INCOME TAXES

The components of income tax expense (benefit) for the years ended December 31, 2015, 2014 and 2013 were as follows (dollars in millions):



	Year Ended December 31,
	2015			2014		2013
Current income tax expense (benefit):
Federal	$	(5	)	$	—	$	—
State	(5		)	4		3
Foreign	5			—		—
Total current	(5		)	4		3
Deferred income tax expense (benefit):
Federal	(145		)	152		127
State	(31		)	3		(20		)
Foreign	—			—		—
Total deferred	(176		)	155		107
Non-current income tax expense (benefit)⁽¹⁾	4			—		(1		)
Income tax expense (benefit)	$	(177	)	$	159	$	109


(1)	Non-current income tax expense (benefit) primarily relates to amortization for investments in qualified affordable housing projects recognized under the proportional amortization method.

The following table presents the components of income before income tax expense (benefit) for the years ended December 31, 2015, 2014 and 2013 (dollars in millions):



	Year Ended December 31,
	2015		2014		2013
Domestic	$	84	$	438	$	186
Foreign	7		14		9
Income before income tax expense (benefit)	$	91	$	452	$	195

Unrecognized Tax Benefits

The following table provides a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2015, 2014, and 2013 (dollars in millions):



	Year Ended December 31,
	2015			2014			2013
Unrecognized tax benefits, beginning of period	$	330		$	333		$	492
Additions based on tax positions related to prior years	5			12			10
Additions based on tax positions related to current year	2			—			—
Reductions based on tax positions related to prior years	(304		)	(14		)	(163		)
Settlements with taxing authorities	(3		)	—			(5		)
Statute of limitations lapses	(1		)	(1		)	(1		)
Unrecognized tax benefits, end of period	$	29		$	330		$	333

The unrecognized tax benefits decreased $301 million to $29 million during the year ended December 31, 2015. At December 31, 2015, the Company had $18 million, net of federal benefits on state issues, of unrecognized tax benefits that, if recognized, would favorably impact the effective income tax rate in future periods. In 2015, the Company settled the IRS examination of its 2007, 2009 and 2010 federal tax returns. As a result, the Company released $303 million of reserves related to the uncertain tax positions in 2015. During 2009, the Company incurred a loss on the exchange of $1.7 billion interest-bearing corporate debt for non-interest-bearing convertible debentures. The uncertain tax positions were primarily related to whether certain components of that loss were considered deductible or non-deductible for tax purposes.

The following table summarizes the tax years that are either currently under examination or remain open under the statute of limitations and subject to examination by the major tax jurisdictions in which the Company operates:




Jurisdiction	Open Tax Years
Hong Kong	2008-2015
United Kingdom	2013-2015
United States	2012-2015
Various states⁽¹⁾	2007-2015


(1)	Major state tax jurisdictions include California, Georgia, Illinois, New Jersey, New York and Virginia.

It is reasonably possible that the Company's unrecognized tax benefits could be reduced by as much as $4 million within the next twelve months as a result of settlements of certain examinations or expiration of statutes of limitations.

The Company recognizes interest and penalties, if any, related to income tax matters in income tax expense. The Company has total reserves for interest and penalties of $13 million and $21 million as of December 31, 2015 and 2014, respectively. The tax expense for the year ended December 31, 2015 includes a benefit related to reduction of interest and penalties of $8 million, primarily related to the settlement of the IRS examination mentioned above. The tax expense for the years ended December 31, 2014 and December 31, 2013 included an increase in the accrual for interest and penalties of $1 million, principally related to state taxes, and an increase in accrual for interest and penalties of $5 million, principally related to federal taxes, respectively.

Deferred Taxes and Valuation Allowance

Deferred income taxes are recorded when revenues and expenses are recognized in different periods for financial statement and tax return purposes. The temporary differences and tax carryforwards that created deferred tax assets and deferred tax liabilities at December 31, 2015 and 2014 are summarized in the following table (dollars in millions):



	December 31,
	2015			2014
Deferred tax assets:
Net operating losses	$	782		$	632
Reserves and allowances, net	482			601
Mark to market	158			110
Deferred compensation	44			43
Tax credits	44			37
Basis differences in investments	10			9
Other	28			1
Total deferred tax assets	1,548			1,433
Valuation allowance	(82		)	(91		)
Total deferred tax assets, net of valuation allowance	1,466			1,342
Deferred tax liabilities:
Depreciation and amortization	(433		)	(387		)
Other	—			(4		)
Total deferred tax liabilities	(433		)	(391		)
Net deferred tax assets, net	$	1,033		$	951

