Income taxes

On December 22, 2017, the United States enacted major tax reform legislation, Public Law No. 115-97, commonly referred to as the Tax Cuts and Jobs Act (2017 Tax Act). The 2017 Tax Act imposes a repatriation tax on accumulated earnings of foreign subsidiaries, implements a territorial tax system together with a current tax on certain foreign earnings and lowers the general corporate income tax rate to 21%. On December 22, 2017, the SEC staff issued SAB 118 that allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. We currently are analyzing the 2017 Tax Act, and in certain areas, have made reasonable estimates of the effects on our consolidated financial statements and tax disclosures, including the amount of the repatriation tax and changes to our existing deferred tax balances.

The repatriation tax is based primarily on our accumulated foreign earnings and profits that we previously deferred from U.S. income taxes. We recorded an estimated amount for our repatriation tax liability of $7.3 billion as of December 31, 2017. See Note 18, Contingencies and commitments. We no longer reinvest our undistributed earnings of our foreign operations indefinitely outside the United States. In addition, we remeasured certain net deferred and other tax liabilities based on the tax rates at which they are expected to reverse in the future. The estimated amount recorded related to the remeasurement of these balances was a net benefit of $1.2 billion. The net estimated impact of the 2017 Tax Act is $6.1 billion.

We consider the key estimates on the repatriation tax, net deferred tax remeasurement and the impact on our unrealized tax benefits to be incomplete due to our continuing analysis of final year-end data and tax positions. Our analysis could affect the measurement of these balances and give rise to new deferred and other tax assets and liabilities. Since the 2017 Tax Act was passed late in the fourth quarter of 2017, and further guidance and accounting interpretation is expected over the next 12 months, our review is still pending. We expect to complete our analysis within the measurement period.

Income before income taxes included the following (in millions):



	Years ended December 31,
	2017		2016		2015
Domestic	$	4,436	$	4,478	$	3,532
Foreign	5,161		4,685		4,446
Total income before income taxes	$	9,597	$	9,163	$	7,978

The provision for income taxes included the following (in millions):



	Years ended December 31,
	2017			2016			2015
Current provision:
Federal	$	8,615		$	984		$	1,129
State	5			65			40
Foreign	275			176			272
Total current provision	8,895			1,225			1,441
Deferred (benefit) provision:
Federal	(1,120		)	372			(290		)
State	—			(69		)	(78		)
Foreign	(157		)	(87		)	(34		)
Total deferred (benefit) provision	(1,277		)	216			(402		)
Total provision for income taxes	$	7,618		$	1,441		$	1,039

Deferred income taxes reflect the tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, tax credit carryforwards and the tax effects of net operating loss (NOL) carryforwards.

Significant components of our deferred tax assets and liabilities were as follows (in millions):



	December 31,
	2017			2016
Deferred income tax assets:
NOL and credit carryforwards	$	812		$	688
Accrued expenses	362			562
Expenses capitalized for tax	155			255
Stock-based compensation	99			167
Other	154			117
Total deferred income tax assets	1,582			1,789
Valuation allowance	(497		)	(381		)
Net deferred income tax assets	1,085			1,408

Deferred income tax liabilities:
Acquired intangible assets	(1,748		)	(3,139		)
Debt	(184		)	(345		)
Other	(240		)	(307		)
Total deferred income tax liabilities	(2,172		)	(3,791		)
Total deferred income taxes, net	$	(1,087	)	$	(2,383	)

Valuation allowances are provided to reduce the amounts of our deferred tax assets to an amount that is more likely than not to be realized based on an assessment of positive and negative evidence, including estimates of future taxable income necessary to realize future deductible amounts.

The valuation allowance increased in 2017 due primarily to the Company’s expectation that some state R&D credits and foreign NOLs will not be utilized. This increase was offset partially by the release of state R&D credits projected to be utilized in 2018 related to the repatriation tax on foreign earnings. The valuation allowance increased in 2016 due primarily to the Company’s expectation that some state R&D credits will not be utilized. This increase was offset partially by valuation allowance releases due to sufficient positive evidence to conclude that it is more likely than not that certain foreign NOL carryforwards are realizable.

As of December 31, 2017, we had $20 million of federal tax credit carryforwards available to reduce future federal income taxes and have provided no valuation allowance for those federal tax credit carryforwards. The federal tax credit carryforwards expire between 2026 and 2035. We had $524 million of state tax credit carryforwards available to reduce future state income taxes and have provided a valuation allowance for $392 million of those state tax credit carryforwards. The state credits for which no valuation allowance has been provided will begin to expire in 2022.

As of December 31, 2017, we had $146 million of NOL carryforwards available to reduce future federal income taxes and have provided a valuation allowance for $6 million of those federal NOL carryforwards. The federal NOL carryforwards, for which no valuation allowance has been provided, expire between 2020 and 2035. We had $425 million of NOL carryforwards available to reduce future state income taxes and have provided a valuation allowance for $400 million of those state NOL carryforwards. The state NOLs for which no valuation allowance has been provided expire between 2018 and 2032. We had $2.0 billion of NOL carryforwards available to reduce future foreign income taxes and have provided a valuation allowance for $819 million of those foreign NOL carryforwards. For the foreign NOLs with no valuation allowance provided, $678 million has no expiry; and the remainder will expire starting in 2018.

