Note 12. Income Taxes

We conduct business globally and, as a result, file numerous consolidated and separate income tax returns within and outside the U.S. For all of our U.S. subsidiaries, we file a consolidated federal income tax return. Income from continuing operations before income taxes is as follows:

(In millions)	2013		2012		2011
U.S.	$	454	$	644	$	137
Non-U.S.	220		197		200
Total income from continuing operations before income taxes	$	674	$	841	$	337

Income tax expense for continuing operations is summarized as follows:

(In millions)	2013			2012			2011
Current:
Federal	$	23		$	40		$	(23	)
State	10			9			15
Non-U.S.	56			29			29
	89			78			21
Deferred:
Federal	91			169			67
State	13			23			1
Non-U.S.	(17		)	(10		)	6
	87			182			74
Income tax expense	$	176		$	260		$	95

The current federal and state provisions for 2012 and 2011 included $25 million and $37 million, respectively, of tax related to the sale of certain leveraged leases in the Finance segment for which we had previously recorded significant deferred tax liabilities.

The following table reconciles the federal statutory income tax rate to our effective income tax rate for continuing operations:

	2013	2012	2011
Federal statutory income tax rate	35.0%	35.0%	35.0%
Increase (decrease) in taxes resulting from:
State income taxes	2.4	2.2	3.1
Non-U.S. tax rate differential and foreign tax credits	(7.2)	(5.4)	(9.4)
Research credit	(3.8)	—	(2.5)
Other, net	(0.3)	(0.9)	1.9
Effective rate	26.1%	30.9%	28.1%

The amount of income taxes we pay is subject to ongoing audits by U.S. federal, state and non-U.S. tax authorities, which may result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is highly judgmental. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions for which it is more likely than not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. Interest and penalties are accrued, where applicable. If we do not believe that it is not more likely than not that a tax benefit will be sustained, no tax benefit is recognized.

Our future results may include favorable or unfavorable adjustments to our estimated tax liabilities due to settlement of income tax examinations, new regulatory or judicial pronouncements, expiration of statutes of limitations or other relevant events. As a result, our effective tax rate may fluctuate significantly on a quarterly and annual basis.

Our unrecognized tax benefits represent tax positions for which reserves have been established. Unrecognized state tax benefits and interest related to unrecognized tax benefits are reflected net of applicable tax benefits. A reconciliation of our unrecognized tax benefits, excluding accrued interest, is as follows:

(In millions)	December 28, 2013			December 29, 2012
Balance at beginning of year	$	290		$	294
Additions for tax positions related to current year	15			5
Additions for tax positions of prior years	1			2
Reductions for tax positions of prior years	(17		)	(3		)
Reductions for expiration of statute of limitations and settlements	(5		)	(8		)
Balance at end of year	$	284		$	290

At both December 28, 2013 and December 29, 2012, approximately $204 million of these unrecognized tax benefits, if recognized, would favorably affect our effective tax rate in a future period. The remaining $80 million in unrecognized tax benefits were related to discontinued operations.

It is reasonably possible that within the next 12 months our unrecognized tax benefits, exclusive of interest, may decrease in the range of $0 to $213 million, as a result of the conclusion of audits and any related appeals or review processes, the expiration of statutes of limitations and additional worldwide uncertain tax positions. This potential decrease primarily relates to uncertainties with respect to prior dispositions and research tax credits. However, based on the process of finalizing audits and any required review process by relevant authorities, it is difficult to estimate the timing and amount of potential changes to our unrecognized tax benefits. Although the outcome of these matters cannot be determined, we believe adequate provision has been made for any potential unfavorable financial statement impact.

In the normal course of business, we are subject to examination by taxing authorities throughout the world, including major jurisdictions such as Canada, China, Germany, Japan, Mexico and the U.S. With few exceptions, we no longer are subject to U.S. federal, state and local income tax examinations for years before 1997. We are no longer subject to non-U.S. income tax examinations in our major jurisdictions for years before 2005.

During 2013, 2012 and 2011, we recognized net tax-related interest expense totaling approximately $6 million, $9 million and $10 million, respectively, in the Consolidated Statements of Operations. At December 28, 2013 and December 29, 2012, we had a total of $126 million and $134 million, respectively, of net accrued interest expense included in our Consolidated Balance Sheets.

The tax effects of temporary differences that give rise to significant portions of our net deferred tax assets and liabilities are as follows:


(In millions)	December 28, 2013			December 29, 2012
Deferred tax assets
Obligation for pension and postretirement benefits	$	358		$	643
Accrued expenses*	182			205
Deferred compensation	161			180
Loss carryforwards	84			81
Allowance for credit losses	29			39
Inventory	18			30
Deferred income	14			29
Valuation allowance on finance receivables held for sale	7			40
Other, net	123			168
Total deferred tax assets	976			1,415
Valuation allowance for deferred tax assets	(166		)	(165		)
	$	810		$	1,250
Deferred tax liabilities
Leasing transactions	$	(184	)	$	(217	)
Property, plant and equipment, principally depreciation	(174		)	(138		)
Prepaid pension and postretirement benefits	(143		)	—
Amortization of goodwill and other intangibles	(109		)	(110		)
Total deferred tax liabilities	(610		)	(465		)
Net deferred tax asset	$	200		$	785

* Accrued expenses includes warranty and product maintenance reserves, self-insured liabilities and interest.

We believe that our earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future income tax benefits. For those jurisdictions where the expiration date of tax carryforwards or the projected operating results indicate that realization is not more than likely, a valuation allowance is provided.

The following table presents the breakdown between current and long-term net deferred tax assets:


(In millions)	December 28, 2013			December 29, 2012
Manufacturing group:
Other current assets	$	206		$	256
Other assets	270			591
Other liabilities	(147		)	—
Finance group - Other liabilities	(129		)	(62		)
Net deferred tax asset	$	200		$	785

Our net operating loss and credit carryforwards at December 28, 2013 are as follows:


(In millions)
Non-U.S. net operating loss with no expiration	$	95
Non-U.S. net operating loss expiring through 2033	53
State net operating loss and tax credits, net of tax benefits, expiring through 2033	55

The undistributed earnings of our non-U.S. subsidiaries approximated $778 million at December 28, 2013. We consider the undistributed earnings to be indefinitely reinvested; therefore, we have not provided a deferred tax liability for any residual U.S. tax that may be due upon repatriation of these earnings. Because of the effect of U.S. foreign tax credits, it is not practicable to estimate the amount of tax that might be payable on these earnings in the event they no longer are indefinitely reinvested.