7. INCOME TAXES

The components of income (loss) before income tax provision are as follows:



	2017		2016			2015
Domestic	$	308,751	$	245,046		$	249,380
Foreign	62,127		(270,264		)	118,613
Total	$	370,878	$	(25,218	)	$	367,993

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



	2017		2016			2015
Federal	$	68,336	$	87,166		$	95,499
Foreign	2,535		(71,828		)	20,365
State and local	13,304		(7,646		)	9,420
Total income tax provision	$	84,175	$	7,692		$	125,284

Current	$	26,371	$	15,419		$	24,897
Deferred	57,804		(7,727		)	100,387
Total income tax provision	$	84,175	$	7,692		$	125,284

A reconciliation of the difference between the effective income tax rate and the statutory federal income tax rate is as follows:



	2017		2016		2015
Tax provision at statutory U.S. federal income tax rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal income tax benefit⁽¹⁾	2.3		43.2		4.0
Uncertain tax benefits	1.3		41.8		1.8
Effect of foreign tax rates⁽²⁾	(3.9	)	(172.5	)	(4.8	)
Changes in U.K. tax rates on deferred tax assets and liabilities	(1.1	)	33.2		—
Net (income) loss attributable to noncontrolling interests	(5.4	)	(15.6	)	(0.5	)
Change in valuation allowances⁽³⁾	1.6		(33.9	)	(2.7	)
Federal effect of permanent tax adjustments	(0.5	)	39.1		1.7
Holding company restructuring⁽⁴⁾	(5.0	)	—		—
Other, net	(1.6	)	(0.8	)	(0.5	)
Effective income tax rate	22.7	%	(30.5	)%	34.0	%


(1)	State income taxes include changes in valuation allowances related to change in apportionment and provision to return differences, net of the impact on related deferred tax assets.


(2)	The effect of foreign tax rates for fiscal 2017 and 2016 includes a $2,890 and $66,780, respectively, tax benefit for non-cash impairment charges related to the intangible assets of the Permal business, as further discussed in Note 5.


(3)	See schedule below for the change in valuation allowances by jurisdiction.


(4)	In fiscal 2017, as part of a larger strategic initiative, Legg Mason restructured certain of its holding company businesses, which increased the amount of foreign tax credits available for utilization.

In November 2015, the U.K. Finance Bill 2015 was enacted, which reduced the main U.K. corporate tax rate from 20% to 19% effective April 1, 2017, and to 18% effective April 1, 2020. In September 2016, the U.K. Finance Act 2016 was enacted, which further reduced the main U.K. corporate tax rate effective on April 1, 2020 to 17%. The reductions in the U.K. corporate tax rate resulted in tax benefits of $4,055 and $8,383, recognized in fiscal 2017 and 2016, respectively, as a result of the revaluation of deferred tax assets and liabilities at the new rates.

On April 13, 2015, reforms to New York City’s corporate tax structure were enacted which included changes in the calculation of net operating loss carryforwards and changes in the way sales revenue is sourced. The revaluation of deferred tax assets and liabilities under the new rules resulted in the recognition of a one-time income tax benefit of $17,053 for the year ended March 31, 2016.

Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the Consolidated Balance Sheets. These temporary differences result in taxable or deductible amounts in future years. A summary of Legg Mason's deferred tax assets and liabilities are as follows:



	2017			2016
DEFERRED TAX ASSETS
Accrued compensation and benefits	$	221,895		$	185,311
Accrued expenses	46,311			50,865
Operating loss carryforwards	246,614			273,133
Capital loss carryforwards	6,183			3,121
Foreign tax credit carryforward	283,746			258,486
Federal benefit of uncertain tax positions	13,421			12,290
Mutual fund launch costs	25,292			30,234
Martin Currie defined benefit pension liability	5,293			5,896
Charitable contributions carryforwards	814			4,552
Net unrealized losses from investments	—			4,389
Other	—			5,181
Deferred tax assets	849,569			833,458
Valuation allowance	(71,063		)	(79,476		)
Deferred tax assets after valuation allowance	$	778,506		$	753,982

DEFERRED TAX LIABILITIES
Basis differences, principally for intangible assets and goodwill	$	20,339		$	56,625
Depreciation and amortization	801,133			686,421
Net unrealized gains from investments	4,730			—
Basis differences in partnerships	75,653			64,525
Other	3,037			—
Deferred tax liabilities	904,892			807,571
Net deferred tax liabilities	$	(126,386	)	$	(53,589	)

Certain tax benefits associated with Legg Mason's employee stock plans are recorded directly in Stockholders' Equity. No tax benefit was recorded to equity in fiscal 2016 or 2015, due to the cumulative net operating loss position of the Company. As of March 31, 2017, the related unrecognized tax benefit aggregated $22,585. As further described in Note 1, upon the adoption of a new accounting standard effective April 1, 2018, this tax benefit will be recognized as an increase in deferred tax assets and Retained earnings on the Consolidated Balance Sheet.

