Income taxes

The Company’s subsidiaries file a consolidated U.S. federal income tax return. Under a tax sharing agreement, KCGI collects from or refunds to its subsidiaries the amount of taxes determined as if KCGI and the subsidiaries filed separate returns. The Company is no longer subject to income tax examination by tax authorities for the years ended before January 1, 2014.

Income tax expense includes the following components for the years ending December 31, 2017, 2016 and 2015:



	Year Ended December 31,
	2017		2016		2015
	(in thousands)
Current federal income tax expense	$	12,555	$	12,808	$	12,163
Deferred federal income tax expense (benefit)	1,065		561		(879		)
Income tax expense	$	13,620	$	13,369	$	11,284

The Company paid $13.5 million, $13.3 million and $13.6 million in federal income taxes during the years ended December 31, 2017, 2016 and 2015, respectively. Current income taxes receivable was $0.8 million at December 31, 2017 and income taxes payable was $0.1 million at December 31, 2016, and were included in "other assets" and "other liabilities" in the accompanying consolidated balance sheets.

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act of 2017 (the "TCJA"). The legislation significantly changes U.S. tax law by, among other things, lowering corporate income tax rates from 35% to 21%, effective January 1, 2018, and modifying the manner in which property and casualty insurance loss reserves are computed for federal income tax purposes. In computing its taxable income, the Company records a deduction for unpaid losses and loss adjustment expenses. The deduction is discounted using interest rates and loss payment patterns prescribed by the U.S. Treasury. The TCJA changes the prescribed interest rates, which are now based on corporate bond yield curves, and extends the applicable time periods for the loss payment pattern period for long-tailed lines of business. The changes are effective for tax years beginning after 2017 with a transition rule that spreads adjustments related to pre-effective-date losses and loss adjustment expenses over the next eight years beginning in 2018.

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 35% to 21%, resulting in a $1.9 million increase in income tax expense and a corresponding decrease in net deferred tax assets as of the enactment date.

U.S. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. The TCJA did not specify the application of certain elements of the legislation and the U.S. Treasury has yet to issue interpretive guidance to specify the loss payment patterns and the corporate bond yield curve under the new law for 2018. The Company has recognized the provisional tax impacts of $3.5 million related to the transition adjustment for loss discounting which has been included in its components of deferred tax assets and liabilities as part of its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the TCJA. The accounting is expected to be complete when the U.S. Treasury issues further guidance.

The Company’s effective income tax rate on income before income taxes differs from the prevailing federal income tax rate and is summarized as follows:



	Year ended December 31,
	2017			2016			2015
	(in thousands)
Income tax expense at federal income tax rate of 35%	$	13,482		$	13,837		$	11,745
Tax-exempt investment income	(1,064		)	(528		)	(436		)
Stock options exercised	(471		)	—			—
Effect of tax rate change	1,915			—			—
Other	(242		)	60			(25		)
Total	$	13,620		$	13,369		$	11,284

The significant components of the net deferred tax asset are summarized as follows:



	December 31,
	2017			2016
	(in thousands)
Deferred tax assets:
Unpaid losses and loss adjustment expenses	$	7,001		$	4,528
Unearned premiums	3,748			5,308
Organizational costs	230			1,513
State operating loss carryforwards	645			476
Allowance for doubtful accounts	449			693
Other	431			438
Deferred tax assets before allowance	12,504			12,956
Less: valuation allowance	(690		)	(623		)
Total deferred tax assets	11,814			12,333

Deferred tax liabilities:
Unrealized gain on investments	2,375			620
Deferred policy acquisition costs, net of ceding commissions	2,473			3,553
Intangible assets	743			1,238
Transition adjustment for loss reserve discount	3,524			—
Other	207			317
Total deferred tax liabilities	9,322			5,728
Net deferred tax asset	$	2,492		$	6,605

At December 31, 2017 and 2016, the Company had state net operating loss carryforwards ("NOLS") of $13.6 million and $12.2 million, respectively. The state NOLs are available to offset future taxable income or reduce taxes payable and begin expiring in 2029.

Management evaluates the need for a valuation allowance related to its deferred tax assets. At December 31, 2017 and 2016, the Company recorded a tax valuation allowance equal to the state NOLs and the deferred tax assets, net of existing deferred tax liabilities that were expected to reverse in future periods, related to certain state jurisdictions. No other valuation allowances were established against the Company’s deferred tax assets at December 31, 2017 and 2016, as the Company believes that it is more likely than not that the remaining deferred tax assets will be realized given the carry back availability, reversal of existing temporary differences and future taxable income.

A reconciliation of the beginning and ending amounts of unrecognized tax benefits for 2017 and 2016 was as follows:



	December 31,
	2017			2016
	(in thousands)
Balance at beginning of year	$	1,003		$	1,125
Deductions for tax positions taken during prior years	(1,003		)	(122		)
Balance at end of year	$	—		$	1,003

The Company recognized the entire remaining uncertain tax position (UTP) of $1.0 million in the third quarter of 2017 due to lapse of the statute of limitations. The recognition of the UTP had no impact on the effective tax rate as it resulted in a decrease of current taxes and an offsetting increase to deferred taxes.