Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

Income Taxes

(12) Income Taxes

Income Tax Expense

        The components of the income tax expense from continuing operations are as follows:

	Successor		Predecessor
	Nine Months Ended December 31, 2011		Three Months Ended March 31, 2011			Year Ended December 31, 2010			Year Ended December 31, 2009
	(Dollars in millions)
Income tax expense:
Current tax provision (benefit):
Federal	$	2		(1	)		(14	)		10
State and local		2		1			11			2
Total current tax (benefit) provision		4		—			(3	)		12
Deferred tax provision:
Federal		24		120			470			187
State and local		4		26			38			42
Total deferred tax expense		28		146			508			229
Income tax expense	$	32		146			505			241

        For the successor nine months ended December 31, 2011 and the predecessor three months ended March 31, 2011, we increased the total valuation allowance by $7 million and $1 million, respectively. For the predecessor year ended December 31, 2010, we increased the total valuation allowance by $7 million. For the predecessor years ended December 31, 2009, we decreased the total valuation allowance by $2 million. These amounts are included in the deferred tax provision. Immaterial amounts relate to a change in the beginning of year valuation allowance for both predecessor years ended December 31, 2010, and 2009.

        The effective income tax rate for continuing operations differs from the statutory tax rate as follows:

	Successor			Predecessor
	Nine Months Ended December 31, 2011			Three Months Ended March 31, 2011			Year Ended December 31, 2010			Year Ended December 31, 2009
	(in percent)
Effective income tax rate:
Federal statutory income tax rate		35.0	%		35.0	%		35.0	%		35.0	%
State income taxes—net of federal effect and tax expense (benefit) of income (loss) not recognized		5.3			4.8			9.0			3.3
Medicare subsidy, including effect of 2010 Health Care Legislation		(1.5	)		—			22.8			(1.6	)
Loss on embedded option in convertible debt		—			—			37.0			—
Excess compensation		—			—			4.3			0.2
Merger-related costs		—			—			1.7			—
Uncertain tax position changes		(1.1	)		0.2			—			(10.0	)
Disallowed meals and entertainment		4.2			0.2			0.5			0.3
Foreign tax expense		2.5			—			—			—
Other		3.7			0.5			1.2			0.1
Adjustments related to prior periods		—			—			(0.6	)		(0.4	)
Changes in valuation allowance		15.3			0.1			1.3			(0.2	)
Effective income tax rate		63.4	%		40.8	%		112.2	%		26.7	%

Deferred Tax Assets and Liabilities

        The components of the deferred tax assets and liabilities are as follows:

	Successor			Predecessor
	Year Ended December 31, 2011			Year Ended December 31, 2010
	(Dollars in millions)
Deferred tax assets and liabilities:
Deferred tax assets:
Net operating loss carryforwards	$	2,437			2,029
Post-retirement and pension benefit costs		1,314			1,256
Deferred loss subject to amortization		264			282
Debt related differences		262			—
Restructuring charge		53			68
Other employee benefits		94			91
Other		504			364
Gross deferred tax assets		4,928			4,090
Valuation allowance on deferred tax assets		(239	)		(139	)
Net deferred tax assets		4,689			3,951
Deferred tax liabilities:
Property, plant and equipment and intangible assets		(1,543	)		(1,802	)
Intangibles		(3,031	)		(141	)
Deferred Revenue		(146	)		(30	)
Other		(66	)		(58	)
Total deferred tax liabilities		(4,786	)		(2,031	)
Net deferred tax (liability) assets	$	(97	)		1,920

Tax Audits and Uncertain Tax Positions

        The IRS examines all of our federal income tax returns because we are included in its coordinated industry case program. As of December 31, 2010, our federal income tax returns for tax years 2006-2007 and prior have been examined by the IRS. As a result of the examinations and the resulting settlements, our total unrecognized tax benefits decreased by $74 million. In 2010, we filed amended federal income tax returns for 2006-2007 to make protective claims with respect to items reserved in our audit settlements and to correct items not addressed in prior audits. Those amended federal income tax returns are subject to adjustment in an IRS audit.

        In 2009, we filed amended federal income tax returns for 2002-2005 to make protective claims with respect to items reserved in our audit settlements and to correct items not addressed in prior audits. Those amended federal income tax returns are subject to adjustment in an IRS audit. Additionally, our federal income tax returns filed for tax years after 2008 are still subject to adjustment in an IRS audit.

        We file combined income tax returns in many states, and these combined returns remain open for adjustments to our federal income tax returns. In addition, certain combined state income tax returns we have filed since 1996 are still open for state specific adjustments.

