Income Taxes

Continuing Operations

Significant components of the provision for income taxes from continuing operations are as follows for the years ended December 31:



	2012			2011		2010
	(Dollars in millions)
Current tax expense:
Federal	$	(3.4	)	$	77.8	$	58.9
State	(1.2		)	14.5		12.0
Total current tax expense	(4.6		)	92.3		70.9
Deferred tax expense (benefit):
Federal	11.1			5.1		27.1
State	(2.2		)	2.7		10.1
Total deferred tax expense (benefit)	8.9			7.8		37.2
Interest expense, gross of related tax effects	1.7			0.6		0.6
Total income tax provision	$	6.0		$	100.7	$	108.7

A reconciliation of the statutory federal income tax rate and the effective income tax rate on income from continuing operations is as follows for the years ended December 31:



	2012	2011	2010
Statutory federal income tax rate	35.0%	35.0%	35.0%
State and local taxes, net of federal income tax effect	(6.9)	6.9	5.2
Valuation allowance (release) against capital losses, net operating losses or tax credits	(26.5)	21.9	(2.5)
Non-deductible compensation	17.7	2.3	1.1
Tax exempt interest income	(12.7)	(2.2)	(1.2)
Sale of subsidiaries	1.8	(3.9)	(1.2)
Interest expense	5.3	0.5	0.0
Lobbying expense	3.4	0.8	0.4
Other, net	1.8	1.0	1.9
Effective income tax rate	18.9%	62.3%	38.7%

The effective income tax rate from continuing operations was 18.9%, 62.3% and 38.7% for the years ended December 31, 2012, 2011 and 2010, respectively. During the year ended December 31, 2011, a judgment was rendered in the AmCareco litigation (see Note 13) that resulted in deferred tax assets of $51.1 million. Realization of these deferred tax assets was uncertain and therefore, a valuation allowance for the full amount was established. The most significant change in the effective income tax rate from 2011 to 2012 is as a result of the absence of such litigation effects in 2012. Additionally, our effective income tax rate for the year ended December 31, 2012 is lower than the statutory federal rate of 35% primarily due to the effect of tax-exempt income and reductions of valuation allowances against deferred assets, which resulted from the utilization of capital loss carryforwards against gains on sale of the marketable securities. Such beneficial impacts are partially offset by the effect of certain compensation treated as non-deductible under the ACA.

Significant components of our deferred tax assets and liabilities as of December 31 are as follows:



	2012			2011
	(Dollars in millions)
DEFERRED TAX ASSETS:
Accrued liabilities	$	92.7		$	71.2
Accrued compensation and benefits	70.5			79.6
Net operating and capital loss carryforwards	22.9			75.2
Insurance loss reserves and unearned premiums	15.4			17.4
Deferred gain and revenues	12.4			12.4
Other	2.4			0.8
Deferred tax assets before valuation allowance	216.3			256.6
Valuation allowance	(19.7		)	(63.7		)
Net deferred tax assets	$	196.6		$	192.9

DEFERRED TAX LIABILITIES:
Depreciable and amortizable property	$	63.6		$	51.0
Prepaid expenses	17.7			23.4
Unrealized gains on investments	22.9			11.6
Deferred revenue	25.8			8.3
Other	1.9			2.3
Deferred tax liabilities	$	131.9		$	96.6

On December 31, 2009, we completed the Northeast Sale (see Note 3). The Northeast Sale resulted in a total federal and state income tax benefit of $60.6 million for 2009 plus additional tax benefits of $6.8 million and $4.4 million for 2011 and 2010, respectively. The 2011 and 2010 adjustments in tax benefits arose due to a change in our estimate of contingent sale price components. During 2012, we recorded $0.6 million of additional tax expense related to examination adjustments.

The Northeast Sale also resulted in deferred tax assets for capital loss carryovers having a potential future state tax benefit of $6.8 million as of December 31, 2012 and a potential future federal and state tax benefit of $25.1 million as of December 31, 2011. A valuation allowance was established for the full amount of these deferred tax assets, as we determined that the future realizability of these benefits could not be assumed.

During 2012, our total valuation allowance decreased by a net $44.0 million, primarily resulting from the utilization of the capital loss carryforwards against the gains realized from the Medicare PDP business sale and marketable securities.

