Provision for Income Taxes

The following table presents the provision for income taxes and the effective tax rate (in thousands, except percentages):



	Three months ended						Six months ended
	June 29, 2014			June 30, 2013			June 29, 2014			June 30, 2013
Provision for income taxes	$	129,131		$	121,668		$	269,722		$	189,333
Effective tax rate	32.0		%	31.7		%	33.2		%	30.7		%

The provision for income taxes for the three and six months ended June 29, 2014 differs from the U.S. statutory tax rate of 35% due primarily to the tax impact of earnings from foreign operations, state taxes, non-deductibility of certain share-based compensation and tax-exempt interest income. Earnings and taxes resulting from foreign operations are largely attributable to the Company’s Irish, Chinese, Israeli and Japanese entities. Earnings in these countries where tax rates are lower than the U.S. notional rate contributed to the majority of the difference between the rate of the Company’s tax provision and the U.S. statutory tax rate. The higher effective tax rate for the six months ended June 29, 2014, compared to the same period in fiscal year 2013, is attributable to the federal R&D tax credit not being extended as of June 29, 2014, while the June 30, 2013 effective tax rate includes both the 2013 federal R&D credit and retroactive inclusion of the 2012 federal R&D tax credit, and changes in the composition of operating income by tax jurisdiction. As of June 29, 2014, the Company believes that most of its deferred tax assets are more likely than not to be realized, except for certain loss and credit carry forwards in certain U.S. and foreign tax jurisdictions.

Unrecognized tax benefits were $185.0 million and $185.3 million as of June 29, 2014 and December 29, 2013, respectively. Unrecognized tax benefits that would impact the effective tax rate in the future were approximately $85.4 million at June 29, 2014. Interest and penalties included in the income tax expense for the three and six months ended June 29, 2014 and June 30, 2013 were immaterial. It is reasonably possible that within the next 12 months, unrecognized tax benefits could decrease by up to $80.0 million as a result of potential settlements of tax authority examinations and could decrease by up to $10.2 million as a result of the expiration of statutes of limitation.

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 fiscal 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 precedents 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. The Company cannot reasonably estimate the outcome of these examinations, or provide assurance that the outcome of these examinations will not materially harm the Company’s financial position, results of operations or liquidity.