        A reconciliation of the unrecognized tax benefits:

	Unrecognized Tax Benefits
	Successor			Predecessor
	2011			2010
	(Dollars in millions)
Balance at January 1	$	203			282
Additions for current year tax positions		—			10
Additions for prior year tax positions		3			—
Reductions for prior year tax positions		(1	)		(15	)
Settlements		(141	)		(74	)
Reductions related to expirations of statute of limitations		—			—
Balance at December 31	$	64			203

        In 2010, we withdrew our claims associated with the treatment of universal services fund receipts resulting in a $141 million settlement decrease in our unrecognized tax benefits. Due to our NOL carryforward, the settlement of the position resulted in a reduction of our unrecognized tax benefits but no cash payment was required. As of December 31, 2011, approximately $64 million of the unrecognized tax benefits could affect our income tax provision and effective income tax rate.

        Effective on April 1, 2011 in conjunction with CenturyLink's acquisition of us, we changed our accounting policy to recognize interest expense and penalties related to income taxes as income tax expense. Prior to April 1, 2011, interest expense and penalties related to income taxes are included in the other—net line of our consolidated statements of operations. For the successor nine months ended December 31, 2011 and the predecessor three months ended March 31, 2011, we recognized $1 million and $1 million, respectively. For the predecessor year ended December 31, 2010, we recognized $4 million of interest benefit related to uncertain tax positions and for the predecessor year ended December 31, 2009, we recognized $2 million for interest expense related to uncertain tax positions. As of the successor date of December 31, 2011 and predecessor date of December 31, 2010, we had recorded liabilities for interest related to uncertain tax positions in the amounts of $8 million and $5 million, respectively. We made no accrual for penalties related to income tax positions.

Other Income Tax Information

        As of December 31, 2011, we had NOLs of $6.3 billion. If unused, the NOLs will expire between 2015 and 2031; however, no significant amounts expire until 2020. We have alternative minimum tax credits of $25 million as of December 31, 2011 which do not expire. We had unamortized investment tax credits of $1 million and $40 million as of December 31, 2011 and 2010, respectively, which are included in other long-term liabilities on our consolidated balance sheets. These investment tax credits are amortized over the lives of the related assets. As of December 31, 2011 and 2010, we also have $72 million and $73 million ($47 million and $47 million, net of federal income tax) of state investment tax credit carryforwards that will expire between 2012 and 2024, if not utilized.

        Income tax expense for the predecessor year ended December 31, 2010 compared to 2009 increased by $113 million as a result of the March 2010 enactments of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. Among other things, these laws will disallow federal income tax deductions for retiree prescription drug benefits to the extent we receive reimbursements for those benefits under the Medicare Part D program. Although this tax increase does not take effect until 2013, under accounting principles generally accepted in the U.S. we recognize the full accounting impact in the period in which the laws are enacted.

        In the predecessor year ended December 31, 2010, we increased our state tax rate based on a review of our state apportionment factors and the current tax rate of the states where we conduct business. This change resulted in a $4 million state deferred tax benefit, net of federal effect.

        In the predecessor year ended December 31, 2009, we reduced our state tax rate based on a review of our state apportionment factors and the current tax rate of the states where we conduct business. This change resulted in a $9 million state deferred tax expense, net of federal effect.

        Effective on April 1, 2011 in conjunction with CenturyLink's acquisition of us, our tax payments and receipts for combined or consolidated returns will be paid to or received from CenturyLink. We will continue to make some tax payments directly to certain tax jurisdictions where we file separate income tax returns. We did not make or receive any tax payments to CenturyLink during 2011 but, we received refunds of approximately $13 million and $1 million for the nine months ended December 31, 2011 and the three months ended March 31, 2011, respectively primarily associated with periods prior to April 1, 2011. In 2010, we paid $25 million for income taxes. In 2009, we paid $48 million for income taxes, of which $10 million was for interest.

Valuation Allowance

        From 2001 through 2005, we reported a significant cumulative loss and generated substantial NOLs for income tax purposes, and we maintained a valuation allowance against the majority of our net deferred tax assets at that time because we could not sustain a conclusion that it was more likely than not that we would realize the NOLs and other deferred tax assets.

        We establish valuation allowances necessary to reduce the deferred tax assets to amounts we expect to realize. At December 31, 2011 and 2010, a valuation allowance of $239 million and $139 million, respectively, was established because as it is more likely than not that this amount of net operating loss carryforwards or other deferred tax assets will not be realized.

        We recognized a $93 million increase in the valuation allowance as a result of acquisition accounting. The allowance was primarily related to state credit carryforwards recognized in acquisition accounting. Previously, the state credit carryforwards were not recognized due to the deferral method of accounting for investment tax credits.