Prudential 2011 Annual Report Download - page 230

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
19. INCOME TAXES (continued)
The Company classifies all interest and penalties related to tax uncertainties as income tax expense (benefit). The amounts recognized
in the consolidated financial statements for tax-related interest and penalties for the years ended December 31, are as follows:
2011 2010 2009
(in millions)
Interest and penalties recognized in the consolidated statements of operations ........................................... $13 $ 7 $(70)
Interest and penalties recognized in liabilities in the consolidated statements of financial position ........................... $28 $72 $65
The Company’s liability for income taxes includes the liability for unrecognized tax benefits and interest that relate to tax years still
subject to review by the Internal Revenue Service (“IRS”) or other taxing authorities. The completion of review or the expiration of the
Federal statute of limitations for a given audit period could result in an adjustment to the liability for income taxes. The Federal statute of
limitations for the 2002 tax year expired on April 30, 2009. The Federal statute of limitations for the 2003 tax year expired on July 31,
2009. The Federal statute of limitations for the 2004 through 2007 tax years will expire in June 2012, unless extended. Tax years 2008
through 2010 are still open for IRS examination.
During 2004 through 2006, the Company entered into two transactions that involved, among other things, the payment of foreign
income taxes that were credited against the Company’s U.S. tax liability. On May 23, 2011, the IRS issued notices of proposed adjustments
disallowing the foreign tax credits claimed and related transaction expenses. The total amount of the proposed adjustments for the
transactions was approximately $200 million of tax and penalties. During the fourth quarter of 2011, the Company reached agreement with
the IRS on the resolution of the proposed foreign tax credits disallowance. The impact to the 2011 results attributable to the settlement was
an increase to tax expense of approximately $93 million. The settlement of the foreign tax credit transactions for 2004 through 2006
marked the conclusion of the IRS audits for those years. As a result, all unrecognized tax positions plus interest relating to tax years prior to
2007 were recognized in 2011. As such, 2011 benefited from a reduction to the liability for unrecognized tax benefits of $70 million,
including the impact from the foreign tax credit disallowance.
The Company does not anticipate any significant changes within the next 12 months to its total unrecognized tax benefits related to
tax years for which the statute of limitations has not expired.
The dividends received deduction (“DRD”) reduces the amount of dividend income subject to U.S. tax and is the primary component
of the non-taxable investment income shown in the table above, and, as such, is a significant component of the difference between the
Company’s effective tax rate and the federal statutory tax rate of 35%. The DRD for the current period was estimated using information
from 2010, current year results, and was adjusted to take into account the current year’s equity market performance. The actual current year
DRD can vary from the estimate based on factors such as, but not limited to, changes in the amount of dividends received that are eligible
for the DRD, changes in the amount of distributions received from mutual fund investments, changes in the account balances of variable
life and annuity contracts, and the Company’s taxable income before the DRD.
In August 2007, the IRS released Revenue Ruling 2007-54, which included, among other items, guidance on the methodology to be
followed in calculating the DRD related to variable life insurance and annuity contracts. In September 2007, the IRS released Revenue
Ruling 2007-61. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54 and informed taxpayers that the U.S. Treasury Department
and the IRS intend to address through new guidance the issues considered in Revenue Ruling 2007-54, including the methodology to be
followed in determining the DRD related to variable life insurance and annuity contracts. On February 13, 2012, the Obama Administration
released the “General Explanations of the Administration’s Revenue Proposals.” One proposal would change the method used to determine
the amount of the DRD. A change in the DRD, including the possible retroactive or prospective elimination of this deduction through
guidance or legislation, could increase actual tax expense and reduce the Company’s consolidated net income. These activities had no
impact on the Company’s 2009, 2010 or 2011 results.
In December 2006, the IRS completed all fieldwork with respect to its examination of the consolidated federal income tax returns for
tax years 2002 and 2003. The final report was initially submitted to the Joint Committee on Taxation for their review in April 2007. The
final report was resubmitted in March 2008 and again in April 2008. The Joint Committee returned the report to the IRS for additional
review of an industry issue regarding the methodology for calculating the DRD related to variable life insurance and annuity contracts. The
IRS completed its review of the issue and proposed an adjustment with respect to the calculation of the DRD. In order to expedite receipt of
an income tax refund related to the 2002 and 2003 tax years, the Company agreed to such adjustment. The report, with the adjustment to
the DRD, was submitted to the Joint Committee on Taxation in October 2008. The Company was advised on January 2, 2009 that the Joint
Committee completed its consideration of the report and took no exception to the conclusions reached by the IRS. Accordingly, the final
report was processed and a $157 million refund was received in February 2009. The Company believed that its return position with respect
to the calculation of the DRD was technically correct. Therefore, the Company filed protective refund claims on October 1, 2009 to recover
the taxes associated with the agreed upon adjustment. The IRS issued an Industry Director Directive (“IDD”) in May 2010 stating that the
methodology for calculating the DRD set forth in Revenue Ruling 2007-54 should not be followed. The IDD also confirmed that the IRS
guidance issued before Revenue Ruling 2007-54, which guidance the Company relied upon in calculating its DRD, should be used to
determine the DRD. The Company has received a refund of approximately $3 million pursuant to the protective refund claims. These
activities had no impact on the Company’s 2009, 2010 or 2011 results.
228 Prudential Financial, Inc. 2011 Annual Report