Provision for Income Taxes

The provision for income taxes consists of the following (in thousands):



	Fiscal years ended
	December 30, 2012			January 1, 2012			January 2, 2011
Current:
Federal	$	74,258		$	447,126		$	268,571
State	(824		)	12,708			20,557
Foreign	101,710			104,760			40,490
	175,144			564,594			329,618
Deferred:
Federal	45,383			(60,934		)	(143,406		)
State	1,634			(49		)	(23,931		)
Foreign	(12,649		)	(13,847		)	(4,990		)
	34,368			(74,830		)	(172,327		)
Provision for income taxes	$	209,512		$	489,764		$	157,291

Income before provision for income taxes consisted of the following (in thousands):



	Fiscal years ended
	December 30, 2012		January 1, 2012		January 2, 2011
United States	$	518,509	$	1,242,529	$	1,273,081
International	108,407		234,225		184,352
Total	$	626,916	$	1,476,754	$	1,457,433

The Company’s provision for income taxes differs from the amount computed by applying the federal statutory rates to income before taxes as follows:



	Fiscal years ended
	December 30, 2012		January 1, 2012		January 2, 2011
U.S. federal statutory rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal benefit	(0.3	)	0.5		(0.6	)
Non-deductible share-based compensation expense	1.3		0.4		0.2
Valuation allowance	0.2		0.4		(17.4	)
Tax-exempt interest income	(1.9	)	(0.9	)	(0.7	)
Foreign earnings at other than U.S. rates	(1.2	)	(1.8	)	(5.1	)
Other	0.3		(0.4	)	(0.6	)
Effective income tax rates	33.4	%	33.2	%	10.8	%

The Company’s earnings and taxes resulting from foreign operations are largely attributable to its Irish, Chinese, Israeli and Japanese entities.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax return reporting purposes. Significant components of the Company’s net deferred tax assets were as follows (in thousands):



	December 30, 2012			January 1, 2012
Deferred tax assets:
Deferred income on shipments to distributors and retailers and deferred revenue recognized for tax purposes	$	46,679		$	32,833
Accruals and reserves not currently deductible	51,636			62,812
Depreciation and amortization not currently deductible	54,474			59,464
Deductible share-based compensation	61,014			62,864
Unrealized loss on investments	9,879			9,620
Unrealized foreign exchange loss	45,122			78,360
Net operating loss carryforwards	40,092			33,871
Tax credit carryforward	25,187			16,939
Other	22,218			26,747
Gross deferred tax assets	356,301			383,510
Valuation allowance	(37,259		)	(25,614		)
Deferred tax assets, net of valuation allowance	319,042			357,896

Deferred tax liabilities:
Acquired intangible assets	(3,820		)	(1,864		)
Unrealized gain on investments	(9,324		)	(6,201		)
Unrealized foreign exchange gain	(43,327		)	(66,006		)
U.S. taxes provided on unremitted earnings of foreign subsidiaries	(28,844		)	(28,844		)
Total deferred tax liabilities	(85,315		)	(102,915		)
Net deferred tax assets	$	233,727		$	254,981

The Company assesses its valuation allowance recorded against deferred tax assets on a regular and periodic basis. The assessment of valuation allowance against deferred tax assets requires estimations and significant judgment. The Company continues to assess and adjust its valuation allowance based on operating results and market conditions. During fiscal years 2012 and 2011, based on weighing both the positive and negative evidence available, including but not limited to, earnings history, projected future outcomes, industry and market trends and the nature of each of the deferred tax assets, the Company determined that it is able to realize most of its deferred tax assets with the exception of certain loss and credit carryforwards. During fiscal year 2010, the Company determined that it was able to realize most of the U.S. federal and state deferred tax assets with the exception of certain net operating losses. As a result, the Company released $306.0 million of valuation allowance related to federal and state deferred tax assets in fiscal year 2010.

