Notes to financial statements
Note 8: Income Taxes
Method for Computing Income Tax Expense - We are required to compute our income tax expense under the liability method. This means deferred income taxes reflect what we estimate we will pay or receive in future years.
A current tax liability is recognized for the estimated taxes payable for the current year.
Income Tax Expense (Benefit) - Income tax expense or benefits are recorded in various places in our financial statements. A summary of the amounts and places follows:
(In thousands)
Year ended December 31
1998
1997
1996
Statements of Income
Expense (benefit) on continuing operations
$338,666
$150,637
$(135,635)
Expense on discontinued operations
-
401
-
Benefit on loss on disposal
-
(35,530)
(291,493)
Total income tax expense (benefit) included in statements of income
303,136
(140,455)
(135,635)
Common Shareholders' Equity
Benefit for deductions relating to:
Dividends on unallocated ESOP and PSOP shares
(3,112)
(3,626)
(5,880)
Employee stock options and awards
(8,211)
(5,623)
(6,468)
Expense for the change in unrealized appreciation and unrealized foreign exchange
98,538
89,232
31,891
Total income tax expense (benefit) included in common shareholders' equity
77,909
22,642
86,190
Total income tax expense (benefit) included in financial statement
$381,045
$(117,035)
$(49,445)
Components of Income Tax Expense (Benefit) - The components of income tax expense (benefit) on continuing operations are as follows:
(In thousands)
Year ended December 31
1998
1997
1996
Federal current tax expense
$281,528
$177,035
$19,650
Federal deferred tax
expense (benefit)
(177,433)
23,299
5,174
Total federal income tax expense (benefit)
304,827
122,209
(157,783)
Foreign income taxes
19,467
22,074
13,740
State income taxes
8,408
14,372
6,354
Total income tax expense (benefit) on continuing operations
$(135,635)
$338,666
$150,637
Our Tax Rate is Different from the Statutory Rate - Our total income tax expense on continuing operations differs from the statutory rate of 35% of pretax income as shown in the following table:
(In thousands)
Year ended December 31
1998
1997
1996
Federal income tax expense (benefit) at statutory rates
$467,498
$346,884
$(16,201)
Increase (decrease) attributable to:
Nontaxable investment income
(112,420)
(96,156)
(112,882)
Valuation allowance
(31,657)
(106,519)
(35,408)
Nondeductible merger expense
31,036
-
-
Other
(2,180)
15,245
6,428
Total income tax expense (benefit) on continuing operations
$(135,635)
$338,666
$150,637
Major Components of Deferred Income Taxes on Our Balance Sheet - Differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years are called temporary differences. The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are presented in the following table:
December 31
(In thousands)
1998
1997
Deferred Tax Assets
Loss reserves
$1,122,326
$1,048,361
Loss on disposal of insurance brokerage operations
199,868
33,036
Unearned premium reserves
198,124
181,165
Net operating loss carryfoward
194,267
459,926
Other
555,562
706,144
Total gross deferred tax assets
2,270,147
2,428,632
Less valuation allowance
(41,222)
(5,814)
Net deferred tax assets
2,228,925
2,422,818
Deferred Tax Liabilities
Unrealized appreciation of investments
437,947
536,334
Deferred acquisition costs
279,469
277,624
Real estate
65,036
115,051
Other
232,683
300,517
1,015,135
1,229,526
Total gross deferred tax liabilities
$1,213,790
$1,193,292
Deferred income taxes
If we believe that all of our deferred tax assets will not result in future tax benefits, we must establish a "valuation allowance" for the portion of these assets that we think will not be realized. The net change in the valuation allowance for deferred tax assets was a decrease of $35.4 million in 1998, and a decrease of $31.7 million in 1997, relating to our foreign underwriting operations and our provision for loss on disposal of insurance brokerage operations. Based upon a review of our refundable taxes, anticipated future earnings, and all other available evidence, both positive and negative, we have concluded it is "more likely than not" that our net deferred tax assets will be realized.
Net Operating Loss (NOL), Foreign Tax Credit (FTC), and Alternative Minimum Tax (AMT) Credit Carryforwards - For tax return purposes, as of Dec. 31, 1998 we had NOL carryforwards that expire, if unused, in 2004-2018 and FTC carryforwards that expire, if unused, in 2000-2003. We have AMT credit carryforwards of approximately $116.7 million which are available to reduce future federal regular income taxes over an indefinite period. The amount and timing of realizing the benefits of NOL, FTC and AMT credit carryforwards depends on future taxable income and limitations imposed by tax laws. The approximate amounts of the NOLs on a regular tax basis and an AMT basis at Dec. 31, 1998 were $1,314.1 million and $908.7 million, respectively. The approximate amounts of the FTCs on a regular tax basis and an AMT basis at Dec. 31, 1998 were $9.9 million and $8.1 million, respectively. The benefits of the NOL, FTC and AMT credit carryforwards have been recognized in our financial statements and are included in our net deferred tax assets.
Undistributed Earnings of Subsidiaries - U.S. income taxes have not been provided on $35.0 million of our foreign operations' undistributed earnings as of Dec. 31, 1998, as such earnings are intended to be permanently reinvested in those operations. Furthermore, any taxes paid to foreign governments on these earnings may be used as credits against the U.S. tax on any dividend distributions from such earnings.
We have not provided taxes on approximately $194.5 million of undistributed earnings related to our majority ownership of The John Nuveen Company as of Dec. 31, 1998, because we currently do not expect those earnings to become taxable to us.
IRS Examinations - The IRS is currently examining the USF&G Life Group's premerger returns for the years 1992 and 1993 and USF&G's pre-merger consolidated returns for the years 1994 through 1997. The IRS has examined The St. Paul's pre-merger consolidated returns through 1994 and is currently examining the years 1995 through 1997. We believe that any additional taxes assessed as a result of these examinations would not materially affect our overall financial position, results of operations or liquidity.