Income taxes

On December 22, 2017, U.S. tax legislation was enacted containing a broad range of tax reform provisions including a corporate tax rate reduction and changes in the U.S. taxation of non-U.S. earnings. We have not completed our accounting for the income tax effects of U.S. tax reform. However, we have made a reasonable estimate of the 2017 financial statement impact as of January 18, 2018, and recognized a provisional charge of $2.371 billion. We will continue to update our calculations as additional required information is prepared and analyzed, interpretations and assumptions are refined, additional guidance is issued, and due to actions we may take as a result of the legislation. These updates could significantly impact the provision for income taxes, the amount of taxes payable, and the deferred tax asset and liability balances.

The provisionally estimated charge includes a $596 million write-down of net deferred tax assets to reflect the reduction in the U.S. corporate tax rate from 35 percent to 21 percent beginning January 1, 2018. We are still analyzing certain aspects of the law and refining our calculations of basis differences as of December 31, 2017, which could affect the measurement of these balances.

The provisionally estimated charge includes $1.775 billion for the estimated cost of a mandatory deemed repatriation of non-U.S. earnings, including changes in the deferred tax liability related to the amount of earnings considered not indefinitely reinvested as well as the amount of unrecognized tax benefits and state tax liabilities associated with these tax positions. The U.S. federal tax cost for the mandatory deemed repatriation is computed at 15.5 percent for non-U.S. earnings held in liquid assets and 8 percent for non-liquid assets, reduced by applicable foreign tax credits. These estimates are provisional due to additional information and analysis required to determine cumulative taxable earnings since 1986 for non-U.S. subsidiaries at two separate points in time and to determine the amount of earnings that are held in liquid versus non-liquid assets as defined in the new legislation at several different measurement periods. In addition, information is being gathered and analyzed to support available foreign tax credits including estimates of credit utilization and valuation allowance considerations for any remaining foreign tax credit carryforward. Due to uncertainty about aspects of the tax law, we have made various assumptions to determine our reasonable estimate that we expect to refine as additional guidance is issued.

As a result of U.S. tax reform legislation, distributions of profits from non-U.S. subsidiaries are not expected to cause a significant U.S. tax impact in the future. However, these distributions may be subject to non-U.S. withholding taxes if profits are distributed from certain jurisdictions. We have recorded a deferred tax liability of $138 million for withholding taxes in non-U.S. jurisdictions where earnings are not considered indefinitely reinvested. Additional information and analysis are needed to determine the final amount of deferred tax liability considering factors such as whether non-U.S. entities are subject to withholding taxes, have reserve requirements, or have projected working capital and other capital needs in the country where the earnings were generated that would result in a decision to indefinitely reinvest a portion or all their earnings.

Reconciliation of the U.S. federal statutory rate to effective rate:



	Years ended December 31,
(Millions of dollars)	2017					2016					2015
Taxes at U.S. statutory rate	$	1,429		35.0	%	$	49		35.0	%	$	1,203		35.0	%
(Decreases) increases resulting from:
Non-U.S. subsidiaries taxed at other than 35%	(282		)	(6.9	)%	(119		)	(85.6	)%	(236		)	(6.9	)%
State and local taxes, net of federal ¹	27			0.7	%	(1		)	(0.7	)%	24			0.7	%
Interest and penalties, net of tax	28			0.7	%	24			17.2	%	12			0.4	%
U.S. research and production incentives	(52		)	(1.3	)%	(52		)	(37.4	)%	(95		)	(2.7	)%
ESOP dividend tax benefit	(21		)	(0.5	)%	(27		)	(19.4	)%	(27		)	(0.8	)%
Net excess tax benefits from stock-based compensation	(64		)	(1.6	)%	—			—	%	—			—	%
U.S. deferred tax rate change	596			14.6	%	—			—	%	—			—	%
Mandatory deemed repatriation of non-U.S. earnings	1,775			43.5	%	—			—	%	—			—	%
Valuation allowances	(111		)	(2.7	)%	141			101.4	%	—			—	%
Nondeductible goodwill ²	—			—	%	191			137.4	%	—			—	%
Prior year tax and interest adjustments	—			—	%	—			—	%	42			1.2	%
Other—net	14			0.3	%	(14		)	(10.1	)%	(7		)	(0.2	)%
Provision (benefit) for income taxes	$	3,339		81.8	%	$	192		137.8	%	$	916		26.7	%

¹ Excludes amounts included in valuation allowances and mandatory deemed repatriation of non-U.S. earnings.
² Portion of Surface Mining & Technology goodwill impairment not deductible for tax purposes. See Note 10 for further discussion.

