Income taxes

12 Months Ended

Dec. 31, 2019

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, 2016.

Income tax expense includes the following components for the years ending December 31, 2019, 2018 and 2017:



	Year Ended December 31,
	2019			2018			2017
	(in thousands)
Current federal income tax expense	$	12,860		$	9,923		$	12,555
Deferred federal income tax (benefit) expense	(125		)	(3,230		)	1,065
Income tax expense	$	12,735		$	6,693		$	13,620

The Company paid $11.6 million, $9.9 million and $13.5 million in federal income taxes during the years ended December 31, 2019, 2018 and 2017, respectively. Current income taxes payable was $0.4 million at December 31, 2019, and included in "other liabilities" in the accompanying consolidated balance sheets. Current income taxes receivable was $0.8 million at December 31, 2018, 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. U.S. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. Accordingly, the Company remeasured its deferred tax assets and liabilities using enacted tax rates applicable in the years in which the temporary differences were expected to be recovered or paid, which resulted in a $1.9 million increase in income tax expense and a corresponding decrease in net deferred tax assets as of the enactment date. In addition, the TCJA modified the manner in which property and casualty insurance loss reserves were computed for federal income tax purposes. In computing its taxable income, the Company records a deduction for unpaid losses and loss adjustment expenses, which 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.

The prevailing federal income tax rate was 21% in 2019 and 2018 and 35% in 2017. 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,
	2019			2018			2017
	(in thousands)
Income tax expense at federal income tax rate	$	15,971		$	8,501		$	13,482
Stock options exercised	(2,411		)	(918		)	(471		)
Tax-exempt investment income	(577		)	(672		)	(1,064		)
Effect of tax rate change	—			—			1,915
Other	(248		)	(218		)	(242		)
Total	$	12,735		$	6,693		$	13,620

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



	December 31,
	2019			2018
	(in thousands)
Deferred tax assets:
Unpaid losses and loss adjustment expenses	$	8,199		$	6,854
Unearned premiums	7,193			4,711
Organizational costs	162			196
Stock compensation	765			557
State operating loss carryforwards	1,497			708
Allowance for doubtful accounts	570			551
Unrealized losses on fixed-maturity securities	—			837
Other	256			196
Deferred tax assets before allowance	18,642			14,610
Less: valuation allowance	(1,592		)	(780		)
Total deferred tax assets	17,050			13,830

Deferred tax liabilities:
Unrealized gains on fixed-maturity securities	3,090			—
Unrealized gains on equity securities	2,995			374
Deferred policy acquisition costs, net of ceding commissions	4,949			3,108
Intangible assets	743			743
Transition adjustment for loss reserve discount	1,537			2,060
Other	362			369
Total deferred tax liabilities	13,676			6,654
Net deferred tax asset	$	3,374		$	7,176

At December 31, 2019 and 2018, the Company had state net operating loss carryforwards ("NOLS") of $31.6 million and $19.5 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, 2019 and 2018, 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, 2019 and 2018, 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.

The Company did not have any uncertain tax positions in 2019 or 2018. Management is not aware of any events that would give rise to any uncertain tax positions. The Company recognized its entire uncertain tax position of $1.0 million in 2017 due to lapse of the statute of limitations. The recognition of the uncertain tax position had no impact on the effective tax rate as it resulted in a decrease of current taxes and an offsetting increase to deferred taxes.