13. Income Taxes

Income taxes included in the income statement are summarized below. We file a consolidated federal income tax return.



Year ended December 31, in millions	2016			2015			2014
Currently payable:
Federal	$	149		$	337		$	288
State	19			42			33
Total currently payable	168			379			321
Deferred:
Federal	13			(69		)	16
State	(2		)	(7		)	(11		)
Total deferred	11			(76		)	5
Total income tax (benefit) expense ^(a)	$	179		$	303		$	326

(a)

There was no income tax (benefit) expense on securities transactions in 2016, 2015, and 2014. Income tax expense excludes equity- and gross receipts-based taxes, which are assessed in lieu of an income tax in certain states in which we operate. These taxes, which are recorded in “noninterest expense” on the income statement, totaled $18 million in 2016, $16 million in 2015, and $17 million in 2014.

Significant components of our deferred tax assets and liabilities included in “accrued income and other assets” and “accrued expense and other liabilities,” respectively, on the balance sheet, are as follows:



December 31, in millions	2016		2015
Allowance for loan and lease losses	$	373	$	327
Employee benefits	276		268
Net unrealized securities losses	146		48
Federal net operating losses and credits	130		88
Fair value adjustments	136		—
Non-tax accruals	150		81
State net operating losses and credits	15		5
Other	236		260
Gross deferred tax assets	1,462		1,077
Less: Valuation Allowance	26		—
Total deferred tax assets	1,436		1,077
Leasing transactions	728		651
Fair Value Adjustments	—		2
Other	101		125
Total deferred tax liabilities	829		778
Net deferred tax assets (liabilities) ^(a)	$	607	$	299


(a)	From continuing operations.

We conduct quarterly assessments of all available evidence to determine the amount of deferred tax assets that are more-likely-than-not to be realized, and therefore recorded. The available evidence used in connection with these assessments includes taxable income in prior periods, projected future taxable income, potential tax-planning strategies, and projected future reversals of deferred tax items. These assessments involve a degree of subjectivity and may undergo significant change. Based on these criteria, we have recorded $26 million of valuation allowances at December 31, 2016; primarily against federal and state capital loss carryforwards acquired in the First Niagara acquisition.

At December 31, 2016, we have federal net operating loss carryforwards of $84 million, federal credit carryforwards of $100 million, and capital loss carryforwards of $23 million. The federal net operating loss carryforwards are from prior acquisitions by First Niagara and are subject to annual limitations under the tax code and, if not utilized, will expire in the years beginning 2027. We currently expect to fully utilize these losses. The federal credit carryforwards which consist primarily of AMT credit carryforwards, have no expiration under the Internal Revenue Code.

The capital loss carryforwards if not utilized, will expire in 2018 and 2019. Realization of these tax benefits is dependent upon Key’s ability to generate sufficient capital gain in an appropriate tax year to offset the capital loss carryforwards. At this time, generation of sufficient capital gain income is uncertain.

We had state net operating loss carryforwards of $79 million, and state credit carryforwards of $12 million, resulting in a net state deferred tax asset of $15 million. Additionally, we had state capital loss carryforwards of $3 million. These carryforwards, if not utilized, will gradually expire through 2031.

The following table shows how our total income tax expense (benefit) and the resulting effective tax rate were derived:



Year ended December 31, dollars in millions	2016					2015					2014
Year ended December 31, dollars in millions	Amount			Rate		Amount			Rate		Amount			Rate
Income (loss) before income taxes times 35% statutory federal tax rate	$	339		35.0	%	$	428		35.0	%	$	445		35.0	%
Amortization of tax-advantaged investments	88			9.0		81			6.7		69			5.4
Foreign tax adjustments	1			.1		(1		)	(.1	)	10			.8
Tax-exempt interest income	(25		)	(2.6	)	(18		)	(1.5	)	(16		)	(1.3	)
Corporate-owned life insurance income	(44		)	(4.5	)	(45		)	(3.6	)	(41		)	(3.2	)
State income tax, net of federal tax benefit	11			1.1		22			1.8		15			1.1
Tax credits	(208		)	(21.3	)	(155		)	(12.7	)	(134		)	(10.5	)
Other	17			1.7		(9		)	(0.8	)	(22		)	(1.7	)
Total income tax expense (benefit)	$	179		18.5	%	$	303		24.8	%	$	326		25.6	%

Liability for Unrecognized Tax Benefits

The change in our liability for unrecognized tax benefits is as follows:



Year ended December 31, in millions	2016			2015
Balance at beginning of year	$	12		$	6
Increase for other tax positions of prior years	10			7
Increase from Acquisitions	33			—
Decrease related to tax positions taken in prior years	(2		)	(1		)
Balance at end of year	$	53		$	12

Each quarter, we review the amount of unrecognized tax benefits recorded in accordance with the applicable accounting guidance. Any adjustment to unrecognized tax benefits is recorded in income tax expense. The amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate was $53 million at December 31, 2016, and $12 million at December 31, 2015. We do not currently anticipate that the amount of unrecognized tax benefits will significantly change over the next 12 months.

As permitted under the applicable accounting guidance, it is our policy to record interest and penalties related to unrecognized tax benefits in income tax expense. We recorded net interest benefit of $.4 million and $10.6 million in 2016 and 2014, respectively and net interest expense of $.6 million in 2015. We recovered state tax penalties of $.3 million in 2015. We did not recover any state tax penalties in 2016 and 2014. At December 31, 2016, we had an accrued interest payable of $3 million, compared to $.9 million at December 31, 2015. Our liability for accrued state tax penalties was $1 million at both December 31, 2016, and December 31, 2015.

The amount of unrecognized tax benefits to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if certain criteria are met at December 31, 2016, and December 31, 2015, are $10.1 million and $2.7 million, respectively.

We file federal income tax returns, as well as returns in various state and foreign jurisdictions. We are subject to income tax examination by the IRS for the tax years 2013 and forward. Currently, we are not under audit for the tax years 2013 and forward. We are not subject to income tax examinations by other tax authorities for years prior to 2007.

Pre-1988 Bank Reserves acquired in a business combination

Resulting from the First Niagara acquisition, at December 31, 2016, the retained earnings of KeyBank had approximately $92 million of allocated bad debt deductions for which no income taxes have been recorded. Under current federal law, these reserves are subject to recapture into taxable income if KeyBank, or any successor, fails to maintain its bank status under the Internal Revenue Code or makes non-dividend distributions or distributions greater than its accumulated earnings and profits. No deferred tax liability has been established as these events are not expected to occur in the foreseeable future.