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, 2015.

Income tax expense includes the following components for the years ending December 31, 2018, 2017 and 2016:



	Year Ended December 31,
	2018			2017		2016
	(in thousands)
Current federal income tax expense	$	9,923		$	12,555	$	12,808
Deferred federal income tax expense (benefit)	(3,230		)	1,065		561
Income tax expense	$	6,693		$	13,620	$	13,369

The Company paid $9.9 million, $13.5 million and $13.3 million in federal income taxes during the years ended December 31, 2018, 2017 and 2016, respectively. Current income taxes receivable was $0.8 million at December 31, 2018 and December 31, 2017, and included in "other assets" 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 changed 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 changed the prescribed interest rates, which are now based on corporate bond yield curves, and extended the applicable time periods for the loss payment pattern period for long-tailed lines of business. The changes were effective for tax years beginning after 2017 with a transition rule that spread the adjustments related to pre-effective-date losses and loss adjustment expenses over the next eight years beginning in 2018.

During 2017, the Company measured its deferred tax assets and liabilities using enacted tax rates applicable 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. At the time of enactment, the application and interpretation of certain elements of the legislation were not specified, particularly as they related to the loss payment patterns and the corporate bond yield curve used to compute discounted loss reserves. The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant did 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. In accordance with SAB 118, the Company recognized the provisional tax impacts of $3.5 million related to the transition adjustment for loss reserve discounting, which were included as components of deferred tax assets and liabilities as part of its consolidated financial statements for the year ended December 31, 2017. During the year ended December 31, 2018, the Company finalized its accounting for the enactment of the TCJA and the provisional amounts decreased by approximately $1.1 million.

The prevailing federal income tax rate was 21% in 2018 and 35% in 2017 and 2016. 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,
	2018			2017			2016
	(in thousands)
Income tax expense at federal income tax rate	$	8,501		$	13,482		$	13,837
Stock options exercised	(918		)	(471		)	—
Tax-exempt investment income	(672		)	(1,064		)	(528		)
Effect of tax rate change	—			1,915			—
Other	(218		)	(242		)	60
Total	$	6,693		$	13,620		$	13,369

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



	December 31,
	2018			2017
	(in thousands)
Deferred tax assets:
Unpaid losses and loss adjustment expenses	$	6,854		$	7,001
Unearned premiums	4,711			3,748
Organizational costs	196			230
State operating loss carryforwards	708			645
Allowance for doubtful accounts	551			449
Unrealized losses on fixed-maturity securities	837			—
Other	753			431
Deferred tax assets before allowance	14,610			12,504
Less: valuation allowance	(780		)	(690		)
Total deferred tax assets	13,830			11,814

Deferred tax liabilities:
Unrealized gains on fixed-maturity securities	—			616
Unrealized gains on equity securities	374			1,759
Deferred policy acquisition costs, net of ceding commissions	3,108			2,473
Intangible assets	743			743
Transition adjustment for loss reserve discount	2,060			3,524
Other	369			207
Total deferred tax liabilities	6,654			9,322
Net deferred tax asset	$	7,176		$	2,492

At December 31, 2018 and 2017, the Company had state net operating loss carryforwards ("NOLS") of $14.9 million and $13.6 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, 2018 and 2017, 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, 2018 and 2017, 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 was as follows:



	December 31, 2017
	(in thousands)
Balance at January 1, 2017	$	1,003
Deductions for tax positions taken during prior years	(1,003		)
Balance at December 31, 2017	$	—

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.

The Company did not have any uncertain tax positions in 2018. Management is not aware of any events that would give rise to any uncertain tax positions.