Income Taxes

Income tax expense applicable to income from continuing operations is comprised of the following:



	Years ended December 31,
(In thousands)	2013		2012		2011
Current:
Federal	$	61,666	$	52,391	$	27,674
State and local	3,577		1,282		1,302
	65,243		53,673		28,976
Deferred:
Federal	10,693		20,012		28,497
State and local	734		980		478
	11,427		20,992		28,975
Total:
Federal	72,359		72,403		56,171
State and local	4,311		2,262		1,780
	$	76,670	$	74,665	$	57,951

The following is a reconciliation of Webster’s reported income tax expense applicable to income from continuing operations to the amount that would result from applying the federal statutory rate of 35%:



	Years ended December 31,
	2013					2012					2011
(Dollars in thousands)	Amount			Percent		Amount			Percent		Amount			Percent
Income tax expense at federal statutory rate	$	89,677		35.0	%	$	86,927		35.0	%	$	72,567		35.0	%
Reconciliation to reported income tax expense:
State and local income taxes, net of federal benefit	2,802			1.1		1,470			0.6		1,157			0.6
Tax-exempt interest income, net	(8,517		)	(3.3	)	(9,577		)	(3.8	)	(10,052		)	(4.8	)
Increase in cash surrender value of life insurance	(4,819		)	(1.9	)	(3,939		)	(1.6	)	(3,626		)	(1.7	)
Decrease in valuation allowance applicable to capital losses	(377		)	(0.2	)	(494		)	(0.2	)	(1,163		)	(0.6	)
Other, net	(2,096		)	(0.8	)	278			0.1		(932		)	(0.5	)
Reported income tax expense	$	76,670				$	74,665				$	57,951
Effective tax rate				29.9	%				30.1	%				28.0	%

Refundable income taxes totaling $56.0 million and $56.5 million at December 31, 2013 and 2012, respectively, are reported as a component of other assets and accrued interest receivable in the accompanying Consolidated Balance Sheets. The receipt of the refunds, largely attributable to Federal carryback claims applicable to 2008 and 2009 losses, is contingent upon the completion of an ongoing examination by the Internal Revenue Service and subsequent review and approval by the U.S. Congressional Joint Committee on Taxation. Refundable income taxes include $0.8 million and $0.9 million of accrued interest income at December 31, 2013 and 2012, respectively, on the estimated non-contingent portions of the refunds applicable to those years.

The significant components of the Company’s deferred tax asset, net (“DTA”) are reflected below:



	At December 31,
(In thousands)	2013			2012
Deferred tax assets:
Allowance for loan and lease losses	$	62,080		$	73,344
Net operating loss and credit carry forwards	66,709			66,308
Compensation and employee benefit plans	34,562			42,497
Net losses on derivative instruments	12,804			16,522
Impairment losses on securities available for sale	8,274			8,622
Non-accrual interest	4,105			8,247
Net unrealized loss on securities available for sale	1,532			—
Other	8,614			9,909
Gross deferred tax assets	198,680			225,449
Valuation allowance	(82,747		)	(82,502		)
Total deferred tax assets, net of valuation allowance	$	115,933		$	142,947
Deferred tax liabilities:
Net unrealized gain on securities available for sale	$	—		$	26,143
Equipment financing leases	13,751			10,784
Deferred income on repurchase of debt	10,627			10,627
Intangible assets	8,239			7,388
Premises and equipment	3,353			6,163
Mortgage servicing assets	7,765			5,461
Deferred loan costs, net	3,423			3,236
Other	3,666			4,464
Gross deferred tax liabilities	50,824			74,266
Deferred tax asset, net	$	65,109		$	68,681

The Company's DTA decreased by $3.6 million during 2013, reflecting the $11.4 million deferred tax expense and a $1.3 million expense charged directly to shareholders equity, partially offset by a $9.1 million benefit recognized as an increase in other comprehensive income.

Webster’s $82.7 million valuation allowance at December 31, 2013 consists of $75.5 million attributable to net state DTAs, including $2.6 million applicable to other comprehensive income, and $7.2 million attributable to capital losses deductible only to the extent of offsetting capital gains for U.S. tax purposes. During 2013, the valuation allowance increased by $0.2 million, net, and was attributable to a $0.4 million net decrease applicable to capital losses and a $0.6 million increase applicable to changes in certain net state DTAs, for which a full valuation allowance had been established at both the beginning and end of the year.

Management believes it is “more likely than not” that Webster will realize its DTAs net of the valuation allowance. Significant “positive evidence” exists in support of management’s conclusion regarding the realization of Webster's DTAs, including: book-taxable income levels in recent years and projected future years; recoverable taxes paid in 2013 and 2012; and future reversals of existing taxable temporary differences. There can, however, be no assurance that any specific level of future income will be generated or that the Company’s DTAs will ultimately be realized.

Connecticut net operating losses approximating $1.3 billion at December 31, 2013 are scheduled to expire in varying amounts during tax years 2020 through 2033. Connecticut income tax credits, totaling $3.3 million at December 31, 2013 have a five-year carryover period with excess credits expiring annually. A full valuation allowance of $66.7 million, net has been established for these Connecticut tax net operating losses and credits, and is included in Webster’s $75.5 million valuation allowance attributable to net state DTAs noted above.

A deferred tax liability of $20.8 million has not been recognized for certain “thrift bad-debt” reserves, established before 1988, that would become taxable upon the occurrence of certain events: distributions by Webster Bank in excess of certain earnings and profits; the redemption of Webster Bank’s stock; or liquidation. Webster does not expect any of those events to occur. At December 31, 2013 and 2012 the cumulative taxable temporary differences applicable to those reserves amounted to approximately $58.0 million.

The following is a reconciliation of the beginning and ending balances of Webster’s unrecognized tax benefits (“UTBs”):



	Years ended December 31,
(In thousands)	2013			2012			2011
Balance at beginning of year	$	3,119		$	4,436		$	4,816
Additions as a result of tax positions taken during the current year	528			858			462
Additions as a result of tax positions taken during prior years	442			283			518
Reductions as a result of tax positions taken during prior years	(460		)	(575		)	(791		)
Reductions relating to settlements with taxing authorities	—			(1,342		)	—
Reductions as a result of lapse of statute of limitations	(520		)	(541		)	(569		)
Balance at end of year	$	3,109		$	3,119		$	4,436

If recognized, $2.0 million of the $3.1 million of UTBs at December 31, 2013 and 2012 would benefit the effective tax rate.

Webster recognizes accrued interest and penalties related to UTBs, where applicable, in income tax expense. During the years ended December 31, 2013, 2012 and 2011, Webster recognized interest and penalties of $0.3 million, $0.3 million and $0.7 million, respectively. At December 31, 2013 and 2012, the Company had accrued interest and penalties related to UTBs of $1.2 million and $0.9 million, respectively.

Webster has determined it is reasonably possible that its total UTBs could decrease by an amount in the range of $0.6 million to $1.2 million by the end of 2014 as a result of potential settlements with state taxing authorities concerning tax-base determinations and/or lapses in statute-of-limitations periods.

Webster is currently under, or subject to, examination by various taxing authorities. Federal tax returns for all years subsequent to 2007 are either under or remain open to examination. For Webster’s principal state tax jurisdictions, Connecticut and Massachusetts tax returns for years subsequent to 2009 remain open to examination while New York and Rhode Island tax returns for years subsequent to 2006 or 2007 are either under or remain open to examination.