Note 13. 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)		2016		2015		2014
U.S.	$	652	$	745	$	553
Non-U.S.		224		226		300

Income from continuing operations before income taxes	$	876	$	971	$	853

Income tax expense for continuing operations is summarized as follows:

(In millions)		2016		2015		2014
Current:
Federal	$	(74)	$	212	$	195
State		18		16		18
Non-U.S.		41		41		54

		(15)		269		267

Deferred:
Federal		47		17		(12)
State		(7)		(14)		(4)
Non-U.S.		8		1		(3)

		48		4		(19)

Income tax expense	$	33	$	273	$	248

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

	2016	2015	2014
U.S. Federal statutory income tax rate	35.0%	35.0%	35.0%
Increase (decrease) resulting from:
Federal tax settlement	(23.5)	—	—
State income taxes (net of federal impact) (a)	0.8	0.2	1.0
Non-U.S. tax rate differential and foreign tax credits (b)	(2.7)	(3.6)	(5.8)
Domestic manufacturing deduction	(1.6)	(2.7)	(1.1)
Research credit	(3.2)	(1.5)	(1.5)
Other, net	(1.0)	0.7	1.5

Effective income tax rate	3.8%	28.1%	29.1%

(a)

Includes a favorable impact of (0.7)% in 2015 and (0.2)% in 2014 related to valuation allowance releases.

(b)

Includes a favorable impact of (1.4)% in 2015 and (0.6)% in 2014 related to a net change in valuation allowances.

The provision for income taxes for 2016 included a benefit of $319 million to reflect the settlement with the U.S. Internal Revenue Service Office of Appeals for our 1998 to 2008 tax years, which resulted in a $206 million benefit attributable to continuing operations and $113 million attributable to discontinued operations.

We have recorded income tax at U.S. tax rates on all earnings, except for undistributed earnings of non-U.S. subsidiaries of approximately $1.4 billion, which are considered indefinitely reinvested. Should these earnings be distributed in the future in the form of dividends or otherwise, we would be subject to both U.S. income taxes (less foreign tax credits) and, in some instances, withholding taxes payable to various non-U.S. jurisdictions. Determination of the amount of unrecognized deferred tax liability related to indefinitely reinvested earnings is not practicable due to the complexity of U.S. and local tax laws.

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 31, 2016		January 2, 2016		January 3, 2015
Balance at beginning of year	$	401	$	385	$	284
Additions for tax positions related to current year		12		12		10
Additions for tax positions of prior years		—		6		—
Additions for acquisitions		—		1		100
Reductions for settlements and expiration of statute of limitations		(219)		(2)		(3)
Reductions for tax positions of prior years		(8)		(1)		(6)

Balance at end of year	$	186	$	401	$	385

Unrecognized tax benefits decreased during 2016 primarily due to the federal tax settlement as discussed above. At December 31, 2016 and January 2, 2016, we had approximately $186 million and $321 million, respectively, of unrecognized tax benefits that, if recognized, would favorably impact the effective tax rate in a future period. At January 2, 2016, the remaining $80 million in unrecognized tax benefits were related to discontinued operations.

In the normal course of business, we are subject to examination by tax authorities throughout the world. We are no longer subject to federal tax examinations for years before 2009, U.S. state and local income tax examinations for years before 1997, and non-U.S. income tax examinations for years before 2011.

During 2016, 2015 and 2014, we recognized net tax-related interest expense totaling approximately $5 million, $7 million and $6 million, respectively, in income tax expense. Our net accrued interest liability decreased to $5 million at December 31, 2016, from $139 million at January 2, 2016, primarily due to the federal tax settlement as discussed above.

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 31, 2016		January 2, 2016
Deferred tax assets
Obligation for pension and postretirement benefits	$	529	$	436
Accrued expenses*		282		288
Deferred compensation		175		184
Loss carryforwards		158		142
Inventory		49		71
Allowance for credit losses		23		29
Deferred income		11		9
Other, net		56		97

Total deferred tax assets		1,283		1,256
Valuation allowance for deferred tax assets		(116)		(115)

	$	1,167	$	1,141

Deferred tax liabilities
Property, plant and equipment, principally depreciation	$	(168)	$	(171)
Amortization of goodwill and other intangibles		(164)		(156)
Leasing transactions		(147)		(146)
Prepaid pension and postretirement benefits		(19)		(21)

Total deferred tax liabilities		(498)		(494)

Net deferred tax asset	$	669	$	647

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

We believe earnings during the period 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 of net deferred tax assets:

(In millions)		December 31, 2016		January 2, 2016
Manufacturing group:
Other assets	$	793	$	778
Other liabilities		(4)		(24)
Finance group - Other liabilities		(120)		(107)

Net deferred tax asset	$	669	$	647

Our net operating loss and credit carryforwards at December 31, 2016 are as follows:

(In millions)
Non-U.S. net operating loss with no expiration	$	182
Non-U.S. net operating loss expiring through 2036		65
U.S. federal net operating losses expiring through 2034, related to 2014 acquisitions		193
State net operating loss and tax credits, net of tax benefits, expiring through 2036		127