The Company is required to establish a valuation allowance for deferred tax assets and record income tax expense if it is determined, based on evaluation of available evidence at the time the determination is made, that it is more likely than not that some or all of the deferred tax assets will not be realized. If the Company were to conclude that a valuation allowance was required, the resulting loss could have a material adverse effect on its financial condition and results of operations. As of December 31, 2015, the Company did not establish a valuation allowance against its federal deferred tax assets as it believes that it is more likely than not that all of these assets will be realized. As of December 31, 2015, the Company had $1.8 billion of gross federal net operating losses, which will begin to expire in approximately 12 years. The increase in the net operating losses deferred tax asset was primarily driven by the release of unrecognized tax benefits as a result of the settlement of the IRS examination of the Company's 2007, 2009, and 2010 federal tax returns.

The Company’s evaluation of the need for a valuation allowance focused on identifying significant, objective evidence that it will be able to realize its deferred tax assets in the future. The Company determined that its expectations regarding future earnings are objectively verifiable due to various factors. One factor is the consistent profitability of the Company’s core business, the trading and investing segment, which has generated substantial income for each of the last 12 years, including through uncertain economic and regulatory environments. The core business is driven by brokerage customer activity and includes trading, brokerage related cash, margin lending, retirement and investing, and other brokerage related activities. These activities drive variable expenses that correlate to the volume of customer activity, which has resulted in stable, ongoing profitability. Another factor is the sustained profitability of the balance sheet management segment driven by various credit loss mitigation activities and improving economic conditions that benefited both our loan portfolio as well as the securities portfolio.

The Company's valuation allowance for deferred tax assets decreased $9 million to $82 million at December 31, 2015. The principal components of the deferred tax assets for which a valuation allowance has been established include the following state and foreign country net operating loss carryforwards which have a limited carryforward period:

•

At December 31, 2015, the Company had certain gross foreign country net operating loss carryforwards of $67 million and other foreign country temporary differences of approximately $16 million for which a deferred tax asset of approximately $17 million was established. The foreign net operating losses represent the foreign tax loss carryforwards in numerous foreign countries, the vast majority of which are not subject to expiration. In most of these foreign countries, the Company has historical tax losses; accordingly, the Company has provided a valuation allowance of $17 million against such deferred tax assets at December 31, 2015.

•

At December 31, 2015, the Company had gross state net operating loss carryforwards that expire between 2016 and 2034 in several states of $3.6 billion, most of which are subject to change by corresponding changes in apportionment. At December 31, 2015, the Company had total state deferred tax assets, net of federal benefit, of approximately $177 million that related to the Company's state net operating loss carryforwards and temporary differences with a valuation allowance of $65 million against such deferred tax assets.

The Company does not intend to permanently reinvest any undistributed earnings and profits in foreign subsidiaries. As a result, the Company has fully recorded income taxes on those earnings at December 31, 2015.

Effective Tax Rate

The effective tax rate differed from the federal statutory rate as summarized in the following table for the years ended December 31, 2015, 2014 and 2013:



	Year Ended December 31,
	2015		2014		2013
Federal statutory rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal tax benefit	0.2		2.0		2.8
Difference between statutory rate and foreign effective tax rate	(2.4	)	(1.0	)	(1.4	)
Tax exempt income	(0.5	)	(0.1	)	(0.3	)
Disallowed executive compensation	6.5		0.6		0.9
Change in valuation allowance	0.1		2.2		1.1
Tax credits	(3.8	)	(0.6	)	(1.8	)
Estimated reserve for uncertain tax positions	4.7		(0.3	)	(2.6	)
Deferred tax adjustments⁽¹⁾	3.5		(3.4	)	4.5
Tax on undistributed earnings and profits in certain foreign subsidiaries	3.9		1.1		2.4
Settled IRS examination	(241.5	)	—		—
Tax impact of exit of market making business	—		—		16.4
Other	(0.4	)	(0.3	)	(1.1	)
Effective tax rate	(194.7	)%	35.2	%	55.9	%


(1)	Includes the impact of New York city tax legislative changes of (5.8)% during the year ended December 31, 2015 and New York state tax legislative changes of (1.8)% during the year ended December 31, 2014.