
	Income Taxes

Total income taxes for continuing operations were as follows.



Year Ended December 31,	2012		2011			2010
	(in millions)
Provision (benefit) for income taxes	$	338	$	227		$	439
Income taxes related to adjustments included in common shareholder’s equity:
Unrealized gains (losses) on securities available-for-sale, net	76		552			96
Unrealized gains (losses) on derivatives classified as cash flow hedges	17		(110		)	10
Employer accounting for post-retirement plans	5		(3		)	(2		)
Other-than-temporary impairment	—		1			30
Total	$	436	$	667		$	573

The components of income tax expense (benefit) follow.



Year Ended December 31,	2012			2011			2010
	(in millions)
Current:
Federal	$	153		$	316		$	85
State and local	173			143			33
Foreign	(28		)	57			47
Total current	298			516			165
Deferred, primarily federal	40			(289		)	274
Total income tax expense (benefit)	$	338		$	227		$	439

The following table is an analysis of the difference between effective rates based on the total income tax provision attributable to pretax income and the statutory U.S. Federal income tax rate.



Year Ended December 31,	2012					2011					2010
	(dollars are in millions)
Tax expense (benefit) at the U.S. federal statutory income tax rate	$	(318	)	(35.0	)%	$	239		35.0	%	$	506		35.0	%
Increase (decrease) in rate resulting from:
State and local taxes, net of federal benefit	46			5.0		92			13.5		28			1.9
Adjustment of tax rate used to value deferred taxes	(13		)	(1.4	)	—			—		(84		)	(5.8	)
Non-deductible expense accrual related to certain regulatory matters⁽¹⁾	483			53.1		—			—		—			—
Non-deductible goodwill related to branch sale⁽¹⁾	139			15.3		—			—		—			—
Valuation allowance⁽²⁾	—			—		(217		)	(31.8	)	(26		)	(1.8	)
Accrual of tax reserves⁽³⁾	45			4.9		161			23.6		75			5.2
Impact of foreign operations⁽⁴⁾	51			5.6		63			9.2		56			3.9
Tax exempt interest income	(14		)	(1.5	)	(10		)	(1.5	)	(12		)	(.8	)
Low income housing and other tax credits	(85		)	(9.3	)	(115		)	(16.9	)	(111		)	(7.7	)
Non-taxable income	—			—		(4		)	(.6	)	(5		)	(.3	)
Other	4			0.4		18			2.8		12			.8
Total income tax expense (benefit)	$	338		37.1	%	$	227		33.3	%	$	439		30.4	%


⁽¹⁾	For 2012, largely impacted by non-deductible expense related to certain regulatory matters and non-deductible goodwill related to the branches sold to First Niagara.


⁽²⁾	For 2011, relates to release of valuation allowance previously established on foreign tax credits.


⁽³⁾	Tax reserves in 2012, 2011 and 2010, relate to state uncertain tax positions which we no longer believe we meet the more likely than not requirement for recognition. Specifically, the increase in 2011 relates to a state court decision that required us to increase our reserves.


⁽⁴⁾	For 2012, relates to foreign (U.K.) tax expense for which no foreign tax credits are allowed, and for 2011 and 2010, primarily related to an accrued foreign tax expense related to Brazilian withholding taxes reversed in 2010 - 2012.

The components of the net deferred tax position are presented in the following table.



At December 31,	2012		2011
	(in millions)
Deferred tax assets:
Allowance for credit losses	$	267	$	369
Benefit accruals	120		147
Accrued expenses not currently deductible	247		315
Tax credit carry-forwards	—		145
Interest and discount income	230		74
Future benefit of state reserves	161		140
REMIC losses not currently deductible	188		130
Other	463		482
Total deferred tax assets	1,676		1,802
Less deferred tax liabilities:
Fair value adjustments	10		172
Unrealized gains (losses) on available-for-sale securities	692		606
Mortgage servicing rights	69		85
Total deferred tax liabilities	771		863
Net deferred tax asset	$	905	$	939

A reconciliation of the beginning and ending amount of unrecognized tax benefits (hereinafter referred to as uncertain tax reserves) is as follows.



	2012			2011			2010
	(in millions)
Balance at January 1,	$	416		$	210		$	88
Additions based on tax positions related to the current year	86			105			62
Reductions based on tax positions related to the current year	(31		)	—			—
Additions for tax positions of prior years	32			145			84
Reductions for tax positions of prior years	(15		)	(44		)	(24		)
Reductions related to settlements with taxing authorities	(10		)	—			—
Balance at December 31,	$	478		$	416		$	210

The state tax portion of this amount is reflected gross and not reduced by Federal tax effect. It is reasonably possible that there could be a change in the amount of our unrecognized tax benefits within the next 12 months due to settlements or statutory expirations in various state and local tax jurisdictions. The total amount of unrecognized tax benefits at December 31, 2012 that, if recognized, would affect the effective income tax rate is $296 million and $276 million at December 31, 2012 and 2011, respectively.

It is our policy to recognize accrued interest related to unrecognized tax positions in interest expense in the consolidated statement of income and to recognize penalties, if any, related to unrecognized tax positions as a component of other operating expenses in the consolidated statement of income. We had accruals for the payment of interest and penalties associated with uncertain tax positions of $159 million and $130 million at December 31, 2012 and 2011, respectively. Our accrual for the payment of interest and penalties associated with uncertain tax positions increased by $29 million and $99 million during 2012 and 2011, respectively.