Legg Mason has various loss and tax credit carryforwards that may provide future tax benefits. Related valuation allowances are established in accordance with accounting guidance for income taxes, if it is management's opinion that it is more likely than not that these benefits will not be realized. To the extent the analysis of the realization of deferred tax assets relies on deferred tax liabilities, Legg Mason has considered the timing, nature, and jurisdiction of reversals, including future increases relating to the tax amortization of goodwill and indefinite-life intangible assets, as well as planning strategies to measure and value the realizability of its deferred tax assets.

On April 13, 2016, Legg Mason acquired a majority ownership in Clarion Partners, which, as a partnership, creates a basis difference and a related deferred tax liability of $21,991.

On May 2, 2016, the Permal business was merged with EnTrust. As part of the transaction, Legg Mason paid cash and a 35% ownership in the Permal business for a 65% ownership in the new EnTrustPermal joint venture. As a result of the transaction, Legg Mason converted a portion of its Permal legacy business into a partnership which decreased the related deferred tax liability by $4,102.

Substantially all of Legg Mason's deferred tax assets relate to U.S. federal, state and U.K. taxing jurisdictions. As of March 31, 2017, U.S. federal deferred tax assets aggregated $731,636, realization of which is expected to require approximately $3,700,000 of future U.S. earnings, of which $811,000 must be foreign sourced earnings. Based on estimates of future taxable income, using assumptions consistent with those used in Legg Mason's goodwill impairment testing, it is more likely than not that substantially all of the current federal tax benefits relating to net operating losses will be realizable. With respect to deferred tax assets relating to foreign tax credit carryforwards, it is more likely than not that tax benefits relating to the utilization of approximately $6,147 of foreign taxes as credits will not be realized and a valuation allowance has been established. Further, the Company's estimates and assumptions do not contemplate certain possible future changes in the ownership of Legg Mason stock, which, under the U.S. Internal Revenue Code, could limit the utilization of net operating loss and foreign tax credit benefits. Any such limitation would impact the timing or amount of net operating loss or foreign tax credit benefits ultimately realized before they expire.

As of March 31, 2017, the change in federal valuation allowances aggregated $11,133. Of the decrease in federal valuation allowances from the prior year, $10,413 relates to expiring foreign tax credits which have been reclassified to net operating losses. This was offset in part by additional valuation allowances of $1,308 related to foreign tax credits and $601 related to Martin Currie’s operating losses. There was also a decrease in the valuation allowance of $2,629 related to charitable contributions.

As of March 31, 2017, U.S. state deferred tax assets aggregated approximately $173,788. Due to limitations on utilization of net operating loss carryforwards and taking into consideration certain state tax planning strategies, the related valuation allowance of $29,075 was substantially established in prior years for state net operating loss benefits generated in certain jurisdictions in cases where it is more likely that these benefits will ultimately not be realized.

For foreign jurisdictions, the net increase in valuation allowances of $502 during fiscal 2017, primarily relates to statutory rate changes and revised estimates of the realization of deferred tax benefits.

The following deferred tax assets and valuation allowances relating to carryforwards have been recorded at March 31, 2017 and 2016, respectively.



	2017		2016		Expires Beginning after Fiscal Year
DEFERRED TAX ASSETS
U.S. federal net operating losses⁽¹⁾	$	57,715	$	82,350	2031
U.S. federal capital losses	3,644		—		2021
U.S. federal foreign tax credits	283,746		258,486		2018
U.S. charitable contributions	814		4,552		2017
U.S. state net operating losses ^(2,3)	168,655		166,772		2017
U.S. state capital losses	4		44		2017
U.S. state tax credits	366		308		2022
Foreign net operating losses	20,244		24,192		2027
Foreign capital losses	2,535		3,077		n/a
Total deferred tax assets for carryforwards	$	537,723	$	539,781

VALUATION ALLOWANCES
U.S. federal net operating losses	$	2,856	$	2,255
U.S. federal foreign tax credits	6,147		15,252
U.S. charitable contributions	814		3,443
U.S. state net operating losses	29,075		26,816
U.S. state capital losses	4		44
Foreign net operating losses	15,975		20,631
Foreign capital losses	2,535		3,077
Valuation allowances for carryforwards	57,406		71,518
Foreign other deferred assets	13,657		7,958
Total valuation allowances	$	71,063	$	79,476


(1)	Currently, there are proposals to significantly change U.S. federal income tax rules, which include proposals to reduce tax rates, limit deductibility of interest expense, and changes to the taxation on non-U.S. earnings. Although details are not yet available, these changes could impact the carrying value of Legg Mason's deferred tax assets.


