Mercury Insurance 2007 Annual Report Download - page 79

2007 MERCURYNOW 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DEFERRED TAX ASSET AND LIABILITY
The temporary differences that give rise to a significant portion of the deferred tax asset (liability) relate to the following:
December 31,
Amounts in thousands 2007 2006
Deferred tax assets
20% of net unearned premium $ 68,027 $ 68,975
Discounting of loss reserves and salvage and subrogation recoverable for tax purposes 15,941 17,812
Write-down of impaired investments 11,549 4,757
Other deferred tax assets 10,800 3,478
Total gross deferred tax assets 106,317 95,022
Deferred tax liabilities
Deferred acquisition costs (73,432) (73,424)
Tax liability on net unrealized gain on securities carried at fair value (43,357) (37,492)
Tax depreciation in excess of book depreciation (10,073) (10,967)
Accretion on bonds (945) (914)
Undistributed earnings of insurance subsidiaries (5,113) (4,510)
Other deferred tax liabilities (4,249) (1,323)
Total gross deferred tax liabilities (137,169) (128,630)
Net deferred tax liabilities $ (30,852) $ (33,608)
Realization of deferred tax assets is dependent on generating sufficient taxable income prior to their expiration. Although realization is not
assured, management believes it is more likely than not that the deferred tax assets will be realized.
UNCERTAINTY IN INCOME TAXES
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. The tax years that remain subject to
examination by major taxing jurisdictions are 2004 through 2006 for federal taxes and 2001 through 2006 for California state taxes.
On March 28, 2006, the California State Board of Equalization (“SBE”) upheld Notices of Proposed Assessments issued against the Company
for tax years 1993 through 1996 in which the Franchise Tax Board (“FTB”) disallowed a portion of the Company’s expenses related to management
services provided to its insurance subsidiaries on grounds that such expenses were allocable to the Company’s tax-deductible dividends from such
subsidiaries. The SBE decision resulted in a smaller disallowance of the Company’s interest expense deductions than was proposed by the FTB in
those years. As a result of this ruling, the Company recorded an income tax charge (including penalties and interest) of approximately $15 million,
after federal tax benefit, in the first quarter of 2006. The Company believes that the deduction of the expenses related to management services
provided to its insurance subsidiaries is appropriate and is challenging the SBE decision in Superior Court.
The California FTB has audited the 1997 through 2002 and 2004 tax returns and accepted the 1997 through 2000 returns to be correct as filed.
The Company received a notice of examination for the 2003 tax return from the FTB in January 2008. For the Company’s 2001, 2002, and 2004
tax returns, the FTB has taken exception to the state apportionment factors used by the Company. Specifically, the FTB has asserted that payroll
and property factors from Mercury Insurance Services, LLC, a subsidiary of Mercury Casualty Company that are excluded from the Mercury
General California Franchise tax return, should be included in the California apportionment factors. In addition, for the 2004 tax return, the FTB
has asserted that a portion of management fee expenses paid by Mercury Insurance Services, LLC should be disallowed. Based on these assertions,
the FTB has issued notices of proposed tax assessments for the 2001, 2002 and 2004 tax years, totaling approximately $5 million. The Company
strongly disagrees with the position taken by the FTB and plans to formally appeal the assessments before the SBE. An unfavorable ruling against
the Company may have a material impact on the Company’s results of operations in the period of such ruling. Management believes that the issue
will ultimately be resolved in favor of the Company. However, there can be no assurance that the Company will prevail on this matter.
The Company adopted the provisions of FIN No. 48 on January 1, 2007. No adjustment to the Company’s financial position was required as
a result of the implementation of this Interpretation.