Income Taxes

Total income taxes for continuing operations were as follows.



Year Ended December 31,	2013			2012		2011
	(in millions)
Provision for income taxes	$	71		$	338	$	227
Income taxes related to adjustments included in common shareholder’s equity:
Unrealized gains (losses) on securities available-for-sale, net	(697		)	76		552
Unrealized gains (losses) on derivatives classified as cash flow hedges	82			17		(110		)
Employer accounting for post-retirement plans	6			5		(3		)
Other-than-temporary impairment on debt securities	(43		)	—		1
Total	$	(581	)	$	436	$	667

The components of income tax expense were as follows.



Year Ended December 31,	2013		2012			2011
	(in millions)
Current:
Federal	$	17	$	153		$	316
State and local	35		173			143
Foreign	17		(28		)	57
Total current	69		298			516
Deferred	2		40			(289		)
Total income tax expense	$	71	$	338		$	227

The following table provides 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,	2013					2012					2011
	(dollars are in millions)
Tax expense (benefit) at the U.S. federal statutory income tax rate	$	(93	)	(35.0	)%	$	(318	)	(35.0	)%	$	239		35.0	%
Increase (decrease) in rate resulting from:
State and local taxes, net of federal benefit	22			8.2		46			5.1		92			13.5
Adjustment of tax rate used to value deferred taxes	—			—		(13		)	(1.4	)	—			—
Non-deductible expense accrual related to certain regulatory matters⁽¹⁾	—			—		483			53.1		—			—
Non-deductible goodwill related to branch sale⁽¹⁾	—			—		139			15.3		—			—
Non-deductible goodwill impairment⁽²⁾	215			80.5		—			—		—			—
Valuation allowance⁽³⁾	—			—		—			—		(217		)	(31.8	)
Other non-deductible / non-taxable items⁽⁴⁾	(11		)	(4.1	)	(14		)	(1.5	)	3			0.4
Items affecting prior periods⁽⁵⁾	(13		)	(4.9	)	—			—		1			0.1
Uncertain tax positions⁽⁶⁾	20			7.5		45			4.9		161			23.6
Impact of foreign operations⁽⁷⁾	13			4.9		51			5.6		63			9.2
Low income housing tax credits	(84		)	(31.2	)	(85		)	(9.4	)	(115		)	(16.7	)
Other	2			0.7		4			0.4		—			—
Total income tax expense	$	71		26.6	%	$	338		37.1	%	$	227		33.3	%


⁽¹⁾	Represents non-deductible expense relating to certain regulatory matters and non-deductible goodwill related to the branches sold to First Niagara in 2012.


⁽²⁾	Represents non-deductible goodwill impairment related to our Global Banking and Markets reporting unit in the fourth quarter of 2013.


⁽³⁾	For 2011, relates to release of valuation allowance previously established on foreign tax credits.


⁽⁴⁾	For 2013 and 2012, mainly relates to tax exempt interest income. For 2011, relates to tax exempt income and tax credits.


⁽⁵⁾	For 2013 and 2011, relates to corrections to current and deferred tax balance sheet accounts and changes in estimates as a result of filing the federal and state income tax returns.


⁽⁶⁾	Reflects changes in state uncertain tax positions which no longer 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.


⁽⁷⁾	For 2013 and 2012, relates to foreign (U.K.) tax expense for which no foreign tax credits are allowed, and for 2011, primarily relates to the reversal of an accrued foreign tax expense related to Brazilian withholding taxes.

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



At December 31,	2013			2012
	(in millions)
Deferred tax assets:
Allowance for credit losses	$	250		$	267
Employee benefit accruals	142			120
Accrued expenses	110			334
Unused tax benefit carry-forwards	30			—
Bond premium amortization	226			143
Future federal tax benefit of state uncertain tax reserves	171			161
Interests in real estate mortgage investment conduits⁽¹⁾	309			188
Other	429			463
Total deferred tax assets	1,667			1,676
Less deferred tax liabilities:
Fair value adjustments	22			10
Unrealized (loss) gain on available-for-sale securities	(8		)	692
Mortgage servicing rights	96			69
Total deferred tax liabilities	110			771
Net deferred tax asset	$	1,557		$	905

⁽¹⁾

Real estate mortgage investment conduits ("REMICs") are investment vehicles that hold commercial and residential mortgages in trust and issue securities representing an undivided interest in these mortgages. HSBC Bank USA holds portfolios of noneconomic residual interests in a number of REMICs. This item represents tax basis in such interests which has accumulated as a result of tax rules requiring the recognition of income related to such noneconomic residuals.

A reconciliation of the beginning and ending amount of unrecognized tax benefits related to uncertain tax positions is as follows.



	2013			2012			2011
	(in millions)
Balance at January 1,	$	478		$	416		$	210
Additions based on tax positions related to the current year	16			86			105
Reductions based on tax positions related to the current year	(5		)	(31		)	—
Additions for tax positions of prior years	66			32			145
Reductions for tax positions of prior years	(15		)	(15		)	(44		)
Reductions related to settlements with taxing authorities	—			(10		)	—
Balance at December 31,	$	540		$	478		$	416

The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate was $334 million, $314 million and $276 million at December 31, 2013, 2012 and 2011, respectively. Included in the unrecognized tax benefits are some items the recognition of which would not affect the effective tax rate, such as the tax effect of temporary differences and the amount of state taxes that would be deductible for U.S. federal purposes. 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.

It is our policy to recognize accrued interest related to uncertain tax positions in interest expense in the consolidated statement of income (loss) and to recognize penalties, if any, related to uncertain tax positions as a component of other expenses in the consolidated statement of income (loss). We had accruals for the payment of interest and penalties associated with uncertain tax positions of $208 million, $159 million and $130 million at December 31, 2013, 2012 and 2011, respectively. Our accrual for the payment of interest and penalties associated with uncertain tax positions increased by $49 million during 2013 and $29 million during 2012.

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 the HNAH Group entities 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 the 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. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period.

Market conditions have created losses in the HNAH Group in recent periods and volatility in our pre-tax book income. As a consequence, our current analysis of the recoverability of the deferred tax assets significantly discounts any future taxable income expected from continuing operations and relies on continued capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. HSBC has indicated it remains fully committed and has the capacity and willingness to provide capital as needed to the HNAH Group 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.

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

HNAH Group valuation allowances are allocated to the principal subsidiaries. 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. At December 31, 2013, none of these valuation allowances were recorded at HUSI.

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 deferred tax liabilities, totaled $1,557 million and $905 million as of December 31, 2013 and 2012, respectively.

The Internal Revenue Service ("IRS") concluded its examination of our 2006 through 2009 income tax returns in the third quarter of 2013. The IRS forwarded the Revenue Agents’ Report (“RAR”) to the Joint Committee of Taxation (“JCT”) for approval in the fourth quarter of 2013. We expect the RAR to be approved by the JCT in the first half of 2014. The final impact is not expected to significantly affect our financial statements.

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.

At December 31, 2013, for Federal tax purposes we had foreign tax credits of $18 million which expire as follows: $6 million in 2018; $8 million in 2019; and $4 million in 2020 and we had general business credits of $12 million which expire in 2029.

At December 31, 2013, we had net operating losses carryforwards of $23 million for state tax purposes which expire as follows:$1 million in 2019 - 2023, $16 million in 2024 - 2028, and $6 million in 2029 and forward.