Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes [Abstract]

Income Taxes

19.    Income Taxes

Total income taxes for continuing operations were as follows.

Year Ended December 31,	2011			2010			2009
	(in millions)
Provision (benefit) for income taxes	$	227		$	439		$	(98	)
Income taxes related to adjustments included in common shareholder’s equity:
Unrealized gains (losses) on securities available-for-sale, net		552			96			248
Unrealized gains (losses) on derivatives classified as cash flow hedges		(110	)		10			101
Employer accounting for post-retirement plans		(3	)		(2	)		-
Other-than-temporary impairment		1			30			(31	)
Total	$	667		$	573		$	220

The components of income tax expense (benefit) follow.

Year Ended December 31,	2011			2010		2009
	(in millions)
Current:
Federal	$	316		$	85	$	300
State and local		143			33		34
Foreign		57			47		29
Total current		516			165		363
Deferred, primarily federal		(289	)		274		(461	)
Total income tax expense (benefit)	$	227		$	439	$	(98	)

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.

Year Ended December 31,	2011					2010					2009
	(dollars are in millions)
Tax expense (benefit) at the U.S. federal statutory income tax rate	$	239		35.0	%	$	506		35.0	%	$	(93	)	(35.0	)%
Increase (decrease) in rate resulting from:
State and local taxes, net of Federal benefit		92		13.5			28		1.9			19		7.2
Sale of minority stock interest		-		-			-		-			74		27.9
Adjustment of tax rate used to value deferred taxes		-		-			(84	)	(5.8	)		(2	)	(.8	)
Valuation allowance		(217	)	(31.8	)		(26	)	(1.8	)		4		1.5
IRS audit settlement		-		-			-		-			(8	)	(3.0	)
Accrual of tax reserves		161		23.6			75		5.2			2		.8
Impact of foreign operations		63		9.2			56		3.9			29		10.9
Tax exempt interest income		(10	)	(1.5	)		(12	)	(.8	)		(14	)	(5.3	)
Low income housing and other tax credits		(115	)	(16.9	)		(111	)	(7.7	)		(114	)	(43.0	)
Non-taxable income		(4	)	(.6	)		(5	)	(.3	)		(6	)	(2.3	)
Other		18		2.6			12		.8			11		4.5
Total income tax expense (benefit)	$	227		33.3	%	$	439		30.4	%	$	(98	)	(36.6	)%

The effective tax rate from continuing operations for 2011 was significantly impacted by expense from foreign operations, the utilization of low income housing tax credits, the impact of state taxes, an adjustment in uncertain tax positions and the release of valuation allowance previously established on foreign tax credits. The effective tax rate from continuing operations for 2010 was significantly impacted by the substantially higher level of pre-tax income, an increased level of low income housing tax credits, an adjustment of uncertain tax positions, the release of valuation allowance reserves on previously unrealizable deferred tax assets related to loss carryforwards and an adjustment of the tax rate used to record deferred taxes. The effective tax rate for 2009 was significantly impacted by the relative level of pre-tax income, the sale of a minority stock interest that was treated as a dividend for tax purposes and the effective settlement of an Internal Revenue Service audit of our 2004 and 2005 federal income tax returns with respect to agreed-upon items.

The components of the net deferred tax position are presented in the following table.

At December 31,	2011		2010
	(in millions)
Deferred tax assets:
Allowance for credit losses	$	369	$	640
Benefit accruals		145		120
Accrued expenses not currently deductible		281		277
Tax credit carry-forwards		145		167
Interest and discount income		74		61
Fair value adjustments		-		128
Other		788		170
Total deferred tax assets before valuation allowance		1,802		1,563
Valuation allowance		-		(217	)
Total deferred tax assets		1,802		1,346
Less deferred tax liabilities:
Fair value adjustments		172		-
Unrealized gains (losses) on available-for-sale securities		606		66
Mortgage servicing rights		85		102
Total deferred tax liabilities		863		168
Net deferred tax asset	$	939	$	1,178

The deferred tax valuation allowance is attributed to the following deferred tax assets, that based on the available evidence, it is more-likely-than-not that the deferred tax asset will not be realized:

At December 31,	2011		2010
	(in millions)
State tax benefit loss limitations	$	-	$	68
Foreign tax credit carryforward		-		80
State tax deferreds		-		69
Total	$	-	$	217

A reconciliation of the beginning and ending amount of unrecognized tax benefits (hereinafter referred to as uncertain tax reserves) is as follows.

