2004 Annual Report: Financial Review: Statements and Notes: Note 17 Income Taxes

Note 17

Income Taxes

The components of Income Tax Expense for 2004, 2003 and 2002 were as follows:

(Dollars in millions)	2004	2003	2002
Current income tax expense
Federal	$6,392	$4,642	$3,386
State	683	412	451
Foreign	405	260	349
Total current expense	7,480	5,314	4,186
Deferred income tax (benefit) expense
Federal	(407)	(222)	(270)
State	(11)	(45)	(200)
Foreign	16	4	26
Total deferred benefit	(402)	(263)	(444)
Total income tax expense(1)	$7,078	$5,051	$3,742
(1) Does not reflect the deferred tax effects of Unrealized Gains and Losses on AFS Debt and Marketable Equity Securities, Foreign Currency Translation Adjustments and Derivatives that are included in Shareholders’ Equity. As a result of these tax effects, Shareholders’ Equity increased (decreased) Shareholders’ Equity. As a result of these tax effects, Shareholders’ Equity increased (decreased) by $383, $1,806 and $(1,090) in 2004, 2003 and 2002, respectively. Also, does not reflect tax benefits associated with the Corporation's employee stock plans which increased Shareholders' Equity by $401, $443 and $251 in 2004, 2003 and 2002, respectively. Goodwill has been reduced by $101, reflecting the tax benefits attributable to 2004 exercises of employee stock options issued by FleetBoston which had vested prior to the merger date.

Income Tax Expense for 2004, 2003 and 2002 varied from the amount computed by applying the statutory income tax rate to Income before Income Taxes. A reconciliation between the expected federal income tax expense using the federal statutory tax rate of 35 percent to the Corporation’s actual Income Tax Expense and resulting effective tax rate for 2004, 2003 and 2002 follows:

	2004: Amount	2004: Percent		2003: Amount	2003: Percent		2002: Amount	2002: Percent
	2004			2003			2002
(Dollars in millions)	Amount	Percent		Amount	Percent		Amount	Percent
Expected federal income tax expense	$7,427	35.0 %		$5,551	35.0 %		$4,547	35.0 %
Increase (decrease) in taxes resulting from:
Tax-exempt income, including dividends	(526)	(2.5)		(325)	(2.1)		(297)	(2.3)
State tax expense, net of federal benefit	437	2.1		239	1.5		210	1.6
Goodwill amortization	-	-		12	0.1		-	-
IRS tax settlement	-	-		(84)	(0.5)		(488)	(3.8)
Low income housing credits/other credits	(352)	(1.6)		(212)	(1.3)		(222)	(1.7)
Foreign tax differential	(78)	(0.4)		(50)	(0.3)		(58)	(0.4)
Other	170	0.8		(80)	(0.6)		50	0.4
Total income tax expense	$7,078	33.4 %		$5,051	31.8 %		$3,742	28.8 %

During 2002, the Corporation reached a tax settlement agreement with the IRS. This agreement resolved issues for numerous tax returns of the Corporation and various predecessor companies and finalized all federal income tax liabilities, excluding those relating to FleetBoston, through 1999. As a result of the settlement, reductions in Income Tax Expense of $84 million in 2003 and $488 million in 2002 were recorded representing refunds received and reductions in previously accrued taxes.

The IRS is currently examining the Corporation’s federal income tax returns for the years 2000 through 2002, as well as the tax returns of FleetBoston and certain other subsidiaries for years ranging from 1997 to 2000. The Corporation’s current estimate of the resolution of these various examinations is reflected in accrued income taxes; however, final settlement of the examinations or changes in the Corporation’s estimate may result in future income tax expense or benefit.

Significant components of the Corporation’s net deferred tax liability at December 31, 2004 and 2003 are presented in the following table.

	December 31, 2004	December 31, 2003
	December 31
(Dollars in millions)	2004	2003
Deferred tax liabilities
Equipment lease financing	$6,192	$5,321
Investments	1,088	905
Intangibles	803	955
Deferred gains and losses	251	189
State income taxes	192	281
Fixed assets	47	246
Employee compensation and retirement benefits	13	17
Other	435	560
Gross deferred tax liabilities	9,021	8,474
Deferred tax assets
Allowance for credit losses	3,668	2,421
Security valuations	2,326	1,876
Accrued expenses	533	421
Foreign tax credit carryforward	467	-
Available-for-sale securities	146	46
Loan fees and expenses	241	85
Net operating loss carryforwards	91	129
Other	1,150	280
Gross deferred tax assets	8,622	5,258
Valuation allowance (1)	(155)	(120)
Total deferred tax assets,           net of valuation allowance	8,467	5,138
Net deferred tax liabilities (2)	$  554	$3,336
(1) At December 31, 2004, $70 of the valuation allowance related to gross deferred tax assets was attributable to the Merger. Future recognition of the tax attributes associated with these gross deferred tax assets would result in tax benefits being allocated to reduce Goodwill. (2) The Corporation's net deferred tax liability was adjusted on April 1, 2004, to include a net deferred tax asset of $2.0 billion attributable to the Merger.

The valuation allowance recorded by the Corporation at December 31, 2004 and 2003 represents net operating loss carryforwards generated by foreign subsidiaries and certain state deferred tax assets, where, in each case, it is more likely than not that realization will not occur. These net operating loss carryforwards begin to expire after 2005 and could fully expire after 2010.

The foreign tax credit carryforward reflected in the table above represents foreign income taxes paid that are creditable against future U.S. income taxes. If not used, these credits begin to expire after 2009 and could fully expire after 2014.

At December 31, 2004 and 2003, federal income taxes had not been provided on $1.1 billion and $871 million, respectively, of undistributed earnings of foreign subsidiaries, earned prior to 1987 and after 1997 that have been reinvested for an indefinite period of time. If the earnings were distributed, an additional $221 million and $185 million of tax expense, net of credits for foreign taxes paid on such earnings and for the related foreign withholding taxes, would result in 2004 and 2003, respectively.

On December 21, 2004, the FASB issued FSP No. 109-2 that provides accounting and disclosure guidance for the foreign earnings repatriation provision within the Act. For additional information on FSP No. 109-2 and the Act, see Note 1 of the Consolidated Financial Statements.