Income Taxes

Our federal income tax expense (benefit) was $1.0 million, $3.7 million and $2.1 million in 2015, 2014 and 2013, respectively. This represents effective tax rates of (37.3)%, (134.0)% and 30.8%, respectively. The 2014 impact is the result of costs to remediate the tax compliance issue we identified in early 2015 which impacted the 2014 effective tax rate negatively by approximately $3.5 million due to approximately $10.0 million of these costs not being deductible for tax. Additionally, after further refinement of these amounts in 2015 plus the effects of toll charges for the IRC Section 72(s) tax compliance issue identified in the second quarter of 2015, an additional $3.3 million of nondeductible toll charges were recorded in 2015, which negatively impacted the current year tax rate by $1.2 million. The Company previously had a valuation allowance related to OTTI write downs on stocks and stock mutual funds in 2008. Due to the sale of these mutual funds in 2009 and 2010, the valuation allowance was released in its entirety in 2009 and 2010. Part of this valuation allowance was released to other comprehensive income ("OCI") in 2009 due to the increase in fair value of mutual funds and stocks still owned. As the stocks and mutual funds have been disposed of since 2009, this valuation allowance has been released as reductions of tax expense. During 2015, 2014 and 2013, $42,000, and $21,000 and $20,000 has been released as a reduction of tax expense, respectively. The entire valuation allowance has now been released.

The table below summarizes the changes in the valuation allowance.



	Deferred Tax Liability		Other Comprehensive Income		Goodwill	Income Tax Expense (Benefit)
	(In thousands)
Balance at December 31, 2012	$	—	(83	)	1,058	(975	)
Release of valuation allowance in 2013	—		20		—	(20	)
Balance at December 31, 2013	—		(63	)	1,058	(995	)
Release of valuation allowance in 2014	—		21		—	(21	)
Balance at December 31, 2014	—		(42	)	1,058	(1,016	)
Release of valuation allowance in 2015	—		42		—	(42	)
Balance at December 31, 2015	$	—	—		1,058	(1,058	)

A reconciliation of federal income tax expense computed by applying the federal income tax rate of 35% in 2015, 2014 and 2013 to income (loss) before federal income tax expense is as follows:



	Years Ended December 31,
	2015					2014					2013
	2015					2014					2013
	Amount			%		Amount			%		Amount			%
	(In thousands)
Expected tax expense (benefit)	$	(912	)	35.0	%	$	(973	)	35.0	%	$	2,426		35.0	%
Release of valuation allowance previously held in other comprehensive income	(42		)	1.6		(21		)	0.8		(20		)	(0.3	)
Taxable intercompany stock sales	—			—		—			—		143			2.1
Tax-exempt interest and dividends-received deduction	(746		)	28.6		(862		)	31.0		(397		)	(5.7	)
Adjustment of prior year taxes	(317		)	12.2		1			—		60			0.9
Effect of graduated rates	(71		)	2.7		(89		)	3.2		(100		)	(1.4	)
Effect of uncertain tax position	1,890			(72.5	)	2,136			(76.8	)	—			—
Nondeductible costs to remediate tax compliance issue	1,152			(44.2	)	3,514			(126.4	)	—			—
Other	18			(0.7	)	19			(0.8	)	26			0.2
Total income tax expense (benefit)	$	972		(37.3	)%	$	3,725		(134.0	)%	$	2,138		30.8	%

Income tax expense (benefit) consists of:



	Years Ended December 31,
	2015			2014		2013
	2015			2014		2013
	(In thousands)
Current	$	(3,071	)	82,900		5,871
Deferred	4,043			(79,175	)	(3,733	)
Total income tax expense (benefit)	$	972		3,725		2,138

Deferred tax expense is comprised of $4.1 million deferred tax expense less $42,000 tax benefit released from OCI.