The reconciliations of the total gross amounts of UTBs (excluding interest, penalties, foreign tax credits and the federal tax benefit of state taxes related to UTBs) were as follows (in millions):



	Years ended December 31,
	2017			2016			2015
Beginning balance	$	2,543		$	2,114		$	1,772
Additions based on tax positions related to the current year	447			425			413
Additions based on tax positions related to prior years	1			18			9
Reductions for tax positions of prior years	(5		)	(7		)	(32		)
Reductions for expiration of statute of limitations	(5		)	—			—
Settlements	(28		)	(7		)	(48		)
Ending balance	$	2,953		$	2,543		$	2,114

Substantially all of the UTBs as of December 31, 2017, if recognized, would affect our effective tax rate. During the year ended December 31, 2017, we effectively settled various examinations with federal and state tax authorities for prior tax years. As a result of these developments, we remeasured our UTBs accordingly. As of December 31, 2017, we believe it is reasonably possible that our gross liabilities for UTBs may decrease by approximately $63 million within the succeeding 12 months due to the resolution of state examinations.

Interest and penalties related to UTBs are included in our provision for income taxes. During the years ended December 31, 2017, 2016 and 2015, we recognized $56 million, $125 million and $17 million, respectively, of interest and penalties through the income tax provision in the Consolidated Statements of Income. As of December 31, 2017 and 2016, accrued interest and penalties associated with UTBs were $332 million and $276 million, respectively.

The reconciliations between the federal statutory tax rate applied to income before income taxes and our effective tax rate were as follows:



	Years ended December 31,
	2017		2016		2015
Federal statutory tax rate	35.0	%	35.0	%	35.0	%
2017 Tax Act, net repatriation tax	71.5	%	—	%	—	%
Foreign earnings	(15.8	)%	(15.5	)%	(18.1	)%
2017 Tax Act, net deferred tax remeasurement	(7.7	)%	—	%	—	%
Credits, Puerto Rico Excise Tax	(2.2	)%	(2.3	)%	(2.5	)%
Share-based payments	(0.7	)%	(1.3	)%	—	%
Credits, primarily federal R&D	(0.6	)%	(0.7	)%	(1.4	)%
State taxes	0.3	%	0.1	%	0.1	%
Audit settlements (federal, state, foreign)	(0.3	)%	—	%	(0.5	)%
Other, net	(0.1	)%	0.4	%	0.4	%
Effective tax rate	79.4	%	15.7	%	13.0	%

The effective tax rates for the year ended December 31, 2017, differ from the federal statutory rates due primarily to impacts of the 2017 Tax Act, including the repatriation tax on accumulated foreign earnings, offset partially by the remeasurement of certain net deferred and other tax liabilities. The effective tax rates for 2016 and 2015 differ from the federal statutory rates primarily as a result of indefinitely invested earnings of our foreign operations. In the past, we have not provided for U.S. income taxes on undistributed earnings of our foreign operations that were intended to be invested indefinitely outside the United States. Substantially all of the foreign earnings that impact our effective tax rate results from foreign income associated with the Company’s operation conducted in Puerto Rico, a territory of the United States, that is treated as a foreign jurisdiction for U.S. tax purposes, and is subject to tax incentive grants through 2035.

The U.S. territory of Puerto Rico imposes an excise tax on the gross intercompany purchase price of goods and services from our manufacturer in Puerto Rico. The rate of 4% is effective through December 31, 2027. We account for the excise tax as a manufacturing cost that is capitalized in inventory and expensed in cost of sales when the related products are sold. For U.S. income tax purposes, the excise tax results in foreign tax credits that are generally recognized in our provision for income taxes when the excise tax is incurred.

Income taxes paid during the years ended December 31, 2017, 2016 and 2015, were $1.5 billion, $1.1 billion and $919 million, respectively.

One or more of our legal entities file income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and certain foreign jurisdictions. Our income tax returns are routinely audited by the tax authorities in those jurisdictions. Significant disputes may arise with authorities involving issues of the timing and amount of deductions, the use of tax credits and allocations of income and expenses among various tax jurisdictions because of differing interpretations of tax laws, regulations and the interpretation of the relevant facts. As previously disclosed, we received a Revenue Agent Report (RAR) from the Internal Revenue Service (IRS) for the years 2010, 2011 and 2012. The RAR proposes to make significant adjustments that relate primarily to the allocation of profits between certain of our entities in the United States and the U.S. territory of Puerto Rico. On November 29, 2017, we received a modified RAR that revised their calculation but continued to propose substantial adjustments. We disagree with the proposed adjustments and are pursuing resolution through the IRS administrative appeals process, which we believe will likely not be concluded within the next 12 months. Final resolution of the IRS audit could have a material impact on our results of operations and cash flows if not resolved favorably, however, we believe our income tax reserves are appropriately provided for all open tax years. We are no longer subject to U.S. federal income tax examinations for years ended on or before December 31, 2009. In addition, we are currently under examination by a number of other state and foreign tax jurisdictions.