Note 10. Income Taxes

The Company and its eligible subsidiaries file a consolidated federal income tax return. The Company has entered into a separate tax allocation agreement with CNA, a majority-owned subsidiary in which its ownership exceeds 80%. The agreement provides that the Company will: (i) pay to CNA the amount, if any, by which the Company’s consolidated federal income tax is reduced by virtue of inclusion of CNA in the Company’s return or (ii) be paid by CNA an amount, if any, equal to the federal income tax that would have been payable by CNA if it had filed a separate consolidated return. The agreement may be canceled by either of the parties upon thirty days written notice.

For 2014 through 2016, the Internal Revenue Service (“IRS”) has accepted the Company into the Compliance Assurance Process (“CAP”), which is a voluntary program for large corporations. Under CAP, the IRS conducts a real-time audit and works contemporaneously with the Company to resolve any issues prior to the filing of the tax return. The Company believes this approach should reduce tax-related uncertainties, if any. Although the outcome of tax audits is always uncertain, the Company believes that any adjustments resulting from audits will not have a material impact on its results of operations, financial position and cash flows. The Company and/or its subsidiaries also file income tax returns in various state, local and foreign jurisdictions. These returns, with few exceptions, are no longer subject to examination by the various taxing authorities before 2012.

Diamond Offshore, which is not included in the Company’s consolidated federal income tax return, files income tax returns in the U.S. federal and various state and foreign jurisdictions. Tax years that remain subject to examination by these jurisdictions include years 2009 to 2016. The 2013 federal income tax return is under examination.

The current and deferred components of income tax expense (benefit) are as follows:


Year Ended December 31	2016		2015			2014

(In millions)

Income tax expense (benefit):
Federal:
Current	$	71	$	79		$	370
Deferred		102		(234	)		(23	)
State and city:
Current		13		21			12
Deferred		13		5			6
Foreign		21		86			92

Total	$	220	$	(43	)	$	457

The components of U.S. and foreign income before income tax and a reconciliation between the federal income tax expense at statutory rates and the actual income tax expense (benefit) is as follows:


Year Ended December 31	2016			2015			2014
(In millions)

Income before income tax:
U.S.	$	1,207		$	543		$	1,499
Foreign		(271	)		(299	)		311
Total	$	936		$	244		$	1,810


Income tax expense at statutory rate	$	328		$	86		$	633
Increase (decrease) in income tax expense resulting from:
Exempt investment income		(126	)		(126	)		(121	)
Foreign related tax differential		40			(18	)		(48	)
Amortization of deferred charges associated with intercompany rig sales to other tax jurisdictions					38			44
Taxes related to domestic affiliate		(14	)		(10	)		14
Partnership earnings not subject to taxes		(52	)		(38	)		(39	)
Allowance for foreign tax credits		62
Unrecognized tax positions, including foreign currency revaluation		(42	)		1			(42	)
Other (a)		24			24			16
Income tax expense (benefit)	$	220		$	(43	)	$	457

(a)	Includes state and local taxes, adjustments to prior year estimates and other non-deductible expenses.

Provision has been made for the expected U.S. federal income tax liabilities applicable to undistributed earnings of subsidiaries, except for certain subsidiaries for which the Company intends to invest the undistributed earnings indefinitely to finance foreign activities, or recover such undistributed earnings tax-free. The determination of the amount of the unrecognized deferred tax liability on approximately $1.8 billion of undistributed earnings related to foreign subsidiaries is not practicable.

A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding tax carryforwards and interest and penalties, is as follows:


Year Ended December 31	2016			2015			2014
(In millions)

Balance at January 1	$	54		$	57		$	91
Additions for tax positions related to the current year		4			7			6
Additions for tax positions related to a prior year		1
Reductions for tax positions related to a prior year		(20	)		(3	)		(35	)
Lapse of statute of limitations		(4	)		(7	)		(5	)
Balance at December 31	$	35		$	54		$	57

The $20 million in reductions for tax positions related to a prior year is primarily from the devaluation of the Egyptian pound. At December 31, 2016, 2015 and 2014, $36 million, $49 million and $51 million of unrecognized tax benefits related to Diamond Offshore would affect the effective tax rate if recognized.

The Company recognizes interest accrued related to: (i) unrecognized tax benefits in Interest expense and (ii) tax refund claims in Other revenues on the Consolidated Statements of Income. The Company recognizes penalties in Income tax expense on the Consolidated Statements of Income. Interest amounts recorded by the Company were insignificant for the years ended December 31, 2016, 2015 and 2014. The Company recorded income tax benefit of $23 million and $22 million for the years ended December 31, 2016 and 2014 and income tax expense of $2 million for the year ended December 31, 2015 related to penalties. The $23 million reduction in penalties related to uncertain tax positions results primarily from the devaluation of the Egyptian pound.

During 2014, Diamond Offshore settled certain disputes for the years 2006 through 2008 with the Egyptian tax authorities, resulting in a net reduction to income tax expense of $17 million. One issue for the 2006 through 2008 period remains open, which Diamond Offshore appealed. The court case is currently pending. Diamond Offshore has sought assistance from an agency of the U.S. Treasury Department, pursuant to international tax treaties and continues to believe that its position will, more likely than not, be sustained. However, if Diamond Offshore’s position is not sustained, tax expense and related penalties would increase by approximately $22 million related to this issue for the 2006 through 2008 tax years as of December 31, 2016.

The following table summarizes deferred tax assets and liabilities:


December 31	2016			2015
(In millions)

Deferred tax assets:
Insurance reserves:
Property and casualty claim and claim adjustment expense reserves	$	125		$	178
Unearned premium reserves		206			230
Receivables		26			30
Employee benefits		407			419
Life settlement contracts		56			48
Deferred retroactive reinsurance benefit		117			84
Net operating loss carryforwards		178			245
Tax credit carryforwards		289			131
Basis differential in investment in subsidiary		17			19
Other		246			282
Total deferred tax assets		1,667			1,666
Valuation allowance		(210	)		(147	)
Net deferred tax assets		1,457			1,519

Deferred tax liabilities:
Deferred acquisition costs		(120	)		(117	)
Net unrealized gains		(295	)		(166	)
Property, plant and equipment		(1,019	)		(998	)
Basis differential in investment in subsidiary		(409	)		(428	)
Other liabilities		(235	)		(173	)
Total deferred tax liabilities		(2,078	)		(1,882	)

Net deferred tax liabilities (a)	$	(621	)	$	(363	)

(a)	Includes $15 and $19 of deferred tax assets reflected in Other assets in the Consolidated Balance Sheets at December 31, 2016 and 2015.

Federal net operating loss carryforwards of $76 million expire in 2034 and 2036. Net operating loss carryforwards in foreign tax jurisdictions of $59 million expire between 2020 and 2025 and $36 million can be carried forward indefinitely. Federal tax credit carryforwards of $157 million have indefinite lives and $98 million of foreign tax credit carryforwards expire between 2024 and 2026. Diamond Offshore intends to carryback foreign tax credits of $33 million to prior years, which otherwise will expire between 2021 and 2023.

Although realization of deferred tax assets is not assured, management believes it is more likely than not that the recognized deferred tax assets will be realized through recoupment of ordinary and capital taxes paid in prior carryback years and through future earnings, reversal of existing temporary differences and available tax planning strategies. As of December 31, 2016, Diamond Offshore recorded a valuation allowance of $210 million related to net operating losses of $91 million, foreign tax credits of $62 million, and other deferred tax assets of $57 million.