(2)	Substantially all of the U.S. state net operating losses carryforward through fiscal 2036.


(3)	Due to potential for change in the factors relating to apportionment of income to various states, Legg Mason's effective state tax rates are subject to fluctuation which will impact the value of the Company's deferred tax assets, including net operating losses, and could have a material impact on the future effective tax rate of the Company.

Legg Mason had total gross unrecognized tax benefits of approximately $70,787, $73,873 and $92,344 as of March 31, 2017, 2016 and 2015, respectively. Of these totals, approximately $50,462, $49,629 and $62,775, respectively, (net of the federal benefit for state tax liabilities) are the amounts of unrecognized benefits which, if recognized, would favorably impact future income tax provisions and effective tax rates. During fiscal 2017, as a result of the net impact of effective settlement of tax examinations, recent developments of case law and the expiration of statutes of limitation in certain jurisdictions, previously unrecognized benefits of $8,611 were realized.

A reconciliation of the beginning and ending amount of unrecognized gross tax benefits for the years ended March 31, 2017, 2016, and 2015, is as follows:



	2017			2016			2015
Balance, beginning of year	$	73,873		$	92,344		$	77,892
Additions based on tax positions related to the current year	3,303			3,514			9,919
Additions for tax positions of prior years	5,673			10,078			13,054
Reductions for tax positions of prior years	(8,257		)	(155		)	—
Decreases related to settlements with taxing authorities	(2,200		)	(25,046		)	(8,521		)
Expiration of statutes of limitations	(1,605		)	(6,862		)	—
Balance, end of year	$	70,787		$	73,873		$	92,344

Although management cannot predict with any degree of certainty the timing of ultimate resolution of matters under review by various taxing jurisdictions, it is reasonably possible that the Company’s gross unrecognized tax benefits balance may change within the next 12 months by up to $15,958 as a result of the expiration of statutes of limitations and the completion of tax authorities' examinations.

The Company accrues interest related to unrecognized tax benefits in interest expense and recognizes penalties in other operating expense. During the years ended March 31, 2017, 2016 and 2015, the Company recognized approximately $(139), $(4,441), and $1,492, respectively, which was substantially all interest. At March 31, 2017, 2016 and 2015, Legg Mason had approximately $2,155, $1,900, and $8,570, respectively, accrued for interest and penalties on tax contingencies in the Consolidated Balance Sheets.

Legg Mason's prior year tax returns are subject to examination by the Internal Revenue Service ("IRS"), Her Majesty’s Revenue & Customs, Brazilian and other tax authorities in various other countries and states. The following tax years remain open to income tax examination for each of the more significant jurisdictions where Legg Mason is subject to income taxes: after fiscal 2015 for U.S. federal; after fiscal 2015 for the U.K.; after calendar year 2008 for Brazil; after fiscal 2012 for the state of California; after fiscal 2008 for the state of New York; and after fiscal 2013 for the states of Connecticut and Maryland. The Company does not anticipate making any significant cash payments with the settlement of these audits in excess of amounts that have been reserved.

Except as noted below, Legg Mason intends to permanently reinvest overseas substantially all of the cumulative undistributed earnings of its foreign subsidiaries. Accordingly, no additional U.S. federal income taxes have been provided for undistributed earnings to the extent that they are permanently reinvested in Legg Mason's foreign operations. However, if circumstances change, Legg Mason will provide for and pay any additional U.S. taxes in connection with repatriation of these earnings.

During the year ended March 31, 2017, Legg Mason implemented a restructure of its offshore holding company structure which resulted in the repatriation of approximately $11,600 of foreign earnings and resulted in a tax benefit of approximately $17,000.

In order to increase the amount of cash available in the U.S. for general corporate purposes, Legg Mason plans to utilize up to approximately $276,000 of foreign cash over the next several years, of which $4,255 is accumulated foreign earnings. Any additional tax provision associated with these repatriations was previously recognized. No further repatriation of accumulated prior period foreign earnings is currently planned. However, if circumstances change, Legg Mason will provide for and pay any applicable additional U.S. taxes in connection with repatriation of offshore funds. It is not practical at this time to determine the income tax liability that would result from any further repatriation of accumulated foreign earnings. Legg Mason had available domestically cash and cash equivalents of approximately $438,000 as of March 31, 2017; and had $500,000 of remaining undrawn capacity on our revolving credit facility to meet domestic liquidity needs, subject to compliance with applicable covenants, and to provide flexibility in maximizing cost effective capital deployment without repatriating additional accumulated foreign earnings.