Note 5 – Income Taxes

The components of earnings before income taxes were:


Years ended December 31,	2011		2010		2009
U.S.	$	5,083	$	4,310	$	1,638
Non-U.S.		310		197		93
Total	$	5,393	$	4,507	$	1,731

Income tax expense/(benefit) consisted of the following:


Years ended December 31,	2011			2010			2009
Current tax expense
U.S. federal	$	(605	)	$	13		$	(132	)
Non-U.S.		93			80			69
U.S. state		(22	)		(137	)		145
Total current		(534	)		(44	)		82
Deferred tax expense
U.S. federal		1,856			969			457
Non-U.S.		(8	)		(13	)		(55	)
U.S. state		68			284			(88	)
Total deferred		1,916			1,240			314
Total income tax expense	$	1,382		$	1,196		$	396

Net income tax payments/(refunds) were $57, $360, and $(198) in 2011, 2010 and 2009, respectively.

Our effective income tax rate was 25.6%, 26.5%, and 22.9% for the years ended December 31, 2011, 2010 and 2009, respectively. Our 2011 effective tax rate was lower than 2010, primarily due to an income tax charge of $150 recorded during the first quarter of 2010 as a result of the Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010. Our 2010 effective tax rate was higher than 2009, primarily because pre-tax book income in 2010 was higher than in 2009 and because of the income tax charge of $150 recorded during the first quarter of 2010. This was partially offset by a tax benefit of $371 recorded during the fourth quarter of 2010 as a result of settling the 1998-2003 federal audit. The following is a reconciliation of the U.S. federal statutory tax rate of 35% to our effective income tax rate:


Years ended December 31,	2011			2010			2009
U.S. federal statutory tax		35.0	%		35.0	%		35.0	%
Research and development credits		(2.7	)		(3.5	)		(10.1	)
Tax on international activities		(0.6	)		(1.2	)		(2.4	)
Tax deductible dividends		(0.8	)		(0.9	)		(2.2	)
State income tax provision, net of effect on U.S. federal tax		0.7			1.8			2.2
Medicare Part D law change					3.3
Federal audit settlement		(7.4	)		(8.2	)
Other provision adjustments		1.4			0.2			0.4
Effective income tax rate		25.6	%		26.5	%		22.9	%

During the fourth quarter of 2011, a tax benefit of $397 was recorded as a result of settling the 2004-2006 federal tax audit. During the fourth quarter we received an audit report for the 2007-2008 IRS examination for which we are filing an appeal. We are also subject to examination in major state and international jurisdictions for the 2001-2011 tax years. We believe appropriate provisions for all outstanding tax issues have been made for all jurisdictions and all open years.

Significant components of our deferred tax assets, net of deferred tax liabilities, at December 31 were as follows:


	2011			2010
Retiree health care accruals	$	2,820		$	3,061
Inventory and long-term contract methods of income recognition, fixed assets and other (net of valuation allowance of $27 and $27)		(5,189	)		(2,644	)
Partnerships and joint ventures		(228	)		(263	)
Other employee benefits accruals		1,352			1,272
In-process research and development related to acquisitions		51			65
Net operating loss, credit and capital loss carryovers (net of valuation allowance of $74 and $78)		488			300
Pension asset		5,315			3,443
Customer and commercial financing		(1,471	)		(1,645	)
Unremitted earnings of non-U.S. subsidiaries		(66	)		(60	)
Other net unrealized losses		69			13
Net deferred tax assets⁽¹⁾	$	3,141		$	3,542

⁽¹⁾

Of the deferred tax asset for net operating loss and credit carryovers, $336 expires in years ending from December 31, 2012 through December 31, 2031 and $152 may be carried over indefinitely.

Net deferred tax assets at December 31 were as follows:


	2011			2010
Deferred tax assets	$	16,181		$	14,383
Deferred tax liabilities		(12,939	)		(10,736	)
Valuation allowance		(101	)		(105	)
Net deferred tax assets	$	3,141		$	3,542

The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Included in the net deferred tax assets at December 31, 2011 and 2010 are deferred tax assets in the amounts of $9,743 and $8,186 related to Accumulated other comprehensive loss.

We have provided for U.S. deferred income taxes and foreign withholding tax in the amount of $66 on undistributed earnings not considered permanently reinvested in our non-U.S. subsidiaries. We have not provided for U.S. deferred income taxes or foreign withholding tax on the remainder of undistributed earnings from our non-U.S. subsidiaries because such earnings are considered to be permanently reinvested and it is not practicable to estimate the amount of tax that may be payable upon distribution.

As of December 31, 2011 and 2010, the amounts accrued for the payment of income tax-related interest and penalties included in the Consolidated Statements of Financial Position were as follows: interest of $48 and $170 and penalties of $10 and $12. The amounts of interest (benefit)/expense were ($94), ($105), and $45 for the years ended December 31, 2011, 2010, and 2009, respectively. The interest benefits recorded during 2011 and 2010 were primarily related to the 2004-2006 and 1998-2003 federal audit settlements.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


	2011			2010			2009
Unrecognized tax benefits – January 1	$	1,198		$	1,787		$	1,453
Gross increases – tax positions in prior periods		154			95			219
Gross decreases – tax positions in prior periods		(383	)		(465	)		(31	)
Gross increases – current-period tax positions		28			76			148
Gross decreases – current-period tax positions		(15	)		(40	)
Settlements		(42	)		(254	)
Lapse of statute of limitations		(1	)		(1	)		(2	)
Unrecognized tax benefits – December 31	$	939		$	1,198		$	1,787

As of December 31, 2011, 2010 and 2009, the total amount of unrecognized tax benefits was $939, $1,198, and $1,787 of which $838, $1,074, and $1,452 would affect the effective tax rate, if recognized. As of December 31, 2011, these amounts are primarily associated with U.S. federal tax issues such as the amount of research and development tax credits claimed, the domestic production activities deductions claimed, and U.S. taxation of foreign earnings. Also included in these amounts are accruals for domestic state tax issues such as the allocation of income among various state tax jurisdictions and the amount of state tax credits claimed.

The research and development credit expired on December 31, 2011. Members of Congress have introduced bills that would extend the credit. If the Research and Development credit is not extended there would be an unfavorable impact to our 2012 effective income tax rate. For the years ended December 31, 2011, 2010 and 2009, the Research and Development credit reduced our effective tax rate by 2.7%, 3.5%, and 10.1%, respectively.