Included in the line item above labeled "Non-U.S. subsidiaries taxed at other than 35%" are the effects of earnings of non-U.S. subsidiaries taxed at local tax rates, changes in the amount of unrecognized tax benefits associated with these earnings, losses at non-U.S. subsidiaries without local tax benefits due to valuation allowances, and other permanent differences between tax and U.S. GAAP results. Caterpillar SARL (CSARL), primarily taxable locally in Switzerland, contributes the most significant amount of this line item. Although not individually significant by jurisdiction, pre-tax permanent differences due to nondeductible net foreign exchange gains/losses of non-U.S. subsidiaries were approximately $160 million of net gains in 2017 and $130 million of net losses in 2016 and 2015.

The provision for income taxes for 2017 also includes a decrease in the valuation allowance for U.S. state deferred tax assets resulting in a $111 million non-cash benefit, net of federal deferred tax adjustment at 35 percent. The primary driver of the decrease is improved U.S. GAAP profits expected to recur in certain state jurisdictions. This reverses a significant portion of the increase in the valuation allowance for U.S. state deferred tax assets in 2016 that resulted in a $141 million non-cash charge, net of federal deferred tax adjustment at 35 percent.

The provision for income taxes for 2015 included a prior year net tax and interest charge of $42 million to increase unrecognized tax benefits by $68 million offset by a benefit of $26 million to record U.S. refund claims related to prior tax years currently under examination. In the audit of 2007 to 2009 including the loss carryback to 2005, the U.S. Internal Revenue Service (IRS) disallowed approximately $125 million of foreign tax credits that arose as a result of certain financings unrelated to CSARL. Decisions of the U.S. Court of Appeals for the Second Circuit involving other taxpayers in 2015 caused us to conclude the benefits of this uncertain tax position were no longer more likely than not to be sustained based on technical merits resulting in an increase of $68 million to unrecognized tax benefits. We continue to monitor ongoing court cases involving other taxpayers for information that may impact our analysis of this tax position.



The components of profit (loss) before taxes were:
	Years ended December 31,
(Millions of dollars)	2017		2016			2015
U.S.	$	240	$	(2,053	)	$	636
Non-U.S.	3,842		2,192			2,803
	$	4,082	$	139		$	3,439

Profit before taxes, as shown above, is based on the location of the entity to which such earnings are attributable. Where an entity’s earnings are subject to taxation, however, may not correlate solely to where an entity is located. Thus, the income tax provision shown below as U.S. or non-U.S. may not correspond to the earnings shown above.



The components of the provision (benefit) for income taxes were:
	Years ended December 31,
(Millions of dollars)	2017			2016			2015
Current tax provision (benefit):
U.S.¹	$	963		$	(90	)	$	525
Non-U.S.	1,124			718			656
State (U.S.)	39			(5		)	42
	2,126			623			1,223

Deferred tax provision (benefit):
U.S.¹	1,385			(544		)	(367		)
Non-U.S.	(17		)	(108		)	66
State (U.S.)	(155		)	221			(6		)
	1,213			(431		)	(307		)
Total provision (benefit) for income taxes	$	3,339		$	192		$	916
¹ Includes U.S. taxes related to non-U.S. earnings.

We paid net income tax and related interest of $1,404 million, $522 million and $1,143 million in 2017, 2016 and 2015, respectively.

