Income Taxes

Total income taxes for continuing operations were as follows:



Year Ended December 31,	2014			2013			2012
	(in millions)
Provision (benefit) for income taxes	$	(56	)	$	156		$	422
Income taxes related to adjustments included in common shareholder’s equity:
Unrealized gains (losses) on investment securities, net	114			(697		)	76
Unrealized gains (losses) on derivatives classified as cash flow hedges	(46		)	82			17
Employer accounting for post-retirement plans	(4		)	6			5
Other-than-temporary impairment on debt securities	43			(43		)	—
Total	$	51		$	(496	)	$	520

The components of income tax expense (benefit) were as follows:



Year Ended December 31,	2014			2013		2012
	(in millions)
Current:
Federal	$	(35	)	$	102	$	238
State and local	(222		)	35		173
Foreign	16			17		(28		)
Total current	(241		)	154		383
Deferred	185			2		39
Total income tax expense (benefit)	$	(56	)	$	156	$	422

The significant components of deferred provision (benefit) attributable to income from continuing operations were:



Year Ended December 31,	2014		2013			2012
	(in millions)
Deferred income tax provision (benefit) (excluding the effects of other components)	$	144	$	31		$	(86	)
Increase in Federal operating loss carryforwards	1		—			—
Increase in state valuation allowance	11		—			—
(Increase) decrease in foreign and general business tax credits	29		(29		)	125
Deferred income tax provision (benefit)	$	185	$	2		$	39

The following table provides 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:



Year Ended December 31,	2014					2013					2012
	(dollars are in millions)
Tax expense (benefit) at the U.S. federal statutory income tax rate	$	104		35.0	%	$	(64	)	(35.0	)%	$	(289	)	(35.0	)%
Increase (decrease) in rate resulting from:
State and local taxes, net of federal benefit	15			5.0		22			12.1		46			5.6
Adjustment of tax rate used to value deferred taxes⁽¹⁾	63			21.1		—			—		(13		)	(1.6	)
Non-deductible expense accrual related to certain regulatory matters⁽²⁾	—			—		—			—		483			58.5
Non-deductible goodwill related to branch sale⁽²⁾	—			—		—			—		139			16.8
Non-deductible goodwill impairment⁽³⁾	—			—		215			118.1		—			—
Other non-deductible / non-taxable items⁽⁴⁾	—			—		(11		)	(6.0	)	(4		)	(0.5	)
Items affecting prior periods⁽⁵⁾	(29		)	(9.7	)	(13		)	(7.1	)	—			—
Uncertain tax positions⁽⁶⁾	(192		)	(64.4	)	20			11.0		45			5.4
Impact of foreign operations⁽⁷⁾	—			—		13			7.1		51			6.2
Low income housing tax credit investments⁽⁸⁾	(26		)	(8.7	)	(28		)	(15.4	)	(29		)	(3.5	)
Change in valuation allowances reserves⁽⁹⁾	10			3.4		—			—		—			—
Other	(1		)	(0.3	)	2			1.1		(7		)	(.8	)
Total income tax expense (benefit)	$	(56	)	(18.8	)%	$	156		85.7	%	$	422		51.1	%


⁽¹⁾	For 2014, the amount relates to the effects of revaluing our deferred tax assets as a result of New York State Tax Reform that was enacted on March 31, 2014.


⁽²⁾	Represents non-deductible expense relating to certain regulatory matters and non-deductible goodwill related to the branches sold to First Niagara in 2012.


⁽³⁾	Represents non-deductible goodwill impairment related to our GB&M reporting unit in 2013.


⁽⁴⁾	The amounts mainly relate to tax exempt interest income net of non-deductible interest expense. For 2013, the amount includes a reversal of penalty exposure.

⁽⁵⁾

For 2014, the amount relates to changes in estimates as a result of filing the Federal and State income tax returns and a change in state tax expense as a result of filing amended State tax returns upon the closing of the Federal audits for the 2006 - 2009 tax years. For 2013, the amount relates to corrections to current and deferred tax balance sheet accounts and changes in estimates as a result of filing the Federal and State income tax returns.


⁽⁶⁾	For 2014, the amount mainly reflects the resolution and settlement with taxation authorities of certain significant state and local tax audits during the second quarter of 2014 which is discussed further below. For 2013 and 2012, the amounts relate to changes in state uncertain tax positions which no longer meet the more likely than not requirement for recognition.


⁽⁷⁾	For 2013 and 2012, the amounts relate to foreign (United Kingdom) tax expense for which no foreign tax credits were allowed.


⁽⁸⁾	The amounts reflect the early adoption of ASU 2014-01 which permits an investor to amortize its Low Income Housing Tax Credit investments in proportion to the Low Income Housing tax benefits and present such benefits net of investment amortization in the tax line.


⁽⁹⁾	For 2014, the amount relates to the establishment of a valuation allowance against our deferred tax assets as a result of New York State Tax Reform that was enacted on March 31, 2014.

