Income Taxes

We file a consolidated U.S. income tax return and tax returns in various state and local jurisdictions. Our subsidiaries file tax returns in various foreign jurisdictions. Our principal foreign jurisdictions include the United Kingdom, France and Germany. The Internal Revenue Service has completed its examination of our federal tax returns through 2010. In addition, our subsidiaries’ tax returns in the United Kingdom, France and Germany have been examined through 2012, 2009 and 2009, respectively.

Income before income taxes for the three years ended December 31, 2014 was (in millions):



	2014		2013		2012
Domestic	$	739.9	$	629.4	$	683.5
International	1,070.1		1,031.5		976.1
	$	1,810.0	$	1,660.9	$	1,659.6

Income tax expense (benefit) for the three years ended December 31, 2014 was (in millions):



	2014			2013			2012
Current:
Federal	$	356.1		$	246.3		$	163.3
State and local	38.1			30.6			40.1
International	344.8			336.5			298.3
	739.0			613.4			501.7
Deferred:
Federal	(106.4		)	0.3			41.7
State and local	(2.3		)	(3.6		)	4.7
International	(37.2		)	(44.9		)	(21.0		)
	(145.9		)	(48.2		)	25.4
	$	593.1		$	565.2		$	527.1

The reconciliation from the statutory U.S. federal income tax rate to our effective tax rate is:



	2014		2013		2012
Statutory U.S. federal income tax rate	35.0	%	35.0	%	35.0	%
State and local income taxes, net of federal income tax benefit	1.3		1.0		1.7
Reduction of tax on unremitted foreign earnings due to legal reorganization	—		—		(1.3	)
International tax rate differentials	(3.3	)	(3.0	)	(3.3	)
Other	(0.2	)	1.0		(0.3	)
Effective tax rate	32.8	%	34.0	%	31.8	%

The effective tax rate for 2014 decreased to 32.8% from 34.0% in 2013. Income taxes for 2014 and 2013 reflect the recognition of an income tax benefit of $11.4 million and $6.5 million, respectively, related to expenses incurred in connection with the proposed merger with Publicis. Prior to the termination of the proposed merger on May 8, 2014, the majority of the merger costs were capitalized for income tax purposes and the related tax benefits were not recorded. Because the proposed merger was terminated, the merger costs were no longer required to be capitalized for income tax purposes. Excluding the income tax effect of the merger expenses from both years, our effective tax rate for 2014 and 2013 was 33.2% and 33.6%, respectively.

Income tax expense in 2012 was reduced by $53 million, primarily resulting from a reduction in the deferred tax liabilities for unremitted foreign earnings of certain of our operating companies located in the Asia Pacific region, as well as lower statutory tax rates in other foreign jurisdictions. In 2012, we completed a legal reorganization in certain countries within the Asia Pacific region. As a result of the reorganization, our unremitted foreign earnings in the affected countries are subject to lower effective tax rates as compared to the U.S. statutory tax rate. Therefore we recorded a reduction in our deferred tax liabilities to reflect the lower tax rate that these earnings are subject to. The reduction in income tax expense was partially offset by a charge of approximately $16 million resulting from U.S. state and local tax accruals recorded for uncertain tax positions, net of U.S. federal income tax benefit.

Income tax expense for 2014, 2013 and 2012 includes $1.7 million, $1.6 million and $2.5 million, respectively, of interest, net of tax benefit, and penalties related to tax positions taken on our tax returns. At December 31, 2014 and 2013, the accrued interest and penalties were $14.2 million and $11.5 million, respectively.

