Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act (the "Act") was signed into law. The Act significantly changes U.S. tax law. The Act reduces the U.S. corporate income tax rate from a maximum of 35% to 21% for all corporations, effective January 1, 2018, and makes certain changes to U.S. taxation of income earned by foreign subsidiaries, capital expenditures, interest expense and various other items.

As a result of the reduction in the U.S. corporate income tax rate from 35% to 21%, we re-measured our net deferred tax liabilities at December 31, 2017 and recognized a provisional tax benefit of approximately $1.1 billion in our consolidated statement of operations for the year ended December 31, 2017.

The Act imposed a one-time repatriation tax on certain earnings of foreign subsidiaries. The Act also includes certain anti-abuse and base erosion provisions that may impact the amounts of U.S. tax that we pay with respect to income earned by our foreign subsidiaries. We have not yet been able to make a reasonable estimate of the impact of these provisions and continue to account for these items based on our existing accounting under U.S. GAAP and the provisions of the tax laws that were in effect prior to the Act's enactment.

On December 22, 2017, the SEC staff addressed the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. We have provisionally recognized the tax impacts related to the re-measurement of deferred tax assets and liabilities in the amount noted above in our consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from our provisional amount due to additional analysis, changes in interpretations and assumptions we have made, additional regulatory guidance that may be issued, and actions we may take as a result of the Act. The change from our current provisional estimates will be reflected in our future statements of operations and could be material. We expect to complete the accounting by the time we file our 2017 U.S. corporate income tax return in the 4th quarter of 2018, although we cannot assure you of this.



	Years Ended December 31,
	2017			2016		2015
	(Dollars in millions)
Income tax expense was as follows:
Federal
Current	$	82		335		28
Deferred	(988		)	5		329
State
Current	21			27		40
Deferred	16			8		21
Foreign
Current	22			26		16
Deferred	(2		)	(7	)	4
Total income tax expense	$	(849	)	394		438



	Years Ended December 31,
	2017			2016		2015
	(Dollars in millions)
Income tax (benefit) expense was allocated as follows:
Income tax (benefit) expense in the consolidated statements of operations:
Attributable to income	$	(849	)	394		438
Stockholders' equity:
Compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes	—			(2	)	(5	)
Tax effect of the change in accumulated other comprehensive loss	81			(109	)	59

The following is a reconciliation from the statutory federal income tax rate to our effective income tax rate:



	Years Ended December 31,
	2017		2016		2015
	(Percentage of pre-tax income)
Statutory federal income tax rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal income tax benefit	3.9	%	2.3	%	2.6	%
Change in liability for unrecognized tax position	1.0	%	0.2	%	0.4	%
Tax reform	(209.8	)%	—	%	—	%
Net foreign income taxes	(0.7	)%	0.1	%	0.7	%
Foreign dividend paid to a domestic parent company	0.2	%	1.8	%	—	%
Affiliate debt rationalization	—	%	—	%	(2.6	)%
Research and development credits	(1.4	)%	(0.6	)%	(2.1	)%
Tax impact on sale of data centers and colocation business	5.0	%	—	%	—	%
Level 3 acquisition transaction costs	6.0	%	—	%	—	%
Other, net	3.6	%	(0.2	)%	(0.7	)%
Effective income tax rate	(157.2	)%	38.6	%	33.3	%

The effective tax rate for the year ended December 31, 2017 reflects the benefit of approximately $1.1 billion from the re-measurement of deferred taxes as noted above, a $27 million tax expense related to the sale of our colocation business and $32 million tax impact of non-deductible transaction costs related to the Level 3 acquisition. The effective tax rate for the year ended December 31, 2016 reflects a tax impact of $18 million from an intercompany dividend payment from one of our foreign subsidiaries to its domestic parent company that was made as part of our corporate restructuring in preparation for the sale of our colocation business. The 2015 rate reflects a tax benefit of approximately $34 million related to affiliate debt rationalization, research and development tax credits of $28 million for 2011 through 2015 and a $16 million tax decrease due to changes in state taxes caused by apportionment changes, state tax rate changes and the changes in the expected utilization of net operating loss carryforwards ("NOLs").

