8. FEDERAL INCOME TAXES

Provisions for federal income taxes have been calculated in accordance with the provisions of ASC 740. A summary of the federal income tax expense in the Consolidated Statements of Income is shown below:


FOR THE YEARS ENDED DECEMBER 31	2010		2009		2008
*(In millions)*
Federal income tax expense:
Current	$	5.7	$	51.2	$	17.5
Deferred		52.2		31.9		62.4

	$	57.9	$	83.1	$	79.9

The federal income tax expense attributable to the consolidated results of operations is different from the amount determined by multiplying income before federal income taxes by the statutory federal income tax rate of 35%. The sources of the difference and the tax effects of each were as follows:


FOR THE YEARS ENDED DECEMBER 31	2010			2009			2008
*(In millions)*
Expected federal income tax expense	$	73.9		$	94.8		$	57.5
Change in valuation allowance		(57.1	)		(6.9	)		34.2
Expired capital loss carryforward		47.4			—			—
Tax difference related to investment disposals and maturities		(3.2	)		—			—
Tax-exempt interest		(2.2	)		(3.1	)		(3.9	)
Dividend received deduction		(0.8	)		(0.8	)		(0.6	)
Tax credits		(0.4	)		(1.5	)		(2.1	)
Prior years' federal income tax settlement		—			(0.3	)		(6.4	)
Changes in other tax estimates		—			—			(0.2	)
Other, net		0.3			0.9			1.4

Federal income tax expense	$	57.9		$	83.1		$	79.9

Effective tax rate		27.4	%		30.7	%		48.6	%

The following are the components of the Company's deferred tax assets and liabilities (excluding those associated with discontinued operations).


DECEMBER 31	2010			2009
*(In millions)*
Deferred tax assets (liabilities)
Insurance reserves	$	171.8		$	157.3
Deferred acquisition costs		(120.9	)		(100.8	)
Tax credit carryforwards		111.1			112.1
Capital losses		69.2			228.6
Employee benefit plans		38.3			70.0
Software capitalization		(28.3	)		(27.0	)
Investments, net		23.4			(28.1	)
Other, net		4.3			11.0

Gross deferred tax asset		268.9			423.1
Valuation allowance		(91.5	)		(194.5	)

Deferred tax asset, net	$	177.4		$	228.6

Gross deferred income tax assets totaled approximately $1.2 billion at December 31, 2010 and 2009. Gross deferred income tax liabilities totaled approximately $1.0 billion at December 31, 2010 and 2009.

Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred tax assets will not be realized.

In January, July, September, and December 2010, the Company completed transactions which resulted in the realization, for tax purposes only, of unrealized gains in its investment portfolio of $98.4 million, $37.1 million, $31.1 million, and $120.8 million, respectively. These transactions enabled the Company to realize capital loss carryforwards to offset these gains, and resulted in the release of $66.2 million and $34.4 million, in 2010 and 2009, respectively, of the valuation allowance held against the deferred tax asset related to these capital loss carryforwards. The total release of $100.6 million was accounted for as an increase in income from continuing operations of $3.2 million and $6.0 million in 2010 and 2009, respectively, with the remaining $91.4 million reflected as a benefit in accumulated other comprehensive income at December 31, 2010. This amount will be released into income from continuing operations related to non-segment income in future years, as the investment securities subject to these transactions are sold or mature.

In 2010, the Company reduced its valuation allowance, for both continuing and discontinued operations, related to its deferred tax assets by $104.1 million, from $195.6 million to $91.5 million. There were four principal components to this reduction. First, the Company reduced the valuation allowance by $66.2 million as a result of the aforementioned transactions, which utilized the capital loss carryforwards. Second, the Company increased its valuation allowance by $20.3 million for certain tax basis unrealized losses which the Company does not believe it can utilize. This increase was reflected as a decrease in accumulated other comprehensive income. Third, $135.5 million of the capital loss carryforwards expired in 2010. As a result, the Company released $47.4 million of its valuation allowance attributable to these expirations with an equal and offsetting reduction in the related deferred tax asset. Fourth, as a result of $29.7 million in net realized gains during 2010, the Company decreased its valuation allowance by $9.7 million as an increase to income from continuing operations, since these gains utilized the Company's capital loss carryforwards. The remaining $1.1 million decrease was attributable to other items reflected as income from discontinued operations.

During 2009, the Company reduced the valuation allowance, for both continuing and discontinued operations, related to its deferred tax assets by $152.6 million, from $348.2 million to $195.6 million. There were two principal components to this reduction. First, the Company reversed through other comprehensive income, the $118.4 million valuation allowance that was recognized at December 31, 2008 associated with the tax benefit related to net unrealized depreciation in the Company's investment portfolio at that time. During 2009, appreciation in the portfolio changed the nature of the tax attribute from that of an asset to that of a liability, and thus there was no longer a need for that portion of the valuation allowance. Second, as a result of the aforementioned transactions, the Company reversed $28.4 million of the valuation allowance as an adjustment to other comprehensive income and $6.0 million of the valuation allowance as an adjustment to income from continuing operations. The remaining $0.2 million net increase in the valuation allowance was attributable to other items, and reflected as a $0.9 million increase in income from continuing operations and a $1.1 million decrease in income from discontinued operations.

