Income Taxes

The majority of the Company’s income from continuing operations before income taxes for fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015 was earned in the United States. The provision for income taxes related to continuing operations for fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015 included the following:



	12 Months Ended			11 Months Ended		12 Months Ended
	December 30, 2016			January 1, 2016		January 30, 2015
	(in millions)
Current:
Federal and foreign	$	88		$	71	$	16
State	16			14		(6		)
Deferred:
Federal and foreign	(29		)	20		26
State	(3		)	7		11
Total	$	72		$	112	$	47

A reconciliation of the provision for income taxes to the amount computed by applying the statutory federal income tax rate to income from continuing operations before income taxes for fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015 follows:



	12 Months Ended			11 Months Ended			12 Months Ended
	December 30, 2016			January 1, 2016			January 30, 2015
	(in millions)
Amount computed at the statutory federal income tax rate (35%)	$	111		$	124		$	(99	)
State income taxes, net of federal tax benefit	8			14			3
Taxable conversion of subsidiary	—			—			(116		)
Change in valuation allowance for deferred tax assets	(8		)	(21		)	105
Change in accruals for uncertain tax positions	1			(4		)	2
Research and development credits	(4		)	(4		)	(4		)
Dividends paid to employee stock ownership plan	(38		)	(3		)	(4		)
Capitalized transaction costs	7			—			—
Excess tax benefits from stock-based compensation	(8		)	—			—
Non-deductible goodwill	—			—			156
Other	3			6			4
Total	$	72		$	112		$	47
Effective income tax rate	22.6		%	31.5		%	(16.6		)%

The Company's effective tax rate for fiscal 2016 was favorably impacted by the tax deductibility of the special cash dividend, related to the Transactions described in “Note 2 - Acquisitions”, on shares held by the Leidos retirement plan, the income tax benefits of the research tax credit and the excess tax benefits related to employee stock-based payment transactions, partially offset by the impact of certain capitalized transactions costs related to the Transactions.

The Company's effective tax rate for the 11-month period ended January 1, 2016, was favorably impacted by the release of the valuation allowance related to the utilization of a capital loss carryforward for capital gains recognized during the current year and the favorable resolution of certain tax contingencies with the tax authorities. In addition, the Company's effective tax rate was favorably impacted by the research tax credit as well as the tax deduction for dividends on shares held by the Leidos Retirement Plan (an employee stock ownership plan).

The Company's effective tax rate in fiscal 2015 was negatively impacted by the goodwill impairment charge of $486 million, recorded in the quarter ended August 1, 2014, which was mostly not deductible. The effective tax rate was also impacted favorably by the tax benefit of a capital loss resulting from the conversion of one of our domestic subsidiaries to a Limited Liability Company ("LLC").

In fiscal 2015, discontinued operations reflect a tax benefit of $18 million due to the conversion of one of the Company's domestic subsidiaries held in discontinued operations. This conversion resulted in a deemed liquidation for U.S. tax purposes and triggered tax deductions and an income tax benefit.

Deferred income taxes are recorded for differences in the basis of assets and liabilities for financial reporting purposes and tax reporting purposes. Deferred tax (liabilities) assets were comprised of the following:



	December 30, 2016			January 1, 2016
	(in millions)
Accrued vacation and bonuses	$	89		$	45
Investments	3			3
Deferred compensation	38			39
Vesting stock awards	23			21
Credits and net operating losses carryovers	35			15
Employee benefit contributions	3			—
Capital loss carryover	81			91
Reserves	103			31
Deferred rent and tenant allowances	16			14
Other	17			13
Total deferred tax assets	408			272
Valuation allowance	(102		)	(102		)
Deferred tax assets, net of valuation allowance	306			170

Deferred revenue	(42		)	(36		)
Fixed asset basis differences	(11		)	(1		)
Purchased intangible assets	(748		)	(138		)
Partnership interest	(14		)	(11		)
Employee benefit contributions	—			(1		)
Other	(15		)	(9		)
Total deferred tax liabilities	(830		)	(196		)
Net deferred tax liabilities	$	(524	)	$	(26	)

Net deferred tax (liabilities) assets were as follows:



	December 30, 2016			January 1, 2016
	(in millions)
Net non-current deferred tax assets	$	16		$	8
Net non-current deferred tax liabilities	(540		)	(34		)
Total net deferred tax liabilities	$	(524	)	$	(26	)

Fiscal 2016 balances include IS&GS as of the date of acquisition on August 16, 2016, and may change upon finalization of the valuation of the acquired assets (see "Note 2 - Acquisitions").

