NOTE 9 INCOME TAXES

Income (loss) before income taxes was $201 million, $(5,476) million and $(2,421) million for the years ended December 31, 2016, 2015 and 2014, respectively. The provision (benefit) for federal, state and local income taxes consisted of the following:

For the years ended December 31,	United States Federal			State and Local			Total
	(in millions)
2016
Current	$	—		$	—		$	—
Deferred	(66		)	(12		)	(78		)

	$	(66	)	$	(12	)	$	(78	)


2015
Current	$	255		$	81		$	336
Deferred	(1,961		)	(297		)	(2,258		)

	$	(1,706	)	$	(216	)	$	(1,922	)


2014
Current	$	66		$	99		$	165
Deferred	(840		)	(312		)	(1,152		)

	$	(774	)	$	(213	)	$	(987	)

The following reconciliation of the United States federal statutory income tax rate to our effective tax rate is stated as a percentage of pre-tax income or loss:

	For the years ended December 31,
	2016		2015		2014
United States federal statutory tax rate	35	%	35	%	35	%
State income taxes, net of federal	6		5		6
Valuation allowance	199		(7	)	—
Cancellation of debt income	(288	)	—		—
Stock-based compensation	3		—		—
Federal effect of state taxes on the above items	5		2		—
Other	1		—		—

Effective tax rate	(39	)%	35	%	41	%

Federal and state valuation allowance

In the first quarter of 2016, we reduced our valuation allowance against net deferred tax assets by $82 million. During the course of the year, we also increased the valuation allowance by $480 million. The resulting $398 million increase in the valuation allowance had the effect of increasing our effective tax rate, by 199%.

The first quarter 2016 reduction in the valuation allowance resulted from our evaluation in early 2016 of our assets and liabilities at the time of our fourth quarter 2015 debt exchange, which generated $1.4 billion of cancellation of debt income (CODI) for tax purposes. At that date, our evaluation indicated that our liabilities exceeded the value of our assets, both calculated in accordance with the tax rules, enabling us to move the liability related to CODI to deferred tax liabilities. The resulting increase of our deferred tax liabilities that could be offset against assets caused an $82 million reduction in the valuation allowance.

During the course of the year, based on prevailing product prices, we concluded that we could not realize, on a more-likely-than-not basis, any of the deferred tax assets being generated through operating losses. Accordingly, we provided full allowances against such assets generated during the year by the amount of $480 million.

We evaluate our deferred tax assets to determine if a valuation allowance is required to reduce our gross deferred tax assets to an amount expected to be realized. We expect to realize $375 million of our gross deferred tax assets through reversals of taxable temporary differences. We have maintained a full valuation allowance on our deferred tax assets above this amount as there is not sufficient evidence to support the reversal of any portion of this allowance. Given our recent and anticipated future earnings trends, we do not believe any of the valuation allowance will be released within the next 12 months. The amount of the deferred tax assets considered realizable could however be adjusted if estimates or amounts of deferred tax liabilities change.

Federal and state cancellation of debt income

As a result of our 2015 and 2016 debt transactions and modifications, we generated CODI of $1.4 billion and $1.3 billion, respectively ($2.7 billion in the aggregate), for both U.S. federal and California state tax purposes. These respective amounts were excluded from taxable income in those years because we determined that our liabilities exceeded the value of our assets for tax purposes immediately prior to each of the transactions. In exchange for this exclusion, tax rules require us to reduce the tax basis of our assets. Accordingly, we reduced our net operating losses and the basis of property, plant and equipment by $1.2 billion for U.S. federal and $1.9 billion for California. We were not required to make any further reductions in those assets because, beyond this point, our liabilities would have exceeded the tax basis of our assets. Accordingly, any tax liability attributable to the remaining approximately $1.5 billion of federal and $800 million of California CODI was relieved without any future tax liability. As a result, we recorded a benefit of $577 million for this permanent reduction of tax liability, which reduced our effective tax rate by 288%.

The tax effects of temporary differences resulting in deferred income taxes at December 31, 2016 and 2015 were as follows:

	2016						2015
	Deferred Tax Assets			Deferred Tax Liabilities			Deferred Tax Assets			Deferred Tax Liabilities
	(in millions)
Debt	$	693		$	—		$	608		$	—
Property, plant and equipment differences	60			(335		)	132			(427		)
Postretirement benefit accruals	45			—			41			—
Deferred compensation and benefits	74			—			75			—
Asset retirement obligations	183			—			156			—
Federal effect of state income taxes	—			—			28			(24		)
Net operating loss carryforward	61			—			7			—
All other	39			(40		)	47			(3		)

Subtotal	1,155			(375		)	1,094			(454		)
Valuation allowance	(780		)	—			(382		)	—

Total net deferred taxes	$	375		$	(375	)	$	712		$	(454	)

Our tax returns for the post-Spin off period in 2014 and calendar year 2015 are under examination by the Internal Revenue Service. No significant issues have been raised to date. The returns filed for these same periods remain subject to examination by the California tax authority. Prior to the Spin-off date, we were included in the Occidental income tax returns for all applicable years. Under the tax sharing agreement, Occidental controls tax examinations for the periods in which we were included in a consolidated or combined income tax return filed by Occidental. There were no amounts due to Occidental as of December 31, 2016 and 2015 under the tax sharing agreement. The income tax provision was calculated as if we filed separate tax returns for all periods presented prior to the Spin-off.

Tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement. A liability for unrecognized tax benefits is recorded for any tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards. As of December 31, 2016, we recorded a $25 million liability for tax positions taken in prior periods which has been classified as a deferred tax liability. This amount of unrecognized tax benefits, if recognized, would affect the effective tax rate. We believe there will not be significant increases or decreases to our unrecognized tax benefits within the next 12 months.

As of December 31, 2016, we had a $777 million net operating loss carryforward in California. The California net operating loss carryforward begins expiring in 2026. A portion of the California net operating loss carryforward resulted from acquisitions in prior years and is subject to an annual limitation as a result of these acquisitions. Accordingly, no financial statement benefit has been recognized for $88 million of the California net operating loss carryforward.