The Company has federal and state net operating loss carryforwards of $82.4 million and $208.4 million, respectively. The net operating losses will begin to expire in fiscal year 2014 if not utilized. The Company also has California research credit carryforwards of $36.7 million. California research credits can be carried forward to future years indefinitely. Some of these carryforwards are subject to annual limitations, including under Section 382 and Section 383 of the U.S. Internal Revenue Code of 1986, as amended, for U.S. tax purposes and similar state provisions.

The Company provides for U.S. income taxes on the earnings of foreign subsidiaries unless the earnings are considered indefinitely invested outside of the U.S. No provision has been made for U.S. income taxes or foreign withholding taxes on $582.9 million of cumulative unremitted earnings of certain foreign subsidiaries as of December 30, 2012, since the Company intends to indefinitely reinvest these earnings outside the U.S. The Company determined that the calculation of the amount of unrecognized deferred tax liability related to these cumulative unremitted earnings was not practicable. If these earnings were distributed to the Company’s U.S. entity, the Company would be subject to additional U.S. income taxes and foreign withholding taxes would be reduced by available foreign tax credits.

The tax benefit from share-based plans was applied to capital in excess of par value in the amount of $11.7 million, $20.5 million and $26.8 million in fiscal years 2012, 2011 and 2010, respectively.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):



Balance at January 2, 2011	$	172,060
Additions:
Tax positions related to current year	10,090
Tax positions related to prior years	4,489
Reductions:
Tax positions related to prior years	(296		)
Expiration of statute of limitations	(517		)
Balance at January 1, 2012	185,826
Additions:
Tax positions related to current year	1,943
Tax positions related to prior years	942
Reductions:
Tax positions related to prior years	(7,186		)
Expiration of statute of limitations	(2,003		)
Balance at December 30, 2012	$	179,522

The total amount of unrecognized tax benefits that would impact the effective tax rate, if recognized, is $83.1 million at December 30, 2012. The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. Accrued interest and penalties included in the Company’s liability related to unrecognized tax benefits at December 30, 2012 and January 1, 2012 was $32.2 million and $34.1 million, respectively. Interest and penalties, net, included in the Company’s tax expense for fiscal years 2012, 2011 and 2010 was $2.9 million, $3.2 million and ($2.4) million, respectively.

It is reasonably possible that the unrecognized tax benefits could decrease by approximately $6.6 million within the next 12 months as a result of the expiration of statutes of limitation. The Company is currently under audit by several tax authorities. Because timing of the resolution and/or closure of these audits is highly uncertain it is not possible to estimate other changes to the amount of unrecognized tax benefits for positions existing at December 30, 2012.

The Company is subject to U.S. federal income tax as well as income taxes in multiple state and foreign jurisdictions. In February 2012, the Internal Revenue Service (“IRS”) completed its field audit of the Company’s federal income tax returns for the years 2005 through 2008 and issued the Revenue Agent’s Report. The most significant proposed adjustments are comprised of related party transactions between SanDisk Corporation and its foreign subsidiaries. The Company is contesting these adjustments through the IRS Appeals Office and cannot predict when a resolution will be reached.

The Company strongly believes the IRS’s position regarding the intercompany transactions is inconsistent with applicable tax laws, judicial precedent and existing Treasury regulations, and that the Company’s previously reported income tax provisions for the years in question are appropriate. The Company believes that an adequate provision has been made for the adjustments from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner that is not consistent with management’s expectations, the Company could be required to adjust its provision for income tax in the period such resolution occurs.

The IRS recently initiated an examination of the Company’s federal income tax returns for fiscal years 2009 through 2011. The Company does not expect a resolution of this audit to be reached during the next twelve months. In addition, the Company is currently under audit by various state and international tax authorities. While the Company believes that it has an adequate provision for the years under audit, there is still a possibility that an adverse outcome from these matters could have a material effect on its financial position, results of operations or liquidity.

The aggregate dollar and per share effects of tax holidays available to the Company for fiscal years 2012, 2011 and 2010 were immaterial to its financial results.