INCOME TAXES

12 Months Ended

Dec. 31, 2019

NOTE 22 - INCOME TAXES

Citizens uses an asset and liability (balance sheet) approach for financial accounting and reporting of income taxes, resulting in two components of income tax expense: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period. Deferred income tax expense results from changes in gross deferred tax assets and liabilities between periods. These gross deferred tax assets and liabilities represent changes in taxes expected to be paid in the future due to reversals of temporary differences between the bases of

the assets and liabilities as measured under tax laws, and their bases reported in the Consolidated Financial Statements as measured under GAAP.

Citizens also assesses the probability that the positions taken, or expected to be taken, in its income tax returns will be sustained by taxing authorities. A “more likely than not” (more than 50 percent) recognition threshold must be met before a tax benefit can be recognized. Tax positions that are more likely than not to be sustained are reflected in the Company’s Consolidated Financial Statements.

The following table presents total income tax expense:



	Year Ended December 31,
(in millions)	2019		2018			2017
Income tax expense		$460		$462			$260
Tax effect of changes in OCI	225		(96		)	(7		)
Total comprehensive income tax expense		$685		$366			$253

The following table presents the components of income tax expense:



(in millions)	Current		Deferred			Total
Year Ended December 31, 2019
U.S. federal		$323		$64			$387
State and local	73		—			73
Total		$396		$64			$460
Year Ended December 31, 2018
U.S. federal		$271		$90			$361
State and local	94		7			101
Total		$365		$97			$462
Year Ended December 31, 2017
U.S. federal		$376		($142	)		$234
State and local	20		6			26
Total		$396		($136	)		$260

The following table presents a reconciliation between the U.S. federal income tax rate and the Company’s effective income tax rate:



	Year Ended December 31,
	2019					2018					2017
(in millions, except ratio data)	Amount			Rate		Amount			Rate		Amount			Rate
U.S. federal income tax expense and tax rate		$473		21.0	%		$459		21.0	%		$669		35.0	%
Increase (decrease) resulting from:
Federal rate change	—			—		(34		)	(1.6	)	(331		)	(17.3	)
State and local income taxes (net of federal benefit)	73			3.2		89			4.1		46			2.4
Bank-owned life insurance	(12		)	(0.5	)	(12		)	(0.5	)	(19		)	(1.0	)
Tax-exempt interest	(15		)	(0.7	)	(15		)	(0.7	)	(21		)	(1.1	)
Tax advantaged investments (including related credits)	(50		)	(2.3	)	(44		)	(2.0	)	(51		)	(2.7	)
Other tax credits	(10		)	(0.4	)	(8		)	(0.4	)	(3		)	(0.1	)
Adjustments for uncertain tax positions	—			—		1			0.1		(23		)	(1.2	)
Non-deductible FDIC premiums	13			0.6		21			1.0		—			—
Legacy tax matters	(19		)	(0.8	)	—			—		—			—
Other	7			0.3		5			0.2		(7		)	(0.4	)
Total income tax expense and tax rate		$460		20.4	%		$462		21.2	%		$260		13.6	%

The following table presents the tax effects of temporary differences that give rise to significant portions of the Company’s deferred tax assets and liabilities:



	December 31,
(in millions)	2019			2018
Deferred tax assets:
Other comprehensive income		$141			$366
Allowance for credit losses	315			308
State net operating loss carryforwards	62			90
Accrued expenses not currently deductible	24			36
Investment and other tax credit carryforwards	89			74
Fair value adjustments	—			28
Total deferred tax assets	631			902
Valuation allowance	(79		)	(110		)
Deferred tax assets, net of valuation allowance	552			792
Deferred tax liabilities:
Leasing transactions	513			527
Amortization of intangibles	370			364
Depreciation	186			195
Pension and other employee compensation plans	124			127
Partnerships	71			51
Deferred Income	79			50
MSRs	75			51
Total deferred tax liabilities	1,418			1,365
Net deferred tax liability		$866			$573

Deferred tax assets are recognized for net operating loss carryforwards and tax credit carryforwards. Valuation allowances are recorded as necessary to reduce deferred tax assets to the amounts that management concludes are more likely than not to be realized.

At December 31, 2019, the Company had state tax net operating loss carryforwards of $1.1 billion. Limitations on the ability to realize these carryforwards are reflected in the associated valuation allowance. At December 31, 2019, the Company had a valuation allowance of $79 million against various deferred tax assets related to state net operating losses and state tax credits, 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 assets related to these items. The valuation allowance decreased $31 million during the year ended December 31, 2019.

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, 2019, 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.

Citizens files income tax returns in the U.S. federal jurisdiction and in 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 2016.

The following table presents a reconciliation of the beginning and ending amount of unrecognized tax benefits:



	December 31,
(in millions)	2019			2018		2017
Balance at the beginning of the year		$8			$5		$42
Gross increase for tax positions related to current year	—			3		—
Gross decrease for tax positions related to prior years	(2		)	—		(27		)
Decrease for tax positions as a result of the lapse of the statutes of limitations	(1		)	—		(1		)
Decrease for tax positions related to settlements with taxing authorities	—			—		(9		)
Balance at end of year		$5			$8		$5

Tax positions are measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The difference between the benefit recognized for a position and the tax benefit claimed on a tax return is referred to as an unrecognized tax benefit.

Included in the total amount of unrecognized tax benefits at December 31, 2019, are potential benefits of $5 million that, if recognized, would impact the effective tax rate.

Citizens classifies interest and penalties related to unrecognized tax benefits as a component of income tax expense. There was no interest accrued through income tax expense during the years ended December 31, 2019 and 2018. The Company released $8 million of accrued interest through income tax expense during the year ended December 31, 2017. Citizens had approximately $1 million, $2 million, and $1 million accrued for the payment of interest at December 31, 2019, 2018, and 2017, respectively. There were no amounts accrued for penalties as of December 31, 2019, 2018, and 2017, and there were no penalties recognized during the years ended December 31, 2019, 2018, and 2017.