The components of deferred tax assets and liabilities at December 31, 2014 and 2013 were (in millions):



	2014			2013
Deferred tax assets:
Compensation and severance	$	311.9		$	269.8
Tax loss and credit carryforwards	95.6			149.1
Basis differences from acquisitions	38.0			28.7
Basis differences from short-term assets and liabilities	27.8			28.2
Other	33.0			53.2
Deferred tax assets	506.3			529.0
Valuation allowance	(34.1		)	(56.8		)
Net deferred tax assets	$	472.2		$	472.2

Deferred tax liabilities:
Goodwill and intangible assets	$	706.1		$	673.3
Financial instruments	263.1			421.8
Unremitted foreign earnings	51.1			114.5
Basis differences from investments	(4.2		)	(5.7		)
Deferred tax liabilities	$	1,016.1		$	1,203.9

Net deferred tax assets (liabilities)	$	(543.9	)	$	(731.7	)

Our net deferred tax assets and (liabilities) at December 31, 2014 and 2013, were classified as follows (in millions):



	2014			2013
Other current assets - deferred taxes	$	110.8		$	100.9
Long-term deferred tax liabilities	(654.7		)	(832.6		)
	$	(543.9	)	$	(731.7	)

The American Recovery and Reinvestment Act of 2009 provided an election where qualifying cancellation of indebtedness income for debt reacquired in 2009 and 2010 was deferred and included in taxable income ratably over the five taxable years beginning in 2014 and ending in 2018. In 2009 and 2010, we reacquired and retired $1.4 billion of our convertible debt resulting in a tax liability of approximately $329 million. In 2014, we paid $66 million and the remaining liability will be paid ratably from 2015 through 2018. Substantially all the deferred tax liability for financial instruments at December 31, 2014 and 2013, relates to the convertible debt.

In connection with the conversion of the 2032 Notes in July 2014 (see Note 7), we paid $66.2 million, representing the excess of the accreted value of the notes for income tax purposes over the conversion value and we reclassified $32.2 million, representing the difference between the issue price of the notes and the conversion value from long-term deferred tax liabilities to additional paid-in capital.

In connection with the conversion of the 2033 Notes and 2038 Notes in May 2013 (see Note 7), in 2014 we paid $52.7 million, representing the excess of the accreted value of the notes for income tax purposes over the conversion value and in 2013 we reclassified $34.5 million, representing the tax effect of the difference between the issue price of the notes and the conversion value from long-term deferred tax liabilities to additional paid-in capital.

We have concluded that it is more likely than not that we will be able to realize our net deferred tax assets in future periods because results of future operations are expected to generate sufficient taxable income. The valuation allowance of $34.1 million and $56.8 million at December 31, 2014 and 2013, respectively, relates to tax loss and credit carryforwards in the United States and international jurisdictions. Our tax loss and credit carryforwards for which there is no valuation allowance are available to us for periods ranging from 2019 to 2035, which is longer than the forecasted utilization of such carryforwards.

We have not provided for U.S. federal income and foreign withholding taxes on approximately $1.8 billion of cumulative undistributed earnings of certain foreign subsidiaries. We intend to indefinitely reinvest these undistributed earnings in our international operations. Accordingly, we currently have no plans to repatriate these funds. As such, we do not know the time or manner in which we would repatriate these funds. Because the time or manner of repatriation is uncertain, we cannot determine the impact of local taxes, withholding taxes and foreign tax credits associated with the future repatriation of such earnings and therefore cannot quantify the tax liability. We have provided $51.1 million of U.S. taxes, which are included in deferred tax liabilities, on cumulative undistributed earnings of certain foreign subsidiaries of approximately $1.8 billion that are not indefinitely reinvested. Changes in international tax rules or changes in U.S. tax rules and regulations covering international operations and foreign tax credits may affect our future reported financial results or the way we conduct our business.

A reconciliation of our unrecognized tax benefits at December 31, 2014 and 2013 is (in millions):



	2014			2013
January 1	$	137.8		$	188.6
Additions:
Current year tax positions	6.0			5.1
Prior year tax positions	1.0			0.4
Reduction of prior year tax positions	0.5			(31.4		)
Settlements	(0.8		)	(24.6		)
Lapse of statute of limitations	(2.9		)	(0.2		)
Foreign currency translation	(1.8		)	(0.1		)
December 31	$	139.8		$	137.8

The majority of the liability for uncertain tax positions is included in long-term liabilities in our balance sheet. Approximately $58.6 million and $58.7 million of the liability for uncertain tax positions at December 31, 2014 and 2013, respectively, would affect our effective tax rate upon resolution of the uncertain tax positions.