For 2012, 2011 and 2010 the income tax benefit realized from share-based award exercises was $16.6 million, $8.7 million and $7.5 million, respectively. Of the tax benefits (detriment) realized, $5.1 million, $0.8 million and $(5.7) million were allocated to stockholders’ equity in 2012, 2011 and 2010, respectively.

As of December 31, 2012, we had federal and state net operating loss carryforwards of approximately $6.0 million and $158.1 million, respectively. The net operating loss carryforwards expire at various dates through 2031.

Limitations on utilization may apply to all of the federal and state net operating loss carryforwards. Accordingly, valuation allowances have been provided to account for the potential limitations on utilization of these tax benefits. No portion of the 2012 valuation allowance was allocated to reduce goodwill.

We maintain a liability for unrecognized tax benefits that includes the estimated amount of contingent adjustments that may be sustained by taxing authorities upon examination. A reconciliation of the beginning and ending amount of unrecognized tax benefits, exclusive of related interest, is as follows:



	2012			2011		2010
	(Dollars in millions)
Gross unrecognized tax benefits at beginning of year	$	47.1		$	21.9	$	20.9
Increases in unrecognized tax benefits related to the current year	2.4			25.2		1.0
Increases in unrecognized tax benefits related to prior years	8.0			—		—
Decreases in unrecognized tax benefits related to a prior year	(0.2		)	—		—
Gross unrecognized tax benefits at end of year	$	57.3		$	47.1	$	21.9

Of the $62.7 million total liability at December 31, 2012 for unrecognized tax benefits, including interest and penalties, approximately $13.3 million would, if recognized, impact the Company’s effective tax rate. The remaining $49.4 million would impact deferred tax assets. Of the $50.8 million total liability at December 31, 2011 for unrecognized tax benefits, including interest and penalties, approximately $7.3 million would, if recognized, impact the Company’s effective tax rate. The remaining $43.5 million would impact deferred tax assets.

We recognized interest and any applicable penalties which could be assessed related to unrecognized tax benefits in income tax provision expense. Accrued interest and penalties are included within the related tax liability in the consolidated balance sheet. During 2012, 2011 and 2010, $1.7 million, $0.6 million and $0.6 million of interest was recorded as income tax provision, respectively. We reported interest accruals of $4.1 million and $2.4 million at December 31, 2012 and 2011, respectively. Provision expense and accruals for penalties were immaterial in all reporting periods.

We file tax returns in the federal as well as several state tax jurisdictions. As of December 31, 2012, tax years subject to examination in the federal jurisdiction are 2008 and forward. The most significant state tax jurisdiction for us is California, and tax years subject to examination by that jurisdiction are 2004 and forward. Presently we are under examination by various state taxing authorities. We do not believe that any ongoing examination will have a material impact on our consolidated balance sheet and results of operations.

In the next twelve months, it is reasonably possible that our unrecognized tax benefits could change due to the closure of state statutes of limitations for assessment and examination settlements regarding the Northeast Sale (see Note 3). These resolutions could reduce our unrecognized tax benefits by approximately $7.1 million.

Discontinued Operation

On April 1, 2012, we completed the sale of our Medicare PDP business to CVS Caremark. For the year ended December 31, 2012, we recorded tax expense of $18.0 million net against the gain on sale of discontinued operation. See Note 3 for additional information regarding the sale of our Medicare PDP business. The effective tax rate differs from the federal statutory rate of 35% due primarily to the impact of non-deductible goodwill impairment and a reduction in the valuation allowance against deferred tax assets, which resulted from the utilization of capital loss carryforwards against the gain on the sale of our Medicare PDP business.

Also in connection with the sale, we classified the operating results of the Medicare PDP business as discontinued operation, and accordingly, reclassified our results of operations for the years ended December 31, 2011 and 2010. We recorded a tax benefit of $10.3 million net against the loss from discontinued operation for the year ended December 31, 2012. We recorded tax expense of $6.2 million and $17.9 million net against income from discontinued operation for the years ended December 31, 2011 and 2010, respectively. The effective income tax rates related to income or loss from discontinued operation remained relatively constant throughout 2011 and 2012 at slightly above the federal statutory tax rate of 35% due to state income taxes.