The components of deferred federal income taxes are as follows:



	Years Ended December 31,
	2015			2014
	(In thousands)
Deferred tax assets:
Future policy benefit reserves	$	118,697		123,058
Net operating and capital loss carryforwards	583			16
Accrued policyholder dividends and expenses	71			1,349
Investments	3,848			1,047
State income tax credits	123			125
Other	22			389
Total gross deferred tax assets	123,344			125,984
Valuation allowance	—			—
Total gross deferred tax assets net of valuation allowance	123,344			125,984
Deferred tax liabilities:
Deferred policy acquisition costs, cost of customer relationships acquired and intangible assets	(46,001		)	(45,398	)
Unrealized gains on investments available-for-sale	(7,428		)	(14,123	)
Accrued policyholder dividends	(984		)	—
Other	(167		)	(194	)
Total gross deferred tax liabilities	(54,580		)	(59,715	)
Net deferred tax asset	$	68,764		66,269

A summary of the changes in the components of deferred federal and state income taxes is as follows:



	At December 31,
	2015			2014
	(In thousands)
Deferred federal and state income taxes:
Balance January 1,	$	66,269		(1,704	)
Deferred tax (expense) benefit	(4,085		)	79,154
Acquisition of MGLIC	—			(909	)
Investments available-for-sale	6,695			(10,382	)
Effects of unrealized gains on DAC, CCRA and reserves	(115		)	110
Balance December 31,	$	68,764		66,269

The Company and our subsidiaries had no net operating losses at December 31, 2015. At December 31, 2015 and 2014, we determined that as a result of our historical income, projected future income, tax planning strategies, and the nature of the items from which the deferred tax assets are derived, other than assets for which OTTI was recorded, it was more likely than not that the deferred tax assets would be realized. The Company has sufficient unrealized gains in its available-for-sale portfolio so as not to need a valuation allowance for OTTI write downs.

The Company and our subsidiaries had approximately $1.7 million of capital loss carry-forwards at December 31, 2015 which expire, if unused in, 2020.

At December 31, 2015, the Company had accumulated approximately $3.3 million in our "policyholders' surplus account." This is a special memorandum tax account into which certain amounts not previously taxed, under prior tax laws, were accumulated. No new additions are expected to be made to this account. Federal income taxes will become payable thereon at the then current tax rate (a) when and if distributions to shareholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income; or (b) when a company ceases to be a life insurance company as defined by the Internal Revenue Code and such termination is not due to another life insurance company acquiring its assets in a nontaxable transaction. We do not anticipate any transactions that would cause any part of this amount to become taxable. However, should the balance at December 31, 2015 become taxable, the tax computed at present rates would be approximately $1.2 million.

The Company recognizes only the impact of tax positions that, based on their technical merits, are more likely than not to be sustained upon an audit by the taxing authority.

A reconciliation of unrecognized tax benefits is as follows:



	At December 31,
	2015			2014
	(In thousands)

Balance at January 1,	$	81,459		1,539
Additions based on tax positions related to the current year	3,608			10,132
Additions for tax positions of prior years	1,570			71,327
Reductions for tax positions of prior years	(8,558		)	(1,539	)
Balance December 31,	$	78,079		81,459

This unrecognized tax benefit is reported net in current federal income tax payable in the Consolidated Statement of Financial Position.

None of the Company’s unrecognized tax benefits at December 31, 2015 would affect the effective tax rate if recognized. There is a reasonable possibility that the unrecognized tax benefit relative to reserve deductions will decrease by $78.1 million within the next twelve months based upon the filing of an accounting method change in 2016.

The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense. The Company has recorded a material interest expense uncertainty of $3.5 million, net of tax, with respect to an unrecognized tax benefit as of December 31, 2015.

The Company's Federal income tax return is filed on a consolidated basis with the following entities:

Citizens, Inc.

CICA Life Insurance Company of America

Security Plan Life Insurance Company

Security Plan Fire Insurance Company

Computing Technology, Inc.

Insurance Investors, Inc.

Citizens National Life Insurance Company

The method of allocation among companies is subject to a written tax sharing agreement, approved by the Board of Directors, whereby allocation is made primarily on a separate return basis with current credit for any net operating losses or other items utilized in the consolidated tax return. Intercompany tax balances are settled quarterly.

The Company and our subsidiaries file income tax returns in the U.S. Federal jurisdiction and various U.S. states. Most of our subsidiaries are not subject to examination by U.S. tax authorities for years prior to 2012.