Taxes on Income

A reconciliation between the effective tax rate and the U.S. statutory rate is as follows:



	2016					2015					2014
	Amount			Tax Rate		Amount			Tax Rate		Amount			Tax Rate
U.S. statutory rate applied to income before taxes	$	1,631		35.0	%	$	1,890		35.0	%	$	6,049		35.0	%
Differential arising from:
Foreign earnings	(1,593		)	(34.2	)	(2,105		)	(39.0	)	(1,367		)	(7.9	)
Unremitted foreign earnings	(30		)	(0.6	)	260			4.8		(209		)	(1.2	)
Tax settlements	—			—		(417		)	(7.7	)	(89		)	(0.5	)
AstraZeneca option exercise	—			—		—			—		(774		)	(4.5	)
Sale of Sirna Therapeutics, Inc.	—			—		—			—		(357		)	(2.1	)
Impact of purchase accounting adjustments, including amortization	623			13.4		797			14.8		1,013			5.9
Foreign currency devaluation related to Venezuela	—			—		321			5.9		—			—
State taxes	173			3.7		159			2.9		7			—
Restructuring	145			3.1		167			3.1		289			1.7
U.S. health care reform legislation	68			1.4		66			1.2		134			0.8
Divestiture of Merck Consumer Care	—			—		—			—		440			2.5
Other ⁽¹⁾	(299		)	(6.4	)	(196		)	(3.6	)	213			1.2
	$	718		15.4	%	$	942		17.4	%	$	5,349		30.9	%


⁽¹⁾	Other includes the tax effect of contingency reserves, research credits, and miscellaneous items.

The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants, where the earnings have been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate as compared with the 35.0% U.S. statutory rate. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate as compared to the 35.0% U.S. statutory rate.

The Company’s 2015 effective tax rate reflects the impact of the Protecting Americans From Tax Hikes Act, which was signed into law on December 18, 2015, extending the research credit permanently and the controlled foreign corporation look-through provisions for five years. The Company’s 2014 effective tax rate reflects the impact of the Tax Increase Prevention Act, which was signed into law on December 19, 2014, extending the research credit and the controlled foreign corporation look-through provisions for one year only.

Income before taxes consisted of:



Years Ended December 31	2016		2015		2014
Domestic	$	518	$	2,247	$	15,730
Foreign	4,141		3,154		1,553
	$	4,659	$	5,401	$	17,283

Taxes on income consisted of:



Years Ended December 31	2016			2015			2014
Current provision
Federal	$	1,166		$	732		$	7,136
Foreign	916			844			438
State	157			130			375
	2,239			1,706			7,949
Deferred provision
Federal	(1,255		)	(552		)	(2,162		)
Foreign	(225		)	(163		)	(201		)
State	(41		)	(49		)	(237		)
	(1,521		)	(764		)	(2,600		)
	$	718		$	942		$	5,349

Deferred income taxes at December 31 consisted of:



	2016					2015
	Assets			Liabilities		Assets			Liabilities
Intangibles	$	86		$	3,734	$	—		$	4,962
Inventory related	30			660		49			752
Accelerated depreciation	28			927		43			910
Unremitted foreign earnings	—			2,044		—			2,124
Pensions and other postretirement benefits	727			109		435			131
Compensation related	438			—		535			—
Unrecognized tax benefits	383			—		412			—
Net operating losses and other tax credit carryforwards	437			—		565			—
Other	1,128			46		1,217			—
Subtotal	3,257			7,520		3,256			8,879
Valuation allowance	(268		)			(304		)
Total deferred taxes	$	2,989		$	7,520	$	2,952		$	8,879
Net deferred income taxes				$	4,531				$	5,927
Recognized as:
Other assets	$	546				$	608
Deferred income taxes				$	5,077				$	6,535

The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2016, $243 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions, none of which are individually significant. Valuation allowances of $268 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $194 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry.

Income taxes paid in 2016, 2015 and 2014 were $1.8 billion, $1.8 billion and $7.9 billion, respectively. Income taxes paid in 2014 reflects approximately $5.0 billion of taxes paid on the divestiture of MCC. Tax benefits relating to stock option exercises were $147 million in 2016, $109 million in 2015 and $202 million in 2014.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	2016			2015			2014
Balance January 1	$	3,448		$	3,534		$	3,503
Additions related to current year positions	196			198			389
Additions related to prior year positions	75			53			23
Reductions for tax positions of prior years ⁽¹⁾	(90		)	(59		)	(156		)
Settlements⁽¹⁾	(92		)	(184		)	(161		)
Lapse of statute of limitations	(43		)	(94		)	(64		)
Balance December 31	$	3,494		$	3,448		$	3,534


⁽¹⁾	Amounts reflect the settlements with the IRS as discussed below.

If the Company were to recognize the unrecognized tax benefits of $3.5 billion at December 31, 2016, the income tax provision would reflect a favorable net impact of $3.3 billion.

The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2016 could decrease by up to $1.7 billion in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Company’s examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. However, there is one item that is currently under discussion with the Internal Revenue Service (IRS) relating to the 2006 through 2008 examination. The Company has concluded that its position should be sustained upon audit. However, if this item were to result in an unfavorable outcome or settlement, it could have a material adverse impact on the Company’s financial position, liquidity and results of operations.

Expenses for interest and penalties associated with uncertain tax positions amounted to $134 million in 2016, $102 million in 2015 and $9 million in 2014. These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $886 million and $766 million as of December 31, 2016 and 2015, respectively.

The IRS is currently conducting examinations of the Company’s tax returns for the years 2006 through 2008, as well as 2010 and 2011. Although the IRS’s examination of the Company’s 2002-2005 federal tax returns was concluded prior to 2015, one issue relating to a refund claim remained open. During 2015, this issue was resolved and the Company received a refund of approximately $715 million, which exceeded the receivable previously recorded by the Company, resulting in a tax benefit of $410 million.

In addition, various state and foreign tax examinations are in progress. For most of its other significant tax jurisdictions (both U.S. state and foreign), the Company’s income tax returns are open for examination for the period 2003 through 2016.

At December 31, 2016, foreign earnings of $63.1 billion have been retained indefinitely by subsidiary companies for reinvestment; therefore, no provision has been made for income taxes that would be payable upon the distribution of such earnings and it would not be practicable to determine the amount of the related unrecognized deferred income tax liability. In addition, the Company has subsidiaries operating in Puerto Rico and Singapore under tax incentive grants that begin to expire in 2022.