At December 31, 2010, the Company's pre-tax capital loss carryforwards are $197.8 million, including $176.5 million resulting from the sale of FAFLIC in 2009. At December 31, 2010, the Company has recorded a full valuation allowance against this asset, since it is the Company's opinion that it is more likely than not that the asset will not be realized. The Company's estimate of the gross amount and likely realization of capital loss carryforwards may change over time.

At December 31, 2010, the Company has a deferred tax asset of $111.1 million of alternative minimum tax credit carryforwards. The alternative minimum tax credit carryforwards have no expiration date. The Company may utilize the credits to offset regular federal income taxes due from future income, and although the Company believes that these assets are fully recoverable, there can be no certainty that future events will not affect their recoverability. The Company believes, based on objective evidence, the remaining deferred tax assets will be realized.

The table below provides a reconciliation of the beginning and ending reserves for uncertain tax positions as follows:


FOR THE YEARS ENDED DECEMBER 31	2010		2009		2008
*(In millions)*
Liability at beginning of year, net	$	0.8	$	0.8	$	27.7
Additions based on tax positions related to the current year		—		—		0.1
Additions for tax positions of prior years		—		—		0.3
Reductions for tax positions of prior years		—		—		(8.2	)
Settlements		—		—		(19.1	)

Liability at end of year, net	$	0.8	$	0.8	$	0.8

Included in the December 31, 2010 balance is a receivable of $3.6 million for tax positions, for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, a change in the timing of deductions would not impact the annual effective tax rate.

The Company recognizes interest and penalties related to unrecognized tax benefits in federal income tax expense. In 2008, as part of the settlement of the 1995 through 2001 audit period, the Company reduced its accrued interest by $34.8 million. The Company had accrued interest of $1.0 million and $0.8 million as of December 31, 2010 and 2009, respectively. The Company has not recognized any penalties associated with unrecognized tax benefits.

The Company or its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, the Company and its subsidiaries are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2005. In 2008, the Company received written notification from the IRS Appeals Division that the Joint Committee on Taxation had completed its review of tax years 1995 through 2001 and found no exceptions. This settlement resulted in a tax benefit of $8.3 million recorded as a component of Net Income in the Consolidated Statement of Income and is comprised of a $6.4 million adjustment to Federal Income Tax Expense and a $1.9 million benefit to Discontinued Operations. Additionally, in 2009, the Company received a Revenue Agents Report for the 2005 and 2006 IRS audit. The Company has agreed to all proposed adjustments other than a disallowance of Separate Account Dividends Received Deductions for which the Company has requested an Appeals conference. Due to available net operating loss carryovers and the 2005 sale of Allmerica Financial Life Insurance and Annuity Company, the effects of the proposed adjustments do not materially affect the Company's financial position. The IRS audits of the years 2007 and 2008 commenced in April 2010. The Company and its subsidiaries are still subject to U.S. state income tax examinations by tax authorities for years after 1998.

A corporation is entitled to a tax deduction from gross income for a portion of any dividend which was received from a domestic corporation that is subject to income tax. This is referred to as a "dividends received deduction." In prior years, the Company has taken this dividends received deduction when filing its federal income tax return. Many separate accounts held by life insurance companies receive dividends from such domestic corporations, and therefore, were regarded as entitled to this dividends received deduction. In its Revenue Ruling 2007-61, issued on September 25, 2007, the IRS announced its intention to issue regulations with respect to certain computational aspects of the dividends received deduction on separate account assets held in connection with variable annuity contracts. Revenue Ruling 2007-61 suspended a revenue ruling issued in August 2007 that purported to change accepted industry and IRS interpretations of the statutes governing these computational questions. Any regulations that the IRS ultimately proposes for issuance in this area will be subject to public notice and comment, at which time insurance companies and other members of the public will have the opportunity to raise legal and practical questions about the content, scope and application of such regulations. As a result, the ultimate timing and substance of any such regulations are not yet known, but they could result in the elimination of some or all of the separate account dividends received deduction tax benefit that the Company receives. Management believes that it is more likely than not that any such regulation would apply prospectively only, and application of this regulation is not expected to be material to the Company's results of operations in any future annual period. However, there can be no assurance that the outcome of the revenue ruling will be as anticipated. The Company believes that retroactive application would not materially affect the Company's financial position or results of operations. In September 2009, as part of the audit of 2005 and 2006, the IRS disallowed the dividends received deduction related to separate account assets for both 2005 and 2006. The Company has challenged the disallowance by filing a formal protest, and has requested an IRS Appeals Conference. As discussed above, should the Company ultimately be unsuccessful in its challenge, due to tax attributes and the sale of Allmerica Financial Life Insurance and Annuity Company, the effects of this proposed adjustment would not be material to the Company's financial position or results of operations.