INCOME TAXES

Total income tax expense (benefit) was as follows:



	Year Ended December 31,
(in millions)	2014		2013			2012
Income tax expense (benefit)		$403		($42	)		$381
Tax effect of changes in OCI	154		(194		)	125
Total comprehensive income tax expense (benefit)		$557		($236	)		$506

Components of income tax expense (benefit) are as follows:



(in millions)	Current		Deferred			Total
Year Ended December 31, 2014
U.S. federal		$224		$145			$369
State and local	38		(4		)	34
Total		$262		$141			$403
Year Ended December 31, 2013
U.S. federal		$3		($47	)		($44	)
State and local	8		(6		)	2
Total		$11		($53	)		($42	)
Year Ended December 31, 2012
U.S. federal		$19		$269			$288
State and local	56		37			93
Total		$75		$306			$381

The effective income tax rate differed from the U.S. federal income tax rate of 35% in 2014, 2013 and 2012 as follows:



	Year Ended December 31,
	2014					2013					2012
(dollars in millions)	Amount			Rate		Amount			Rate		Amount			Rate
U.S. Federal income tax expense (benefit) and tax rate		$444		35.0	%		($1,214	)	35.0	%		$359		35.0	%
Increase (decrease) resulting from:
Goodwill impairment	—			—		1,217			(35.1	)	—			—
State and local income taxes (net of federal benefit)	22			1.7		1			—		61			5.9
Bank-owned life insurance	(17		)	(1.3	)	(17		)	0.5		(18		)	(1.8	)
Tax-exempt interest	(15		)	(1.2	)	(13		)	0.4		(12		)	(1.1	)
Tax credits	(27		)	(2.1	)	(11		)	0.3		(8		)	(0.7	)
Other	(4		)	(0.3	)	(5		)	0.1		(1		)	(0.1	)
Total income tax expense (benefit) and tax rate		$403		31.8	%		($42	)	1.2	%		$381		37.2	%

The tax rates for the years ended December 31, 2013 and 2012 reflected in the table above have been restated with one decimal place to conform to the Company's current year tax rate presentation.

The increase in the effective tax rate from 2013 to 2014 was mainly due to the tax rate impact of the goodwill impairment charge taken in 2013. Goodwill not deductible for tax purposes accounted for 78.4% of the total goodwill impairment charge and generated a reduction of 35.1% in our effective tax rate for the year ended December 31, 2013.

Additionally, the effective income tax rate will be affected in future periods by the impact of the adoption of Accounting Standard Update No. 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects.” We expect this change in accounting method to increase the 2015 effective income tax rate by approximately 2.4 percentage points; however this is not expected to have a material impact on the Company’s Consolidated Financial Statements. For further information, see Recent Accounting Pronouncements in Note 1 “Significant Accounting Policies.”

The decrease in the effective tax rate from 2012 to 2013 represents the tax rate impact of the 2013 goodwill impairment in addition to the tax rate impact of a 2012 tax settlement. The state tax settlement represents 2.5% of the total tax rate for 2012 and is included in the rate reconciliation as a component of state and local income taxes (net of federal benefit).

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below:



	December 31,
(in millions)	2014			2013
Deferred tax assets:
Other comprehensive income		$232			$397
Allowance for credit losses	456			475
Net operating loss carryforwards	155			185
Accrued expenses not currently deductible	170			149
Investment and other tax credit carryforwards	—			62
Deferred income	45			35
Fair value marks	34			30
Other	1			—
Total deferred tax assets	1,093			1,333
Valuation allowance	(157		)	(193		)
Deferred tax assets, net of valuation allowance	936			1,140
Deferred tax liabilities:
Leasing transactions	825			811
Amortization of intangibles	380			296
Depreciation	164			124
Pension and other employee compensation plans	14			56
MSRs	46			50
Other	—			2
Total deferred tax liabilities	1,429			1,339
Net deferred tax liability		$493			$199

Certain of the December 31, 2013 balances reflected in the table above were restated to conform to the current year presentation. The portion of the state net operating losses that management has determined will not be recognized, along with the associated valuation allowance, is now presented without any federal tax impact.

At December 31, 2014, the Company had state tax net operating loss carryforwards of $2.0 billion. Limitations on the ability to realize these carryforwards are reflected in the associated valuation allowance. Additionally, it is planned that RBS Group will divest its remaining ownership interest in CFG by December 31, 2016. The change in ownership resulting from this divestiture will generate an annual limitation on the amount of carryforwards that can be utilized. These net operating losses will expire, if not utilized, in the years 2015 - 2034.

At December 31, 2014, the Company had a valuation allowance of $157 million against the deferred tax assets related to certain state temporary differences and net operating losses, as it is management’s current assessment that it is more likely than not that the Company will not recognize a portion of the deferred tax asset related to these items. The valuation allowance decreased $36 million during the year ended December 31, 2014.

Effective with the fiscal year ended September 30, 1997, the reserve method for bad debts was no longer permitted for tax purposes. The repeal of the reserve method required the recapture of the reserve balance in excess of certain base year reserve amounts attributable to years ended prior to 1988. At December 31, 2014, the Company’s base year loan loss reserves attributable to years ended prior to 1988, for which no deferred income taxes have been provided, was $557 million. This base year reserve may become taxable if certain distributions are made with respect to the stock of the Company or if the Company ceases to qualify as a bank for tax purposes. No actions are planned that would cause this reserve to become wholly or partially taxable.

The Company files income tax returns in the U.S. federal jurisdiction and various state and local jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal or state and local income tax examinations by major tax authorities for years before 2010.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	December 31,
(in millions)	2014			2013			2012
Balance at the beginning of the year, January 1		$33			$34			$136
Gross increases for tax positions related to prior years	60			—			29
Decreases for tax positions as a result of the lapse of the statute of limitations	(1		)	—			—
Decreases for tax positions related to settlements with taxing authorities	(20		)	(1		)	(134		)
Gross increases for tax positions related to the current year	—			—			3
Balance at end of year		$72			$33			$34

Included in the total amount of unrecognized tax benefits at December 31, 2014, are potential benefits of $49 million that, if recognized, would impact the effective tax rate.

The Company classifies interest and penalties related to unrecognized tax benefits as a component of income taxes. The Company accrued $1 million, $2 million, and $14 million of interest expense through December 31, 2014, 2013, and 2012, respectively. The Company had approximately $15 million, $14 million, and $12 million accrued for the payment of interest at December 31, 2014, 2013, and 2012, respectively. There were no amounts accrued for penalties as of December 31, 2014, 2013, and 2012, and there were no penalties recognized during 2014, 2013, and 2012.

It is anticipated that during 2015 the Company will enter into settlement agreements with certain state taxing authorities regarding its passive investment companies. Settlement of these uncertainties would reduce the unrecognized tax benefit by $61 million. During 2014, the Company settled nexus issues with various state taxing authorities for the years 2004 through 2013. Settlement of these uncertainties reduced the unrecognized tax benefit by $20 million.