HSBC North America Consolidated Income Taxes We are included in HSBC North America's consolidated Federal income tax return and in various combined state income tax returns. As such, we have entered into a tax allocation agreement with HSBC North America and its subsidiary entities (the “HNAH Group”) included in the consolidated returns which govern the current amount of taxes to be paid or received by the various entities included in the consolidated return filings. As a result, we have looked at the HNAH Group's consolidated deferred tax assets and various sources of taxable income, including the impact of HSBC and HNAH Group tax planning strategies, in reaching conclusions on recoverability of deferred tax assets. Where a valuation allowance is determined to be necessary at the HSBC North America consolidated level, such allowance is allocated to principal subsidiaries within the HNAH Group as described below in a manner that is systematic, rational and consistent with the broad principles of accounting for income taxes.

The HNAH Group evaluates deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical financial performance, projections of future taxable income, future reversals of existing taxable temporary differences, tax planning strategies and any available carryback capacity.

In evaluating the need for a valuation allowance, the HNAH Group estimates future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC necessary as part of such plans and strategies. The HNAH Group has continued to consider the impact of the economic environment on the North American businesses and the expected growth of the deferred tax assets. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period.

In conjunction with the HNAH Group deferred tax evaluation process, based on our forecasts of future taxable income, which include assumptions about the depth and severity of home price depreciation and the U.S. economic environment, including unemployment levels and their related impact on credit losses, we currently anticipate that our results of future operations will generate sufficient taxable income to allow us to realize our deferred tax assets. However, since these market conditions have created losses in the HNAH Group in recent periods and volatility in our pre-tax book income, our analysis of the realizability of the deferred tax assets significantly discounts any future taxable income expected from continuing operations and relies to a greater extent on continued capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. HSBC has indicated they remain fully committed and have the capacity and willingness to provide capital as needed to run operations, maintain sufficient regulatory capital, and fund certain tax planning strategies.

Only those tax planning strategies that are both prudent and feasible, and which management has the ability and intent to implement, are incorporated into our analysis and assessment. The primary and most significant strategy is HSBC's commitment to reinvest excess HNAH Group capital to reduce debt funding or otherwise invest in assets to ensure that it is more likely than not that the deferred tax assets will be utilized.

Currently, it has been determined that the HNAH Group's primary tax planning strategy, in combination with other tax planning strategies, provides support for the realization of the net deferred tax assets recorded for the HNAH Group. Such determination is based on HSBC's business forecasts and assessment as to the most efficient and effective deployment of HSBC capital, most importantly including the length of time such capital will need to be maintained in the U.S. for purposes of the tax planning strategy.

During the first quarter of 2011, the HNAH Group identified an additional tax planning strategy that provided support for the realization of the deferred tax assets recorded for its foreign tax credits and certain state related deferred tax assets. The use of foreign tax credits is limited by the HNAH Group's U.S. tax liability and the availability of foreign source income. The tax planning strategy included the purchase of foreign bonds and REMIC residual interests. These purchases are expected to generate sufficient foreign source taxable income to allow for the utilization of the foreign tax credits before the credits expire unused and recognition of certain state deferred tax assets.

Notwithstanding the above, the HNAH Group had valuation allowances against certain state deferred tax assets and certain Federal tax loss carry forwards for which the aforementioned tax planning strategies did not provide appropriate support.

HNAH Group valuation allowances are allocated to the principal subsidiaries, including us. The methodology allocates the valuation allowance to the principal subsidiaries based primarily on the entity's relative contribution to the growth of the HSBC North America consolidated deferred tax asset against which the valuation allowance is being recorded.

If future results differ from the HNAH Group's current forecasts or the tax planning strategies were to change, a valuation allowance against some or all of the remaining net deferred tax assets may need to be established which could have a material adverse effect on our results of operations, financial condition and capital position. The HNAH Group will continue to update its assumptions and forecasts of future taxable income, including relevant tax planning strategies, and assess the need for such incremental valuation allowances.

Absent the capital support from HSBC and implementation of the related tax planning strategies, the HNAH Group, including us, would be required to record a valuation allowance against the remaining deferred tax assets.

HSBC USA Inc. Income Taxes We recognize deferred tax assets and liabilities for the future tax consequences related to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits and state net operating losses. Our net deferred tax assets, including both deferred tax liabilities and valuation allowances, totaled $905 million and $939 million as of December 31, 2012 and 2011, respectively.

During the third quarter of 2012, the Internal Revenue Service (“IRS”) Appeals Office closed its review covering the tax periods 2004 and 2005 after the settlement was approved by the Joint Committee of Taxation. There is no resulting impact to our uncertain tax reserves.

The IRS began its audit of our 2006 and 2007 income tax returns in 2009, with an anticipated completion in 2013. The IRS began their examination of 2008 and 2009 during the third quarter of 2011, with an anticipated completion in 2013.

We remain subject to state and local income tax examinations for years 2004 and forward. We are currently under audit by various state and local tax jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law and the closing of statute of limitations. Such adjustments are reflected in the tax provision. As a result of a 2011 state court decision related to a state tax uncertainty, we no longer believe that we can uphold the more likely than not conclusion taken on one of these uncertain tax positions. Therefore, tax reserves of approximately $288 million (net of federal tax benefit) and related accrued interest expense of $143 million were recorded through the fourth quarter of 2012 to recognize the estimated tax exposure on this matter.

At December 31, 2012, we had net operating losses carryforwards of $40 million for state tax purposes which expire as follows: $16 million in 2013 - 2017, $2 million in 2023 - 2027, $22 million in 2028 and forward.

At December 31, 2012, we had general business tax credits carryforwards of $1 million for state income tax purposes with no expiration period.