Income Taxes

The components of our consolidated income tax (benefit) provision are as follows:



	Year Ended December 31,
(In thousands)	2013			2012		2011
Current	$	21,750		$	1,271	$	59,604
Deferred	(31,820		)	6,000		6,758
Total income tax (benefit) provision	$	(10,070	)	$	7,271	$	66,362

The reconciliation of taxes computed at the statutory tax rate of 35% for 2013, 2012 and 2011 to the provision for income taxes is as follows:



	Year Ended December 31,
(In thousands)	2013			2012			2011
(Benefit) provision for income taxes computed at the statutory tax rate	$	(72,469	)	$	(155,469	)	$	128,979
Change in tax resulting from:
Tax-exempt municipal bond interest and dividends received deduction (net of proration)	(2,390		)	(3,101		)	(5,237		)
Foreign tax (benefit) expense	(1		)	146			(13,496		)
State tax expense (benefit)	1,468			4,003			(6,224		)
Unrecognized tax expense (benefit)	1,696			(2,906		)	17,860
Deferred inventory adjustment related to fair value of derivatives and other financial instruments	—			(23,217		)	—
Valuation allowance	59,783			188,290			(50,582		)
Other, net	1,843			(475		)	(4,938		)
(Benefit) provision for income taxes	$	(10,070	)	$	7,271		$	66,362

The significant components of our net deferred tax assets and liabilities are summarized as follows:



	December 31,
(In thousands)	2013		2012
Deferred tax assets:
Accrued expenses	$	79,460	$	51,049
Unearned premiums	54,993		36,060
PDR	625		1,290
Net operating loss (“NOL”)	642,333		666,633
Differences in fair value of derivative and other financial instruments	130,773		54,335
Rescission premium	5,964		16,797
State NOL carryforward	33,095		31,744
Foreign tax credit carryforward	26,292		26,292
Depreciation	6,366		5,478
Partnership investments	75,100		65,704
Loss reserves	28,257		39,540
Residual interest in LPV	22,957		24,084
Other	40,657		53,319
Total deferred tax assets	1,146,872		1,072,325
Deferred tax liabilities:
Deferred policy acquisition costs	23,435		30,882
Convertible and other long-term debt	47,579		28,449
Net unrealized gain on investments	20,030		8,783
Foreign currency	18		18
Other	15,628		14,536
Total deferred tax liabilities	106,690		82,668
Valuation allowance	1,022,280		989,657
Net DTA	$	17,902	$	—

As of December 31, 2013, we recorded a net current income tax payable of approximately $151.1 million, which primarily consists of liabilities related to applying the standards of accounting for uncertainty in income taxes and a current federal income tax recoverable of approximately $3.9 million. For federal income tax purposes, we have approximately $1.8 billion of NOL carryforwards and $26.3 million of foreign tax credit carryforwards as of December 31, 2013. To the extent not utilized, the NOL carryforwards will expire during tax years 2028 through 2032 and the foreign tax credit carryforwards will expire during tax years 2018 through 2020. Certain entities within our consolidated group have also generated deferred tax assets of approximately $33.1 million relating to state and local NOL carryforwards, which if unutilized, will expire during various future tax periods.

A valuation allowance of approximately $1,022.3 million and $989.7 million was recorded against our net DTA of approximately $1,040.2 million and $989.7 million at December 31, 2013 and 2012, respectively. The remaining DTA of approximately $17.9 million at December 31, 2013 represents our NOL carryback, which we may be able to utilize as part of an overall settlement of proposed Internal Revenue Service (”IRS”) adjustments relating to tax years 2000 through 2007. For the year ended December 31, 2013, our valuation allowance increased by approximately $32.6 million. This increase consisted of a $59.8 million increase through continuing operations, a $0.2 million decrease through other comprehensive income, and a $27.0 million decrease through additional paid-in capital. The $27.0 million decrease through additional paid-in capital related to our Convertible Senior Notes due 2019.

Our ability to fully use our tax assets such as NOLs and tax credit carryforwards would be substantially limited if we experience an “ownership change” within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”). Section 382 rules governing when a change in ownership occurs are complex and subject to interpretation; however, in general, an ownership change would occur if any five percent shareholders, as defined under Section 382, collectively increase their ownership by more than 50 percentage points over a rolling three-year period. As of December 31, 2013, we have not experienced an ownership change under Section 382. However, if we were to experience a change in ownership under Section 382 in a future period, then we may be limited in our ability to fully utilize our NOL and tax credit carryforwards in future periods.

On October 8, 2009, we adopted a Tax Benefit Preservation Plan (the “Plan”), which, as amended, was approved by our stockholders at our 2010 and 2013 annual meetings. We also adopted certain amendments to our amended and restated bylaws (the “Bylaw Amendment”) and at our 2010 annual meeting, our stockholders approved certain amendments to our amended and restated certificate of incorporation (the “Charter Amendment”), which our stockholders reapproved at our 2013 annual meeting. The Plan, the Bylaw Amendment and the Charter Amendment were implemented in order to protect our ability to utilize our NOLs and other tax assets and prevent an “ownership change” under U.S. federal income tax rules by restricting or discouraging certain transfers of our common stock that would: (i) create or result in a person becoming a five-percent shareholder under Section 382; or (ii) increase the stock ownership of any existing five-percent shareholder under Section 382.

