxable income, including the impact of HSBC and HNAH Group tax planning strategies, in reaching conclusions on recoverability of deferred tax assets. Where a valuation allowance is determined to be necessary at the HSBC North America consolidated level, such allowance is allocated to principal subsidiaries within the HNAH Group as described below in a manner that is systematic, rational and consistent with the broad principles of accounting for income taxes.

The HNAH Group evaluates deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical financial performance, projections of future taxable income, future reversals of existing taxable temporary differences, tax planning strategies and any available carryback capacity.

In evaluating the need for a valuation allowance, the HNAH Group estimates future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC necessary as part of such plans and strategies. The HNAH Group has continued to consider the impact of the economic environment on the U.S. businesses and the expected growth of the deferred tax assets. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period.

In conjunction with the HNAH Group deferred tax evaluation process, based on our forecasts of future taxable income, which include assumptions about the depth and severity of home price depreciation and the U.S. economic environment, including unemployment levels and their related impact on credit losses, we currently anticipate that our results of future operations will generate sufficient taxable income to allow us to realize our deferred tax assets. However, since these market conditions have created losses in the HNAH Group in recent periods and volatility in our pre-tax book income, our analysis of the recoverability of the deferred tax assets significantly discounts any future taxable income expected from continuing operations and relies to a greater extent on continued capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. HSBC has indicated it remains fully committed and has the capacity and willingness to provide capital as needed to run operations, maintain sufficient regulatory capital, and fund certain tax planning strategies. As financial performance in our U.S. operations improves, it is anticipated that reliance may be placed on projected future operating income in management's evaluation of the recognition of the deferred tax assets.

Only those tax planning strategies that are both prudent and feasible, and which management has the ability and intent to implement, are incorporated into our analysis and assessment. The primary and most significant strategy is HSBC's commitment to reinvest excess HNAH Group capital to reduce debt funding or otherwise invest in assets to ensure that it is more likely than not that the deferred tax assets will be utilized.

Currently, it has been determined that the HNAH Group's primary tax planning strategy, in combination with other tax planning strategies, provides support for the realization of the net deferred tax assets recorded for the HNAH Group. Such determination is based on HSBC's business forecasts and assessment as to the most efficient and effective deployment of HSBC capital, most importantly including the length of time such capital will need to be maintained in the U.S. for purposes of the tax planning strategy.

Notwithstanding the above, the HNAH Group had valuation allowances against certain state deferred tax assets and certain Federal tax loss carry forwards for which the aforementioned tax planning strategies did not provide appropriate support.

HNAH Group valuation allowances are allocated to the principal subsidiaries, including us. The methodology allocates the valuation allowance to the principal subsidiaries based primarily on the entity's relative contribution to the growth of the HSBC North America consolidated deferred tax asset against which the valuation allowance is being recorded.

If future results differ from the HNAH Group's current forecasts or the tax planning strategies were to change, a valuation allowance against some or all of the remaining net deferred tax assets may need to be established which could have a material adverse effect on our results of operations, financial condition and capital position. The HNAH Group will continue to update its assumptions and forecasts of future taxable income, including relevant tax planning strategies, and assess the need for such incremental valuation allowances.

Absent the capital support from HSBC and implementation of the related tax planning strategies, the HNAH Group, including us, would be required to record a valuation allowance against the remaining deferred tax assets.

HSBC USA Inc. Income Taxes We recognize deferred tax assets and liabilities for the future tax consequences related to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits and state net operating losses. Our net deferred tax assets, including deferred tax liabilities and valuation allowances, totaled $1.4 billion and $905 million as of June 30, 2013 and December 31, 2012, respectively.

The Internal Revenue Service is currently auditing our income tax returns for the period 2006 through 2009 with an anticipated completion in the second half of 2013. We remain subject to state and local income tax examinations for years 2004 and forward. We are currently under audit by various state and local tax jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law and the closing of statutes of limitations. Such adjustments are reflected in the tax provision. As a result of a 2011 state court decision related to a state tax uncertainty, we do not believe that we can uphold the more likely than not conclusion taken on one of these uncertain tax positions. At June 30, 2013, total tax reserves are $270 million (net of federal tax benefit) along with related accrued interest expense of $150 million in relation to the estimated exposure on this matter.