Income Taxes

The U.S. Government enacted U.S. Tax Reform on December 22, 2017, which made significant changes to the U.S. tax system. Significant changes under U.S. Tax Reform included, among other things, the reduction of the U.S. corporate income tax rate from 35% to 21%, the implementation of a modified territorial tax system and the imposition of a one-time repatriation tax on deemed repatriated earnings and profits of U.S. owned foreign subsidiaries (Toll Charge). The Securities and Exchange Commission issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Job Act (SAB 118), which allowed companies to record provisional impacts of U.S. Tax Reform during a measurement period not extending beyond one year from the enactment date. As a result, the Company recorded an estimated tax benefit (Preliminary Net Tax Benefit) of $79 million from U.S. Tax Reform in its consolidated financial statements for the year ended December 31, 2017. For the year ended December 31, 2018, the SAB 118 measurement period closed and the Company recorded an additional $1 million net tax benefit related to U.S. Tax Reform. The final cumulative benefit of $80 million includes a $98 million estimated tax benefit related to the remeasurement of deferred taxes partially offset by an estimated tax provision of $18 million related to the Toll Charge. The implementation of a modified territorial tax system under U.S. Tax Reform subjects the Company to tax on its Global Intangible Low-Taxed Income (GILTI) starting with the year ended December 31, 2018. The FASB has permitted companies to make an accounting policy decision to either: (1) treat taxes due on future GILTI inclusions in U.S. taxable income as a current-period expense when incurred (“period cost method”) or (2) factor such amounts into the measurement of its deferred taxes (“deferred method”). The Company has elected to use the period cost method. As of December 31, 2018, the Company has completed the accounting for all impacts of U.S. Tax Reform.

Income from continuing operations before income taxes is summarized in the table below.



	Year Ended December 31,
	2018		2017		2016
	(in millions)
Domestic	$	630	$	649	$	608
Foreign	294		222		196
Income from continuing operations before income taxes	$	924	$	871	$	804

The components of the Company’s current and deferred portions of the provision for income taxes on continuing operations are presented in the table below.



	Year Ended December 31,
	2018			2017			2016
	(in millions)
Current income tax provision:
Federal	$	30		$	44		$	88
State and local	18			10			8
Foreign	62			56			48
Subtotal	110			110			144

Deferred income tax provision/(benefit):
Federal	(7		)	(16		)	25
State and local	—			6			2
Foreign	—			2			—
Subtotal	(7		)	(8		)	27
Total provision for income taxes	$	103		$	102		$	171

A reconciliation of the statutory federal income tax rate to the effective income tax rate on continuing operations of the Company is presented in the table below.



	Year Ended December 31,
	2018		2017		2016
Statutory federal income tax rate	21.0	%	35.0	%	35.0	%
State and local income taxes, net of federal income tax benefit	2.6		2.0		2.0
Foreign income taxes	(0.9	)	(6.7	)	(3.0	)
Manufacturing benefits	—		(1.4	)	(2.2	)
Research and experimentation and other tax credits	(5.2	)	(4.1	)	(4.6	)
Resolution of tax contingencies	(3.8	)	(0.4	)	(3.1	)
Tax deductible dividends	(0.5	)	(0.9	)	(1.0	)
Equity compensation - excess income tax benefits	(4.0	)	(2.3	)	(2.1	)
Mergers, acquisitions and divestitures	1.3		—		—
Tax reform	(0.1	)	(9.1	)	—
Other, net	0.7		(0.4	)	0.3
Effective income tax rate on continuing operations	11.1	%	11.7	%	21.3	%

The significant components of the Company’s net deferred tax assets and liabilities are presented in the table below.



	December 31,
	2018			2017
	(in millions)
Deferred tax assets:
Inventoried costs	$	47		$	44
Compensation and benefits	90			94
Pension and postretirement benefits	271			281
Loss carryforwards	13			12
Tax credit carryforwards	4			5
Other	67			57
Deferred tax assets	492			493
Less: valuation allowance	(14		)	(10		)
Deferred tax assets, net of valuation allowance	478			483
Deferred tax liabilities:
Goodwill and other intangible assets	$	(549	)	$	(514	)
Income recognition on contracts in process	(18		)	(24		)
Property, plant and equipment	(66		)	(59		)
Other	(36		)	(41		)
Deferred tax liabilities	(669		)	(638		)
Total deferred tax liabilities, net of valuation allowance	$	(191	)	$	(155	)

The classification of the Company’s deferred tax assets and liabilities are presented in the table below.



