Income Taxes

In December 2017, Tax Legislation was signed into law which reduced the Federal corporate income tax rate from 35 percent to 21 percent effective January 1, 2018. During 2017, we increased our income tax provision by $865 million as a result of the Federal corporate tax rate change, due to a lower carrying value of our net deferred tax asset.

Total income taxes was as follows:



Year Ended December 31,	2019			2018			2017
	(in millions)
Provision for income taxes	$	157		$	266		$	1,228
Income tax expense (benefit) included in common equity related to:
Unrealized gains (losses) on investment securities	128			(68		)	127
Unrealized gains (losses) on fair value option liabilities attributable to our own credit spread	(98		)	103			(115		)
Unrealized gains (losses) on derivatives designated as cash flow hedges	3			12			(5		)
Employer accounting for post-retirement plans	(5		)	3			1
Cumulative effect adjustment to initially apply new accounting guidance for stranded tax effects resulting from Tax Legislation⁽¹⁾	—			91			—
Total income taxes	$	185		$	407		$	1,236


⁽¹⁾	Reflects the adoption of new accounting guidance in 2018 which resulted in a cumulative effect adjustment as of January 1, 2018 to reclassify the stranded tax effects resulting from the change in the Federal corporate income tax rate discussed above from accumulated other comprehensive loss to retained earnings.

The components of the provision for income taxes were as follows:



Year Ended December 31,	2019			2018		2017
	(in millions)
Current:
Federal	$	(3	)	$	68	$	795
State and local	35			41		109
Foreign	16			6		21
Total current	48			115		925
Deferred	109			151		303
Provision for income taxes	$	157		$	266	$	1,228

In February 2020, we elected to change the tax accounting method we use to record tax asset disposals effective beginning with our 2019 Federal income tax return. In conjunction with this change, during 2019, we recorded an immaterial out of period adjustment related to prior periods which decreased our current provision for income taxes and increased our deferred provision for income taxes by $47 million in connection with tax asset disposals. This change had no impact on our total provision for income taxes.

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



Year Ended December 31,	2019					2018					2017
	(dollars are in millions)
Tax expense at the U.S. Federal statutory income tax rate	$	57		21.0	%	$	123		21.0	%	$	367		35.0	%
Increase (decrease) in rate resulting from:
State and local taxes, net of Federal benefit	23			8.5		40			6.8		28			2.7
Adjustment of Federal tax rate used to value deferred taxes⁽¹⁾	—			—		(31		)	(5.3	)	865			82.4
Adjustment of State tax rate used to value deferred taxes⁽²⁾	—			—		2			.3		(15		)	(1.4	)
Non-deductible FDIC assessment fees	5			1.9		27			4.6		—			—
Non-deductible goodwill impairment⁽³⁾	77			28.5		—			—		—			—
Other non-deductible / non-taxable items⁽⁴⁾	—			—		107			18.3		1			.1
Items affecting prior periods⁽⁵⁾	7			2.6		(1		)	(.2	)	6			.6
Uncertain tax positions	5			1.9		6			1.0		—			—
Low income housing and other tax credit investments	(13		)	(4.8	)	(5		)	(.9	)	(17		)	(1.6	)
Stock-based compensation	(2		)	(.7	)	(2		)	(.2	)	(8		)	(.8	)
Other	(2		)	(.8	)	—			—		1			.1
Provision for income taxes	$	157		58.1	%	$	266		45.4	%	$	1,228		117.1	%


⁽¹⁾	For 2018, the amount primarily relates to tax return adjustments on certain deferred tax assets impacted by the Federal tax rate change. For 2017, the amount relates to the effects of revaluing our net deferred tax asset for new Tax Legislation that was enacted in December 2017.


⁽²⁾	For 2017, the amount includes an out of period adjustment to our deferred tax asset balance which decreased tax expense by $9 million.


⁽³⁾	Represents non-deductible goodwill impairment related to our Retail Banking and Wealth Management reporting unit in 2019.


⁽⁴⁾	For 2018, the amount primarily relates to non-deductible penalties related to legal matters.

⁽⁵⁾

For 2019, the amount primarily relates to changes in estimates as a result of filing the 2018 Federal income tax return and a reduction in a State and local capital loss carryback claim, partially offset by prior year State audit adjustments. For 2017, the amount relates to the impact of adjustments associated with filing the 2016 State income tax returns and changes in tax credits as a result of filing the 2016 Federal income tax return.

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



At December 31,	2019			2018
	(in millions)
Deferred tax assets:
Allowance for credit losses	$	153		$	131
Interests in real estate mortgage investment conduits⁽¹⁾	181			182
Unrealized losses on investment securities	36			164
Capitalized costs⁽²⁾	595			680
Fair value adjustments	15			—
Other	364			350
Total deferred tax assets	1,344			1,507
Valuation allowance	(8		)	(6		)
Total deferred tax assets, net of valuation allowance	1,336			1,501
Deferred tax liabilities:
Fair value adjustments	—			75
Amortization of intangible assets	18			18
Other	18			22
Total deferred tax liabilities	36			115
Net deferred tax asset	$	1,300		$	1,386

⁽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⁾	Reflects our tax return election to capitalize certain service costs.

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



	2019			2018			2017
	(in millions)
Balance at January 1,	$	24		$	17		$	16
Additions based on tax positions related to the current year	—			2			2
Additions for tax positions of prior years	7			6			—
Reductions for tax positions of prior years	(1		)	—			(1		)
Reductions related to settlements with taxing authorities	—			(1		)	—
Balance at December 31,	$	30		$	24		$	17

The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate was $24 million, $19 million and $13 million at December 31, 2019, 2018 and 2017, respectively. Included in the unrecognized tax benefits are certain 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 tax 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). Accruals for the payment of interest associated with uncertain tax positions totaled $10 million, $7 million and $4 million at December 31, 2019, 2018 and 2017, respectively. Our accrual for the payment of interest associated with uncertain tax positions increased by $3 million during 2019 and by $3 million during 2018.

Deferred tax assets and liabilities are recognized 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. Our net deferred tax assets, including deferred tax liabilities, totaled $1,300 million and $1,386 million at December 31, 2019 and 2018, respectively.

See Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," for further discussion regarding our accounting policy relating to the evaluation, recognition and measurement of both the HNAH Group's and HSBC USA's deferred tax assets and liabilities. In evaluating the need for a valuation allowance at December 31, 2019, it has been determined that HNAH Group projections of future taxable income from U.S. operations based on management approved business plans provide sufficient and appropriate support for the recognition of our net deferred tax assets. At December 31, 2019, we have valuation allowances against certain State capital loss carryforwards for which the aforementioned projections of future taxable income do not provide the appropriate support.

Federal income tax returns for 2016 and forward remain open to examination by the Internal Revenue Service.

We remain subject to State and local income tax examinations for years 2010 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, 2019, for State tax purposes, we had apportioned and pre-tax effected net operating loss carryforwards of $11 million which expire as follows: $10 million in 2025 - 2029 and $1 million in 2030 and beyond.