14. 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	2017		2016			2015
Currently payable:
Federal	$	334	$	149		$	337
State	—		19			42
Total currently payable	334		168			379
Deferred:
Federal	274		13			(69		)
State	29		(2		)	(7		)
Total deferred	303		11			(76		)
Total income tax (benefit) expense ^(a)	$	637	$	179		$	303

(a)

There was no income tax (benefit) expense on securities transactions in 2017, 2016, and 2015. 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 $22 million in 2017, $18 million in 2016, and $16 million in 2015.

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	2017		2016
Allowance for loan and lease losses	$	233	$	373
Employee benefits	147		276
Net unrealized securities losses	138		146
Federal net operating losses and credits	205		130
Fair value adjustments	63		136
Non-tax accruals	89		150
State net operating losses and credits	7		15
Other	223		236
Gross deferred tax assets	1,105		1,462
Less: Valuation Allowance	15		26
Total deferred tax assets	1,090		1,436
Leasing transactions	588		728
Other	182		101
Total deferred tax liabilities	770		829
Net deferred tax assets (liabilities) ^(a)	$	320	$	607


(a)	From continuing operations.

On December 22, 2017, the TCJ Act was signed into law. This comprehensive tax legislation provides for significant changes to the U.S. Internal Revenue Code of 1986, as amended, that impact corporate taxation requirements, such as the reduction in the federal corporate income tax rate from 35% to 21% effective January 1, 2018. The TCJ Act retains the low-income housing and research and development credits and repeals the corporate alternative minimum tax. Other relevant corporate changes include earlier recognition of certain revenue; accelerating expensing of investments in tangible property, including leasing assets; and limiting several deductions such as FDIC premiums, certain executive compensation, and meals and entertainment expenses.

Key is required to re-value certain tax-related assets under the provisions of the TCJ Act at December 31, 2017. Under current U.S. GAAP, deferred tax assets and liabilities are to be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. The tax-related assets consist primarily of deferred tax assets and liabilities and investments in low-income housing transactions. Due to the close proximity of our year end to the date the TCJ Act was signed into law, we estimated the impact of the income tax effects as of December 31, 2017 based upon currently available information which resulted in a reduction to our net income of $161 million. The significant components of this reduction included a $14 million reduction in our investments in certain low-income housing that is reflected in other expenses and a $147 million, or 7.6%, increase in our income tax provision due to the reduction to our net deferred tax asset and related actions. This reduction is primarily the result of the lower federal corporate income tax rate, is based on information available at this time, and is subject to change due to a variety of factors, including among others: (i) completion of Key’s 2017 federal and state income tax returns, and (ii) management’s further assessment of the TCJ Act and related regulatory guidance. Adjustments may be made in future periods to these estimates as we continue to obtain, prepare and analyze information about facts and circumstances that existed as of the enactment date that, if known, would have affected the income tax effects reported as provisional amounts. Key expects to finalize this impact in the quarter ending September 30, 2018.

The accounting for the changes in tax law resulted in stranded tax effects within accumulated other comprehensive income for items that were originally recognized in other comprehensive income rather than in net income. The FASB recently issued an accounting standard update allowing companies to reclassify stranded tax effects resulting from the TCJ Act from accumulated other comprehensive income to retained earnings. We early adopted this guidance during the quarter ended December 31, 2017 and utilizing the portfolio method reclassified $141 million from accumulated other comprehensive income to retained earnings to eliminate the stranded tax effects.

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 $15 million of valuation allowances at December 31, 2017; primarily against federal and state capital loss carryforwards acquired in the First Niagara acquisition.

At December 31, 2017, we have federal net operating loss carryforwards of $79 million, federal credit carryforwards of $189 million, and capital loss carryforwards of $15 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 and general business credits which expire in 2037.

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 $72 million, and state credit carryforwards of $5 million, resulting in a net state deferred tax asset of $7 million. Additionally, we had state capital loss carryforwards of $2 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	2017					2016					2015
Year ended December 31, dollars in millions	Amount			Rate		Amount			Rate		Amount			Rate
Income (loss) before income taxes times 35% statutory federal tax rate	$	675		35.0	%	$	339		35.0	%	$	428		35.0	%
Amortization of tax-advantaged investments	104			5.4		88			9.0		81			6.7
Foreign tax adjustments	1			.1		1			.1		(1		)	(.1	)
Tax-exempt interest income	(37		)	(1.9	)	(25		)	(2.6	)	(18		)	(1.5	)
Corporate-owned life insurance income	(46		)	(2.4	)	(44		)	(4.5	)	(45		)	(3.6	)
State income tax, net of federal tax benefit	19			1.0		11			1.1		22			1.8
Tax credits	(218		)	(11.3	)	(208		)	(21.3	)	(155		)	(12.7	)
Tax Cuts and Jobs Act	147			7.6		—			—		—			—
Other	(8		)	(.5	)	17			1.7		(9		)	(.8	)
Total income tax expense (benefit)	$	637		33.0	%	$	179		18.5	%	$	303		24.8	%

Liability for Unrecognized Tax Benefits

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



Year ended December 31, in millions	2017			2016
Balance at beginning of year	$	53		$	12
Increase for other tax positions of prior years	3			10
Increase from Acquisitions	3			33
Decrease for payments and settlements	(4		)	—
Decrease related to tax positions taken in prior years	(16		)	(2		)
Balance at end of year	$	39		$	53

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 $39 million at December 31, 2017, and $53 million at December 31, 2016. 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 $1.3 million and $.4 million in 2017 and 2016, respectively and net interest expense of $.6 million in 2015. We recovered state tax penalties of $1 million in 2017 and $.3 million in 2015. We did not recover any state tax penalties in 2016. At December 31, 2017, we had an accrued interest payable of $4 million, compared to $3 million at December 31, 2016. Our liability for accrued state tax penalties was $0 million at December 31, 2017, and $1 million at December 31, 2016.

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, 2017, and December 31, 2016, are $17.2 million and $10.1 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

Retained earnings of KeyBank included 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.