At December 30, 2016, the Company had $26 million of federal net operating loss ("NOL") carryforwards and $184 million of state net operating losses, which will begin to expire in calendar year 2018. The Company also has $12 million of state tax credits, which will begin to expire in calendar year 2018. The Company expects to utilize $6 million and $69 million of these state tax credits and state net operating losses, respectively. The company also had foreign net operating losses of $38 million. The majority of the NOLs were acquired in the Transactions.

As of December 30, 2016, the Company had a capital loss carryforward of $206 million, $68 million of which will expire in 2018. The Company does not believe it will be able to generate capital gains to realize the benefit from the capital loss carryforward. As a result, a full valuation allowance has been provided as of December 30, 2016.

The Company’s unrecognized tax benefits are primarily related to certain recurring deductions customary for the Company’s industry. The changes in the unrecognized tax benefits, excluding accrued interest and penalties, were as follows:



	12 Months Ended			11 Months Ended			12 Months Ended
	December 30, 2016			January 1, 2016			January 30, 2015
	(in millions)
Unrecognized tax benefits at beginning of year	$	11		$	17		$	14
Additions for tax positions related to current year	1			5			2
Additions for tax positions related to prior years	4			4			11
Reductions for tax positions related to prior years	(7		)	(15		)	(5		)
Settlements with taxing authorities	—			—			(1		)
Lapse of statute of limitations	—			—			(4		)
Unrecognized tax benefits at end of year	$	9		$	11		$	17
Unrecognized tax benefits that, if recognized, would affect the effective income tax rate	$	4		$	7		$	5

In fiscal 2016, The Company's unrecognized tax benefits decreased primarily due to the resolution of the uncertain characterization of certain gains and state claims with the tax authorities, partially offset by an increase due to additional state and foreign items.

In the 11-month period ended January 1, 2016, the Company's unrecognized tax benefits decreased primarily due to the resolution of the uncertain portion of the deferral of certain revenues, the resolution of the research and development tax credit and certain state claims with the tax authorities, which were offset by an increase due to the uncertain characterization of certain gains. In fiscal 2015, the Company's unrecognized tax benefits increased primarily due to the uncertain portion of the deferral of certain revenues, certain affirmative state claims and the research and development tax credit offset by a decrease due to the expiration of federal and several states statutes of limitations and the termination of certain state credits.

At December 30, 2016, January 1, 2016, and January 30, 2015, accrued interest and penalties totaled $1 million, $1 million and $2 million, respectively. A negligible amount of interest and penalties were recognized in the Company's consolidated statements of income (loss) in fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015.

At December 30, 2016, the balance of unrecognized tax benefits included liabilities for uncertain tax positions of $10 million, $5 million of which were classified as other long-term liabilities on the Company's consolidated balance sheets. At January 1, 2016, the balance of unrecognized tax benefits included liabilities for uncertain tax positions of $12 million, $5 million of which were classified as other long-term liabilities on the Company's consolidated balance sheets. At January 30, 2015, the balance of unrecognized tax benefits included liabilities for uncertain tax positions of $19 million, $6 million of which were classified as other long-term liabilities on the Company's consolidated balance sheets.

The Company files income tax returns in the United States and various state and foreign jurisdictions. The Company participates in the Internal Revenue Service (“IRS”) Compliance Assurance Process, a real-time audit of the Company’s consolidated federal corporate income tax return. The IRS has examined the Company’s consolidated federal income tax returns through the 11-month period ended January 1, 2016. With a few exceptions, as of December 30, 2016, the Company is no longer subject to state, local, or foreign examinations by the tax authorities for years before fiscal 2014.

During the next 12 months, it is reasonably possible that resolution of reviews by taxing authorities, both domestic and international, could be reached with respect to $4 million of the Company’s unrecognized tax benefits, depending on the timing of ongoing examinations, any litigation and expiration of statute of limitations, either because the Company’s tax positions are sustained or because the Company agrees to their disallowance and pays the related income tax. While the Company believes it has adequate accruals for uncertain tax positions, the tax authorities may determine that the Company owes taxes in excess of recorded accruals or the recorded accruals may be in excess of the final settlement amounts agreed to by tax authorities.