INCOME TAXES

The Company's earnings before income taxes as generated from its U.S. and international operations are as follows (in millions):



	2014		2013			2012
U.S.	$	157	$	(17	)	$	316
International	911		801			689
Earnings before income taxes and noncontrolling interest	$	1,068	$	784		$	1,005

Income tax expense consisted of the following (in millions):



	2014			2013			2012
Current:
U.S. federal	$	150		$	101		$	236
U.S. state and other	11			7			16
International	39			108			78
Total current	200			216			330
Deferred	(87		)	(124		)	(77		)
Income tax expense	$	113		$	92		$	253

Deferred income taxes result from temporary differences between the amount of assets and liabilities recognized for financial reporting and tax purposes. The components of deferred tax assets and liabilities are as follows (in millions):



	2014			2013
Deferred income tax assets:
Net operating loss carryforwards	$	415		$	402
Tax credit carryforwards	119			75
Inventories	134			136
Stock-based compensation	46			47
Compensation and benefits	131			123
R&D expenditures, capitalized for tax	92			112
Accrued liabilities and other	129			130
	1,066			1,025
Less: valuation allowance	(400		)	(368		)
Deferred income tax assets, net	666			657
Deferred income tax liabilities:
Unrealized gain on available-for-sale securities	(9		)	(11		)
Property, plant and equipment	(171		)	(189		)
Intangible assets	(322		)	(352		)
Deferred income tax liabilities	(502		)	(552		)
Net deferred income tax assets (liabilities)	$	164		$	105

As of January 3, 2015, the Company had U.S. federal net operating loss carryforwards, the tax effect of which was $14 million and U.S. tax credit carryforwards, the tax effect of which was $56 million that will expire from 2017 through 2032 if not utilized. The Company also has state tax carryforwards, the tax effect of which was $79 million, that have an unlimited carryforward period. These amounts are subject to annual usage limitations. In addition, the Company had foreign tax net operating loss carryforwards, the tax effect of which was $401 million as of January 3, 2015. These tax attributes have an unlimited carryforward period.

The Company establishes valuation allowances for deferred tax assets when, after consideration of all positive and negative evidence, it is considered more-likely-than-not that a portion of the deferred tax assets will not be realized. Certain of the Company's subsidiaries in international tax jurisdictions, however, are in cumulative loss positions and have experienced cumulative losses in recent periods. A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset that is difficult to overcome when determining that a valuation allowance is not needed against deferred tax assets. The Company's valuation allowances of $400 million and $368 million as of January 3, 2015 and December 28, 2013, respectively, reduced the carrying value of deferred tax assets associated with certain net operating loss and tax credit carryforwards in these tax jurisdictions.

A reconciliation of the U.S. federal statutory income tax rate to the Company's effective income tax rate is as follows:



	2014		2013		2012
U.S. federal statutory tax rate	35.0	%	35.0	%	35.0	%
Increase (decrease) in tax rate resulting from:
U.S. state income taxes, net of federal tax benefit	0.2		0.6		0.5
International taxes at lower rates	(19.6	)	(13.6	)	(12.1	)
Tax benefits from domestic manufacturer's deduction	(1.2	)	(1.9	)	(2.2	)
Research and development credits	(2.8	)	(4.6	)	(1.1	)
Puerto Rico excise tax	(1.7	)	(3.0	)	(1.8	)
Tax settlements	—		(1.9	)	4.6
Noncontrolling interest	1.8		3.6		—
Other	(1.1	)	(2.5	)	2.3
Effective income tax rate	10.6	%	11.7	%	25.2	%

Currently, the Company’s operations in Puerto Rico, Costa Rica and Malaysia have various tax incentive grants. In 2014, 2013 and 2012, the tax reductions as compared to the local statutory rates favorably impacted diluted net earnings per share attributable to St. Jude Medical, Inc. by $1.06, $0.96 and $0.67, respectively. Unless these grants are extended, they will expire between 2018 and 2026. The Company’s historical practice has been to renew, extend or obtain new tax incentive grants upon expiration of existing tax incentive grants.

The Company has not recorded U.S. deferred income taxes on approximately $4.2 billion of its non-U.S. subsidiaries' undistributed earnings because such amounts are intended to be reinvested outside the United States indefinitely. If these earnings were repatriated to the United States, the Company would be required to accrue and pay U.S. federal income taxes and foreign withholding taxes, as adjusted for foreign tax credits. Determination of the amount of any unrecognized deferred income tax liability on these earnings is not practicable.

The Company recognizes liabilities for uncertain tax positions that require application of accounting estimates that are subject to the inherent uncertainties associated with the tax audit process, and therefore include certain contingencies. The Company recognizes interest and penalties related to income tax matters in income tax expense. The Company recognized interest and penalties, net of tax benefit, of $4 million, $2 million and $22 million during fiscal years 2014, 2013 and 2012, respectively. The Company's accrued liability for gross interest and penalties was $44 million, $37 million and $69 million as of January 3, 2015, December 28, 2013 and December 29, 2012, respectively.

The following table summarizes the activity related to the Company's uncertain tax positions (in millions):



	2014			2013			2011
Balance at beginning of year	$	315		$	314		$	205
Increases related to current year tax positions	67			74			38
Increases related to prior year tax positions	6			33			90
Reductions related to prior year tax positions	(27		)	(16		)	(18		)
Reductions related to settlements / payments	(27		)	(90		)	(1		)
Expiration of the statute of limitations for the assessment of taxes	(6		)	—			—
Balance at end of year	$	328		$	315		$	314

The Company is subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. The Company has substantially concluded all material U.S. federal, state, foreign and local income tax matters for all tax years through 2004. In February 2014, the U.S. Internal Revenue Service (IRS) completed an audit of the Company’s 2008 and 2009 tax returns, and proposed adjustments in an audit report. The Company has begun and intends to vigorously defend its positions and initiated defense of these adjustments at the IRS appellate level. An unfavorable outcome could have a material negative impact on the Company's effective income tax rate in future periods. The Company does not expect its uncertain tax positions to change significantly over the next 12 months.