	December 31,
	2018			2017
	(in millions)
Non-current deferred tax assets	$	5		$	3
Non-current deferred tax liabilities	(196		)	(158		)
Total net deferred tax liabilities	$	(191	)	$	(155	)

Non-current deferred tax assets are presented in other assets on the consolidated balance sheets.

The following table presents the Company’s loss and tax credit carryforwards at December 31, 2018 on a tax-return basis. The Company has established a valuation allowance as indicated in those instances in which it does not believe that it is more likely than not it will generate sufficient taxable income, of the appropriate character and in the applicable subsidiary, to utilize the carryforwards.



	Year Ended December 31, 2018
	Carryforwards				Valuation Allowances
	Gross		Tax Effected		Gross			Tax Effected			Expiration Periods
	(in millions)
Federal net operating loss carryforwards	$	23	$	5	$	(5	)	$	(1	)	2026-2034
Foreign net operating loss carryforwards	18		4		(10		)	(3		)	Indefinite
State net operating loss carryforwards	291		4		(131		)	(3		)	2019-2038
Total loss carryforwards			$	13				$	(7	)

State tax credit carryforwards	5		4		(4		)	(3		)	2019-2033
Total tax credit carryforwards			$	4				$	(3	)

At December 31, 2018, the total amount of unrecognized tax benefits was $183 million, $150 million of which would reduce the effective income tax rate, if recognized. A reconciliation of the change in unrecognized income tax benefits, excluding potential interest and penalties, is presented in the table below.



	2018			2017			2016
	(in millions)
Balance at January 1	$	178		$	110		$	124
Additions for tax positions related to the current year	13			14			16
Additions for tax positions related to prior years	37			66			2
Reductions for tax positions related to prior years	(20		)	(4		)	(24		)
Reductions for tax positions related to settlements with taxing authorities	(7		)	—			(1		)
Reduction for tax positions related to prior years as a result of a lapse of statute of limitations	(18		)	(8		)	(7		)
Balance at December 31	$	183		$	178		$	110

At December 31, 2018, the Company anticipates that unrecognized tax benefits will decrease by approximately $27 million over the next 12 months due to the potential resolution of unrecognized tax benefits involving several jurisdictions and tax periods. The actual amount of the decrease over the next 12 months could vary significantly depending on the ultimate timing and nature of any settlements.

The Company and its subsidiaries file income tax returns in the U.S. Federal jurisdiction, which is the Company’s primary tax jurisdiction, and various state and foreign jurisdictions. At December 31, 2018, the statutes of limitations for the Company’s U.S. Federal income tax returns for the years ended December 31, 2012, 2013, 2015, 2016 and 2017 were open.

During the year ended December 31, 2018, the Company reached an agreement with the U.S. Internal Revenue Service (IRS) relating to the audit of the Company’s 2012 and 2013 U.S. Federal income tax returns and extended the statute of limitations to September 2019. The Company also reached agreement on several state and foreign audits. In addition, the statute of limitations expired for several of the Company’s tax returns, including the Company’s 2014 U.S. Federal income tax return as well as certain state and foreign tax returns. As a result, the Company reduced its income tax provision by $35 million, including interest and penalties.

During the years ended 2017 and 2016, the Company effectively settled various Federal, state and local and foreign audits. As a result of these settlements, the Company reversed previously accrued income tax expense of $4 million and $25 million, including interest and penalties.

At December 31, 2018 and 2017, current and non-current income taxes payable include accrued potential interest of $15 million ($11 million after income taxes) for each of the years, and potential penalties of $9 million and $8 million, respectively. With respect to the interest related items, the Company’s income tax expense included expenses of $2 million and $5 million for the years ended December 31, 2018 and 2017, respectively.

At December 31, 2018, the Company had not provided deferred income taxes and foreign withholding taxes for approximately $1 billion of undistributed earnings by its non-U.S. subsidiaries as such earnings are intended to be reinvested indefinitely. Although U.S. Tax Reform imposed the Toll Charge on accumulated earnings through December 31, 2017 and introduced a GILTI tax on foreign earnings beginning in 2018, undistributed earnings may still be subject to additional taxes upon repatriation, including foreign withholding taxes. Quantification of additional taxes that may be payable on distribution is not practicable.