	2011			2010			2009
	(in millions)
Balance at January 1,	$	210		$	88		$	136
Additions based on tax positions related to the current year		105			62			3
Additions for tax positions of prior years		145			84			1
Reductions for tax positions of prior years		(44	)		(24	)		(52	)
Balance at December 31,	$	416		$	210		$	88

The state tax portion of this amount is reflected gross and not reduced by Federal tax effect. 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. The total amount of unrecognized tax benefits at December 31, 2011 that, if recognized, would affect the effective income tax rate is $276 million and $113 million at December 31, 2011 and 2010, respectively.

It is our policy to recognize accrued interest related to unrecognized tax positions in interest expense in the consolidated statement of income and to recognize penalties, if any, related to unrecognized tax positions as a component of other operating expenses in the consolidated statement of income. We had accruals for the payment of interest and penalties associated with uncertain tax positions of $139 million and $40 million at December 31, 2011 and 2010, respectively. We increased our accrual for the payment of interest and penalties associated with uncertain tax positions by $99 million and $16 million during 2011 and 2010, respectively.

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 North American 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 realizability 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 they remain fully committed and have the capacity and willingness to provide capital as needed 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 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.

During the first quarter of 2011, the HNAH Group identified an additional tax planning strategy that provides support for the realization of the deferred tax assets recorded for its foreign tax credits and certain state related deferred tax assets. The use of foreign tax credits is limited by the HNAH Group’s U.S. tax liability and the availability of foreign source income. The tax planning strategy included the purchase of foreign bonds and REMIC residual interests. These purchases are expected to generate sufficient foreign source taxable income to allow for the utilization of the foreign tax credits before the credits expire and recognition of certain state deferred tax assets.

Notwithstanding the above, the HNAH Group had valuation allowances against certain state deferred tax assets and certain Federal tax loss carryforwards prior to 2011 for which 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, net of both deferred tax liabilities and valuation allowances, totaled $0.9 billion and $1.2 billion as of December 31, 2011 and 2010, respectively. The decrease in net deferred tax assets is primarily due to the reduction in the allowance for credit losses and a decrease in the overall net unrealized losses on available-for-sale securities.

During the second quarter of 2011, we reached a pending resolution of an issue with the Internal Revenue Service (“IRS”) Appeals Office covering the tax periods 2004 and 2005. We anticipate finalizing the resolution of this matter within the next twelve months. There is no resulting impact to our uncertain tax reserves.

The IRS began its audit of our 2006 and 2007 income tax returns in 2009, with an anticipated completion in 2012. The IRS began their examination of 2008 and 2009 during the third quarter of 2011, with an anticipated completion in 2013.

We remain subject to state and local income tax examinations for years 2000 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. As a result of a recent state court decision related to a state tax uncertainty, we no longer believe that we can uphold the more likely than not conclusion taken on one of these uncertain tax positions. Therefore, tax reserves of approximately $225 million and related accrued interest expense of $116 million were recorded through the fourth quarter of 2011 to recognize the estimated tax exposure on this matter.

At December 31, 2011, we had foreign tax credit carryforwards of $74 million for U.S. federal income tax purposes which expire as follows: $8 million in 2015, $22 million in 2016, $5 million in 2017, $23 million in 2018, $8 million in 2019 and $8 million in 2020.

At December 31, 2011, we had general business credit carryforwards of $52 million for U.S. federal income tax purposes which expire as follows: $16 million in 2028 and $36 million in 2029.

At December 31, 2011 we had net operating losses carryforwards of $1.1 billion for state tax purposes which expire as follows: $33 million in 2012 – 2016, $2 million in 2022 – 2026 and $1.0 billion in 2027 and forward

At December 31, 2011 we had general business tax credits carryforwards of $1 million for state income tax purposes with no expiration period.

As of December 31, 2011, the HNAH Group had not provided for withholding or U.S. Federal income taxes on current or prior year undistributed earnings of certain foreign subsidiaries since such earnings are expected to be reinvested indefinitely or be substantially offset by available foreign tax credits and operating loss carry forwards. As of December 31, 2011 and 2010, we had approximately $175 million of undistributed earnings in our foreign subsidiaries. It is not practicable to determine the amount of unrecognized deferred U.S. income tax liability on these unremitted earnings.