Accounting for income taxes under U.S. GAAP requires that individual tax-paying entities of the company offset all deferred tax liabilities and assets within each particular tax jurisdiction and present them as a noncurrent deferred tax liability or asset in the Consolidated Financial Position. Amounts in different tax jurisdictions cannot be offset against each other. The amount of deferred income taxes at December 31, included on the following lines in Statement 3, are as follows:



	December 31,
(Millions of dollars)	2017		2016
Assets:
Noncurrent deferred and refundable income taxes	1,569		2,683
Liabilities:
Other liabilities	281		237
Deferred income taxes—net	$	1,288	$	2,446



Deferred income tax assets and liabilities:
	December 31,
(Millions of dollars)	2017			2016
Deferred income tax assets:
Tax carryforwards	$	1,286		$	1,999
Pension	980			1,887
Postemployment benefits other than pensions	841			1,318
Warranty reserves	226			339
Stock-based compensation	135			316
Allowance for credit losses	149			209
Post sale discounts	160			207
Other employee compensation and benefits	203			262
Other—net	302			569
	4,282			7,106

Deferred income tax liabilities:
Capital and intangible assets	(1,360		)	(2,455		)
Bond discount	(133		)	(223		)
Translation	(165		)	(368		)
Other outside basis differences	(205		)	(227		)
Undistributed profits of non-U.S. subsidiaries	(138		)	(285		)
	(2,001		)	(3,558		)
Valuation allowance for deferred tax assets	(993		)	(1,102		)
Deferred income taxes—net	$	1,288		$	2,446

At December 31, 2017, approximately $1,437 million of U.S. state tax net operating losses (NOLs) and $124 million of U.S. state tax credit carryforwards were available. The state NOLs primarily expire over the next twenty years. The state tax credit carryforwards primarily expire over the next fifteen years. In total, we have established a valuation allowance of $269 million related to certain of these carryforwards along with other U.S. state deferred tax assets.

At December 31, 2017, amounts and expiration dates of net operating loss carryforwards in various non-U.S. taxing jurisdictions were:



(Millions of dollars)
2018		2019		2020		2021-2023		2024-2038		Unlimited		Total
$	23	$	133	$	212	$	272	$	223	$	3,625	$	4,488

At December 31, 2017, non-U.S. entities that have not yet demonstrated consistent and/or sustainable profitability to support the realization of net deferred tax assets have recorded valuation allowances of $724 million, including certain entities in Luxembourg.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for uncertain tax positions, including positions impacting only the timing of tax benefits, follows.



Reconciliation of unrecognized tax benefits: ¹
	Years ended December 31,
(Millions of dollars)	2017			2016
Balance at January 1,	$	1,032		$	968

Additions for tax positions related to current year	270			73
Additions for tax positions related to prior years	20			55
Reductions for tax positions related to prior years	(27		)	(36		)
Reductions for settlements ²	(9		)	(24		)
Reductions for expiration of statute of limitations	—			(4		)

Balance at December 31,	$	1,286		$	1,032

Amount that, if recognized, would impact the effective tax rate	$	1,209		$	963


¹	Foreign currency impacts are included within each line as applicable.


²	Includes cash payment or other reduction of assets to settle liability.

We classify interest and penalties on income taxes as a component of the provision for income taxes. We recognized a net provision for interest and penalties of $38 million, $34 million and $20 million during the years ended December 31, 2017, 2016 and 2015, respectively. The total amount of interest and penalties accrued was $157 million and $120 million as of December 31, 2017 and 2016, respectively.

On January 31, 2018, we received a Revenue Agent's Report from the IRS indicating the end of the field examination of our U.S. income tax returns for 2010 to 2012. In the audits of 2007 to 2012 including the impact of a loss carryback to 2005, the IRS has proposed to tax in the United States profits earned from certain parts transactions by CSARL, based on the IRS examination team’s application of the “substance-over-form” or “assignment-of-income” judicial doctrines. We are vigorously contesting the proposed increases to tax and penalties for these years of approximately $2.3 billion. We believe that the relevant transactions complied with applicable tax laws and did not violate judicial doctrines. We have filed U.S. income tax returns on this same basis for years after 2012. Based on the information currently available, we do not anticipate a significant increase or decrease to our unrecognized tax benefits for this matter within the next 12 months. We currently believe the ultimate disposition of this matter will not have a material adverse effect on our consolidated financial position, liquidity or results of operations.

With the exception of a loss carryback to 2005, tax years prior to 2007 are generally no longer subject to U.S. tax assessment. In our major non-U.S. jurisdictions including Australia, Brazil, China, Germany, Japan, Mexico, Switzerland, Singapore and the U.K., tax years are typically subject to examination for three to ten years. Due to the uncertainty related to the timing and potential outcome of audits, we cannot estimate the range of reasonably possible change in unrecognized tax benefits in the next 12 months.