We are currently contesting proposed adjustments resulting from the examination by the IRS of our 2000 through 2007 consolidated federal income tax returns. The IRS opposes the recognition of certain tax losses and deductions that were generated through our investment in a portfolio of non-economic REMIC residual interests and has proposed adjustments denying the associated tax benefits of these items. The proposed adjustments relating to the 2000 through 2007 tax years, if sustained, would result in additional income taxes of approximately $128 million plus proposed penalties of approximately $42 million. Additionally, we would incur interest expense on any sustained adjustments. We appealed these proposed adjustments to the IRS Office of Appeals (“Appeals”) and made “qualified deposits” with the U.S. Department of the Treasury (“U.S. Treasury”) in the amount of approximately $85 million in June 2008 relating to the 2000 through 2004 tax years and approximately $4 million in May 2010 relating to the 2005 through 2007 tax years in order to avoid the accrual of above-market-rate interest with respect to the proposed adjustments.

We have made several attempts to reach a compromised settlement with Appeals, but in January 2013, we were notified that Appeals had rejected our latest settlement offer and plans to issue the formal notice of deficiency. Upon receipt of that notice, we will have 90 days to either pay the assessed tax liabilities, penalties and interest (the “deficiency amount”) in full or petition the U.S. Tax Court to litigate the deficiency amount. Litigation of the deficiency amount may result in substantial legal expenses and the litigation process could take several years to resolve. We can provide no assurance regarding the outcome of any such litigation or whether a compromised settlement with the IRS will ultimately be reached. After discussions with counsel about the issues raised in the examination, we believe that an adequate provision for income taxes has been made for the potential liabilities that may result from this matter. However, if the ultimate resolution of this matter produces a result that differs materially from our current expectations, there could be a material impact on our effective tax rate, results of operations and cash flows.

As of December 31, 2013, we have approximately $60.7 million of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Our policy for the recognition of interest and penalties associated with uncertain tax positions is to record such items as a component of our income tax provision. The table below details the cumulative effect of applying the provisions of the standard relating to accounting for uncertainty of income taxes as of December 31, 2013.

The effect of unrecognized tax benefits on our consolidated balance sheets and results of operations is as follows:



(In thousands)	December 31, 2012		Increase		December 31, 2013
Unrecognized tax benefits	$	114,013	$	5,223	$	119,236
Unrecognized tax benefits that, if recognized, would affect the effective tax rate	$	58,994	$	1,696	$	60,690
Interest and penalties accrued	$	53,002	$	5,348	$	58,350
Interest and penalties charged to income tax benefit					$	5,348

A reconciliation of the beginning and ending unrecognized tax benefits is as follows:



	Year Ended December 31,
(In thousands)	2013			2012
Balance at beginning of period	$	114,013		$	125,757
Tax positions related to the current year:
Increases	2,363			1,209
Decreases	—			(1,624		)
Tax positions related to prior years:
Increases	29,962			27,302
Decreases	(3,615		)	(4,243		)
Lapses of applicable statute of limitation	(23,487		)	(34,388		)
Balance at end of period	$	119,236		$	114,013

We have taken a position in various jurisdictions that we are not required to remit taxes with regard to the income generated from our investment in certain partnership interests. Although we believe that these tax positions are more likely than not to succeed if adjudicated, measurement of the potential amount of liability for state and local taxes and the potential for penalty and interest thereon is performed on a quarterly basis. Our net unrecognized tax benefits related to prior years increased by approximately $26.3 million during 2013. This net increase primarily reflects the impact of unrecognized tax benefits associated with our recognition of certain premium income. Although unrecognized tax benefits for this item decreased by approximately $21.3 million due to the expiration of the applicable statute of limitations for the taxable period ended December 31, 2009, the related amounts continued to impact subsequent years resulting in a corresponding increase to the unrecognized tax benefits related primarily to the 2010 taxable year.

As discussed above, in January 2013, we were notified that Appeals rejected our latest settlement offer, with regard to the proposed IRS adjustments described above, and plans to issue a formal notice of deficiency. Based on these developments, we do not currently believe that a settlement is likely, and we expect to litigate the disputed amounts. Over the next 12 months, if we determine that a compromised settlement cannot be reached with the IRS, then it is estimated that approximately $73.7 million of unrecognized tax benefits in the above tabular reconciliation may be reversed pursuant to the accounting standard for uncertain tax positions.

In the event we are not successful in defense of our tax positions taken for U.S. Federal income tax purposes, and for which we have recorded unrecognized tax benefits, then such adjustments originating in NOL or NOL carryback years may serve as a reduction to our existing NOL.

The following calendar tax years, listed by major jurisdiction, remain subject to examination:



U.S. Federal Corporation Income Tax	2000 - 2007(1), 2010 - 2012
Significant State and Local Jurisdictions (2)	1999 - 2012

_________________________

(1)

We are currently contesting proposed adjustments resulting from the examination by the IRS of our 2000 through 2007 consolidated federal income tax returns. As part of this process, we have agreed to extend all relevant statute of limitations for the assessment of tax to June 30, 2014. All such statute of limitation extensions have limited the scope of the examinations to the recognition of certain tax benefits that relate to our investment in a portfolio of non-economic REMIC residual interests.


(2)	Arizona, California, Florida, Georgia, New York, Ohio, Pennsylvania, Texas and New York City.