Income Taxes

Continuing Operations

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



	2014			2013			2012
	(Dollars in millions)
Current tax expense:
Federal	$	87.7		$	79.0		$	(3.4	)
State	(15.0		)	12.5			(1.2		)
Total current tax expense	72.7			91.5			(4.6		)
Deferred tax expense (benefit):
Federal	2.4			15.0			11.1
State	(19.0		)	(6.4		)	(2.2		)
Total deferred tax expense (benefit)	(16.6		)	8.6			8.9
Interest expense, gross of related tax effects	(1.9		)	(0.3		)	1.7
Total income tax provision	$	54.2		$	99.8		$	6.0

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:



	2014	2013	2012
Statutory federal income tax rate	35.0%	35.0%	35.0%
State and local taxes, net of federal income tax effect	(11.1)	1.5	(6.9)
Valuation allowance (release) against capital losses, net operating losses or tax credits	—	—	(26.5)
Loss on subsidiary stock	(24.9)	—	—
Non-deductible health insurer fee	24.8	—	—
Non-deductible compensation	4.8	3.6	17.7
Tax exempt interest income	(2.9)	(2.4)	(12.7)
Sale of subsidiaries	—	—	1.8
Interest expense	(1.0)	(0.1)	5.3
Lobbying expense	0.6	0.4	3.4
Other, net	1.8	(1.0)	1.8
Effective income tax rate	27.1%	37.0%	18.9%

The effective income tax rate from continuing operations was 27.1%, 37.0% and 18.9% for the years ended December 31, 2014, 2013 and 2012, respectively. For the year ended December 31, 2014, our effective tax rate was impacted by the health insurer fee which became effective under the ACA. Our health insurance industry fee payment of $141.4 million in 2014 was not deductible for federal income tax purposes and in many state jurisdictions. See Note 2, under the heading "Accounting for Certain Provisions of the ACA—Premium-based Fee on Health Insurers" for additional information regarding the health insurance industry fee.

During the year ended December 31, 2014, we recorded a $73.7 million tax benefit, net of adjustments to our reserve for uncertain tax benefits, as a result of a worthless stock loss. The loss was incurred with respect to the stock of Health Net of the Northeast, Inc., the former parent company of subsidiaries sold to an affiliate of UnitedHealth Group in 2009. The amount and character of the loss could be challenged by the taxing authorities, and as such, we increased our reserve for uncertain tax positions by $16.4 million related to this transaction. The tax benefit from the stock loss was primarily responsible for reducing our statutory tax rate below the statutory federal tax rate of 35% for the year ended December 31, 2014.

In all periods presented, our effective income tax rate has not been impacted by operations in foreign jurisdictions with varying statutory tax rates. Our health care operations are almost entirely domestic.

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



	2014			2013
	(Dollars in millions)
DEFERRED TAX ASSETS:
Accrued liabilities	$	72.8		$	87.8
Accrued compensation and benefits	68.8			67.1
Net operating and capital loss carryforwards	21.6			22.2
Unrealized losses on investments	0.5			16.7
Insurance loss reserves and unearned premiums	13.7			12.7
Deferred gain and revenues	1.3			6.6
Tax credits	10.8			8.8
Deferred tax assets before valuation allowance	189.5			221.9
Valuation allowance	(13.3		)	(23.3		)
Net deferred tax assets	$	176.2		$	198.6
DEFERRED TAX LIABILITIES:
Depreciable and amortizable property	$	53.0		$	77.1
Prepaid expenses	10.7			14.9
Deferred revenue	9.6			13.2
Unrealized gains on investments	5.6			—
Other	6.3			4.0
Deferred tax liabilities	$	85.2		$	109.2

During 2014, our total valuation allowance decreased by a net $10 million, primarily resulting from the expiration of a $6 million state capital loss carryforward upon which the valuation allowance was based.

For 2014, 2013 and 2012 the income tax benefit realized from share-based award exercises was $8.7 million, $6.1 million and $16.6 million, respectively. Of the tax benefits realized, $1.1 million, $(1.4) million and $5.1 million were allocated to stockholders’ equity in 2014, 2013 and 2012, respectively.

As of December 31, 2014, we had federal and state net operating loss carryforwards of approximately $6.1 million and $270.6 million, respectively. The net operating loss carryforwards expire at various dates through 2034.

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 2014 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:



	2014			2013			2012
	(Dollars in millions)
Gross unrecognized tax benefits at beginning of year	$	55.6		$	57.3		$	47.1
Increases in unrecognized tax benefits related to the current year	25.5			4.4			2.4
Increases in unrecognized tax benefits related to prior years	—			—			8.0
Decreases in unrecognized tax benefits related to a prior year	(17.5		)	(0.2		)	(0.2		)
Settlements with taxing authorities	—			(1.9		)	—
Lapse in statute of limitation for assessment	(2.1		)	(4.0		)	—
Gross unrecognized tax benefits at end of year	$	61.5		$	55.6		$	57.3

Of the $64.9 million total liability at December 31, 2014 for unrecognized tax benefits, including interest and penalties, approximately $19.6 million would, if recognized, impact the Company’s effective tax rate. The remaining $45.3 million would impact deferred tax assets. Of the $59.3 million total liability at December 31, 2013 for unrecognized tax benefits, including interest and penalties, approximately $9.7 million would, if recognized, impact the Company’s effective tax rate. The remaining $49.6 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 2014, 2013 and 2012, ($1.9) million, ($0.3) million and $1.7 million, respectively, of interest was recorded as income tax (benefit) provision. We reported interest accruals of $1.8 million, $3.7 million and $4.1 million at December 31, 2014, 2013 and 2012, 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, 2014, tax years subject to examination in the federal jurisdiction are 2010 and forward. The most significant state tax jurisdiction for us is California, and tax years subject to examination by that jurisdiction are 2010 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 decrease by up to $7.2 million due to examination settlements or alternatively increase by up to $2.6 million assuming we are able to utilize certain net operating loss and tax credit carryforwards that are currently subject to uncertainty.

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.

As a result of the sale, the operating results of our Medicare PDP business have been classified as discontinued operation in our consolidated statements of operations for the year ended December 31, 2012. We recorded a tax benefit of $10.3 million net against the loss from discontinued operation for the year ended December 31, 2012. The effective income tax rates related to income or loss from discontinued operation remained relatively constant throughout 2012 at slightly above the federal statutory tax rate of 35% due to state income taxes. We had no income or loss and no tax expense or benefit for discontinued operation for the years ended December 31, 2013 and 2014.