The components of the net deferred tax asset are presented in the following table:



At December 31,	2014			2013
	(in millions)
Deferred tax assets:
Allowance for credit losses	$	265		$	250
Employee benefit accruals	130			142
Accrued expenses	143			111
Unused tax benefit carry-forwards	16			46
Bond premium amortization	284			226
Future federal tax benefit of state uncertain tax reserves	6			171
Interests in real estate mortgage investment conduits⁽¹⁾	453			309
Other	398			499
Total deferred tax assets	1,695			1,754
Valuation allowance⁽²⁾	(11		)	—
Total deferred tax assets less valuation allowance	1,684			1,754
Deferred tax liabilities:
Fair value adjustments	71			22
Unrealized gain (loss) on investment securities	103			(8		)
Mortgage servicing rights	62			96
Capitalized costs	42			34
Others	53			53
Total deferred tax liabilities	331			197
Net deferred tax asset	$	1,353		$	1,557

¹⁾

Real estate mortgage investment conduits ("REMICs") are investment vehicles that hold commercial and residential mortgages in trust and issue securities representing an undivided interest in these mortgages. HSBC Bank USA holds portfolios of noneconomic residual interests in a number of REMICs. This item represents tax basis in such interests which has accumulated as a result of tax rules requiring the recognition of income related to such noneconomic residuals.


²⁾	The deferred tax valuation allowance is attributed to state temporary differences that, based on available evidence, it is more-likely-than-not that the deferred tax asset will not be realized. The valuation allowance was established as a result of New York State Tax Reform that was enacted on March 31, 2014.

A reconciliation of the beginning and ending amount of unrecognized tax benefits related to uncertain tax positions is as follows:



	2014			2013			2012
	(in millions)
Balance at January 1,	$	540		$	478		$	416
Additions based on tax positions related to the current year	18			16			86
Reductions based on tax positions related to the current year	(10		)	(5		)	(31		)
Additions for tax positions of prior years	5			66			32
Reductions for tax positions of prior years	(337		)	(15		)	(15		)
Reductions related to settlements with taxing authorities	(202		)	—			(10		)
Balance at December 31,	$	14		$	540		$	478

During the second quarter of 2014, we concluded certain state and local tax audits resulting in the settlement of significant uncertain tax positions covering a number of years. As a result, we released tax reserves previously maintained in relation to the periods and issues under review which resulted in an income tax benefit of $183 million. In addition, we released our accrued interest associated with the tax reserves released which resulted in a $120 million benefit to interest expense.

The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate was $11 million, $334 million and $314 million at December 31, 2014, 2013 and 2012, respectively. Included in the unrecognized tax benefits are some items the recognition of which would not affect the effective tax rate, such as the tax effect of temporary differences and the amount of state taxes that would be deductible for U.S. federal purposes. 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 state and local tax jurisdictions.

It is our policy to recognize accrued interest related to uncertain tax positions in interest expense in the consolidated statement of income (loss) and to recognize penalties, if any, related to uncertain tax positions as a component of other expenses in the consolidated statement of income (loss). We had accruals for the payment of interest associated with uncertain tax positions of $3 million, $208 million and $159 million at December 31, 2014, 2013 and 2012, respectively. Our accrual for the payment of interest associated with uncertain tax positions decreased by $205 million during 2014 and increased by $49 million during 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 the HNAH Group entities included in the consolidated returns which governs 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 the 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. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period.

Market conditions have created losses in the HNAH Group in recent periods and volatility in our pre-tax book income. As a consequence, our current analysis of the recoverability of the deferred tax assets significantly discounts any future taxable income expected from continuing operations and relies 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 the HNAH Group to run operations, maintain sufficient regulatory capital, and fund certain tax planning strategies.

Only those tax planning strategies that are both prudent and feasible, and for 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 realized.

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 North America'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 has valuation allowances against certain state deferred tax assets and certain Federal tax loss carry forwards for which the aforementioned tax planning strategies do not provide appropriate support.

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

If future events 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 or adjusted which could have a material 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, and adequacy of, any valuation allowances.

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

We expect financial performance for the HNAH Group will continue to improve, and therefore, it is anticipated that reliance may be placed solely on projected future taxable income from continuing operations in management's evaluation of the recognition of the deferred tax assets in future periods as the sustainability of the improving financial performance is demonstrated. The reliance on future taxable income from continuing operations within our evaluation of the recognition of deferred tax assets may result in the reversal of valuation allowances against certain state deferred tax assets. At December 31, 2014, we had recorded approximately $11 million of valuation allowances against these certain state deferred tax assets. These state deferred tax assets represent unitary filing states with partial valuation allowances against net operating loss carryforwards that could be utilized against future taxable income from continuing operations. The actual amount of any reversal of these valuation allowances will depend on a number of factors, including potential prospective legislative developments.

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, for state net operating losses and for state tax credits. Any Federal tax credits that cannot be currently utilized by the consolidated group are effectively transferred to HSBC North America and reflected within the HSBC North America's deferred tax assets. Our net deferred tax assets, including deferred tax liabilities, totaled $1,353 million and $1,557 million as of December 31, 2014 and 2013, respectively.

The Internal Revenue Service concluded its examination of our 2010 through 2011 income tax returns in the fourth quarter of 2014 and forwarded the 2011 Revenue Agents’ Report to the Joint Committee of Taxation (“JCT”) for approval. We received approval from the JCT in December 2014. The final impact did not significantly affect our financial statements.

We remain subject to state and local income tax examinations for years 2003 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 statute of limitations. Such adjustments are reflected in the tax provision.

At December 31, 2014, for Federal tax purposes, we had net operating loss carryforwards of $43 million which expire as follows: $9 million in 2026; $9 million in 2027; $14 million in 2028 and $11 million in 2029.

At December 31, 2014, for State tax purposes, we had pre-apportioned and pre-tax effected net operating loss carryforwards of $21 million which expire as follows: $1 million in 2020 - 2024, $16 million in 2025 - 2029, and $4 million in 2030 and forward.