The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows:



	As of December 31,
	2017			2016
	(Dollars in millions)
Deferred tax assets
Post-retirement and pension benefit costs	$	1,321		2,175
Net operating loss carryforwards	3,951			473
Other employee benefits	112			125
Other	714			342
Gross deferred tax assets	6,098			3,115
Less valuation allowance	(1,341		)	(375	)
Net deferred tax assets	4,757			2,740
Deferred tax liabilities
Property, plant and equipment, primarily due to depreciation differences	(2,935		)	(3,626	)
Goodwill and other intangible assets	(3,785		)	(2,577	)
Other	(16		)	—
Gross deferred tax liabilities	(6,736		)	(6,203	)
Net deferred tax liability	$	(1,979	)	(3,463	)

Of the $1.979 billion and $3.463 billion net deferred tax liability at December 31, 2017 and 2016, respectively, $2.413 billion and $3.471 billion is reflected as a long-term liability and $434 million and $8 million is reflected as a net noncurrent deferred tax asset at December 31, 2017 and 2016, respectively.

At December 31, 2017, we had federal NOLs of $9.1 billion and state NOLs of $21 billion. If unused, the NOLs will expire between 2018 and 2033; however, no significant amounts expire until 2023. We also had foreign NOL carryforwards of $5.8 billion as a result of the Level 3 acquisition. At December 31, 2017, we had an immaterial amount of federal tax credits. Our acquisitions of Level 3, Qwest and SAVVIS, Inc. ("Savvis") caused "ownership changes" within the meaning of Section 382 of the Internal Revenue Code ("Section 382"). As a result, our ability to use these NOLs and AMT credits are subject to annual limits imposed by Section 382. Despite this, we expect to use substantially all of these tax attributes to reduce our future federal tax liabilities, although the timing of that use will depend upon our future earnings and future tax circumstances.

We establish valuation allowances when necessary to reduce the deferred tax assets to amounts we expect to realize. As of December 31, 2017, a valuation allowance of $1.341 billion was established as it is more likely than not that this amount of net operating loss, capital loss and tax credit carryforwards will not be utilized prior to expiration. Our valuation allowance at December 31, 2017 and 2016 is primarily related to foreign and state NOL carryforwards. This valuation allowance increased by $966 million during 2017, primarily due to the acquisition of Level 3 and the related valuation allowances.

A reconciliation of the change in our gross unrecognized tax benefits (excluding both interest and any related federal benefit) from January 1 to December 31 for 2017 and 2016 is as follows:



	2017		2016
	(Dollars in millions)
Unrecognized tax benefits at beginning of year	$	16	15
Assumed in the acquisition of Level 3	18		—
Tax position of prior periods netted against deferred tax assets assumed in the acquisition of Level 3	2		—
Increase in tax positions taken in the current year	1		1
Increase in tax positions taken in the prior year	3		—
Unrecognized tax benefits at end of year	$	40	16

The total amount of unrecognized tax benefits that, if recognized, would impact the effective income tax rate was $66 million and $34 million at December 31, 2017 and 2016, respectively.

Our policy is to reflect interest expense associated with unrecognized tax benefits in income tax expense. We had accrued interest (presented before related tax benefits) of approximately $56 million and $35 million at December 31, 2017 and 2016, respectively.

We, or at least one of our subsidiaries, file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003. The Internal Revenue Service and state and local taxing authorities reserve the right to audit any period where net operating loss carryforwards are available.

Based on our current assessment of various factors, including (i) the potential outcomes of these ongoing examinations, (ii) the expiration of statute of limitations for specific jurisdictions, (iii) the negotiated settlement of certain disputed issues, and (iv) the administrative practices of applicable taxing jurisdictions, it is reasonably possible that the related unrecognized tax benefits for uncertain tax positions previously taken may decrease by up to $16 million within the next 12 months. The actual amount of such decrease, if any, will depend on several future developments and events, many of which are outside our control.