Note 13: Income Taxes

Following is the composition of income tax expense:



	2012		2011			2010
Current
Federal	$	596.8	$	671.4		$	376.2
Foreign	540.6		759.5			513.9
State	56.2		(22.9		)	23.3
Total current tax expense	1,193.6		1,408.0			913.4
Deferred
Federal	87.0		(398.5		)	624.4
Foreign	29.9		(34.7		)	(55.2		)
State	9.1		27.0			(26.9		)
Total deferred tax expense (benefit)	126.0		(406.2		)	542.3
Income taxes	$	1,319.6	$	1,001.8		$	1,455.7

Significant components of our deferred tax assets and liabilities as of December 31 are as follows:



	2012			2011
Deferred tax assets
Compensation and benefits	$	1,081.8		$	1,286.5
Tax credit carryforwards and carrybacks	703.2			695.3
Tax loss carryforwards and carrybacks	370.1			406.1
Asset purchases	366.8			386.2
Sale of intangibles	278.6			207.1
Debt	232.8			214.9
Intercompany profit in inventories	159.6			277.2
Product return reserves	153.8			146.2
Contingencies	113.2			94.5
Other	361.5			292.8
Total gross deferred tax assets	3,821.4			4,006.8
Valuation allowances	(675.8		)	(611.9		)
Total deferred tax assets	3,145.6			3,394.9
Deferred tax liabilities
Unremitted earnings	(920.4		)	(940.2		)
Intangibles	(708.8		)	(797.6		)
Inventories	(573.4		)	(489.2		)
Property and equipment	(407.1		)	(451.0		)
Financial instruments	(257.0		)	(196.9		)
Total deferred tax liabilities	(2,866.7		)	(2,874.9		)
Deferred tax assets - net	$	278.9		$	520.0

At December 31, 2012 and 2011, no individually significant items were classified as “Other” deferred tax assets.

The deferred tax asset and related valuation allowance amounts for U.S. federal and state net operating losses and tax credits shown above have been reduced for differences between financial reporting and tax return filings.

Based on filed tax returns, we have tax credit carryforwards and carrybacks of $973.2 million available to reduce future income taxes; $433.4 million will be carried back; $0.7 million of the tax credit carryforwards will expire between 10 and 20 years; and $3.7 million of the tax credit carryforwards will never expire. The remaining portion of the tax credit carryforwards is related to federal tax credits of $80.3 million, international tax credits of $93.6 million, and state tax credits of $361.5 million, all of which are substantially reserved.

At December 31, 2012, based on filed tax returns we had net operating losses and other carryforwards for international and U.S. income tax purposes of $737.5 million: $309.7 million will expire within 5 years; $394.5 million will expire between 5 and 20 years; and $33.4 million of the carryforwards will never expire. Deferred tax assets related to state net operating losses of $100.7 million and $16.4 million of other state carryforwards are substantially reserved.

Domestic and Puerto Rican companies contributed approximately 54 percent, 24 percent, and 45 percent for the years ended December 31, 2012, 2011, and 2010, respectively, to consolidated income before income taxes. We have a subsidiary operating in Puerto Rico under a tax incentive grant. The current tax incentive grant will not expire prior to 2017.

At December 31, 2012, we had an aggregate of $20.98 billion of unremitted earnings of foreign subsidiaries that have been or are intended to be permanently reinvested for continued use in foreign operations and that, if distributed, would result in additional income tax expense at approximately the U.S. statutory rate.

Cash payments of income taxes totaled $992.0 million, $943.0 million, and $861.0 million, for the years ended December 31, 2012, 2011, and 2010, respectively.

Following is a reconciliation of the income tax expense applying the U.S. federal statutory rate to income before income taxes to reported income tax expense:



	2012			2011			2010
Income tax at the U.S. federal statutory tax rate	$	1,892.9		$	1,872.3		$	2,283.8
Add (deduct)
International operations, including Puerto Rico	(593.8		)	(796.7		)	(823.3		)
U.S. health care reform	59.8			62.9			85.1
General business credits	(11.2		)	(80.8		)	(83.2		)
IRS audit conclusion	—			(85.3		)	—
Other	(28.1		)	29.4			(6.7		)
Income taxes	$	1,319.6		$	1,001.8		$	1,455.7

The American Taxpayer Relief Act of 2012, which included the reinstatement of the research tax credit for the year 2012, was enacted in early 2013. While we expect to claim a research tax credit for 2012, we are required to record the tax benefit, which is presented with other general business credits, in the year it is enacted.

In October 2010, Puerto Rico enacted excise tax legislation that affected our operations beginning with the year ended December 31, 2011. The excise tax is imposed on the purchase of goods and services from a related manufacturer in Puerto Rico, and is therefore included in costs of sales in our consolidated statement of operations rather than income taxes. The Internal Revenue Service (IRS) has stated it would not challenge a taxpayer’s position that this excise tax is creditable for U.S. income tax purposes, pending the resolution of numerous legal and factual issues. As a result, the benefit in 2012 and 2011 on international operations reported in the effective tax rate reconciliation above includes the foreign tax credit related to the excise tax.

The U.S. health care legislation (both the primary Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act) eliminated the tax-free nature of the subsidy we receive for sponsoring retiree drug coverage that is “actuarially equivalent” to Medicare Part D. This provision is effective January 1, 2013. While this change has a future impact on our net tax deductions related to retiree health benefits, we were required to record a one-time charge to adjust our deferred tax asset for this change in the law in the quarter of enactment. Accordingly, we recorded a non-cash charge of $85.1 million in the first quarter of 2010. In addition, U.S. health care reform mandated an annual industry fee effective beginning January 1, 2011, which is not deductible for tax purposes.

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



	2012			2011			2010
Beginning balance at January 1	$	1,274.8		$	1,619.6		$	1,351.2
Additions based on tax positions related to the current year	141.5			89.4			186.2
Additions for tax positions of prior years	70.1			390.0			117.0
Reductions for tax positions of prior years	(38.5		)	(492.3		)	(30.2		)
Settlements	(9.2		)	(326.3		)	(0.1		)
Lapses of statutes of limitation	(4.6		)	(2.6		)	(7.0		)
Changes related to the impact of foreign currency translation	(0.3		)	(3.0		)	2.5
Balance at December 31	$	1,433.8		$	1,274.8		$	1,619.6

The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate was $928.1 million and $812.3 million at December 31, 2012 and 2011, respectively.

We file income tax returns in the U.S. federal jurisdiction and various state, local, and non-U.S. jurisdictions. We are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations in major taxing jurisdictions for years before 2007.

During 2011, we settled the U.S. examinations of tax years 2005-2007, along with certain matters related to tax years 2008-2009. The examination of the remainder of 2008-2009 commenced in the fourth quarter of 2011. Considering this current examination cycle, as well as the settlement of 2005-2007 and certain matters related to 2008-2009, our consolidated results of operations benefited from a reduction in tax expense of $85.3 million in 2011. We made cash payments totaling approximately $300 million for tax years 2005-2007.

The U.S. examination of certain matters related to tax years 2008-2009 that were not settled as part of previous examinations remains in progress. Management believes it is reasonably possible the remaining 2008-2009 tax matters could be concluded within the next 12 months. However, resolution of these matters is still dependent upon a number of factors, including the potential for formal administrative and legal proceedings. As a result, it is not possible to estimate the range of the reasonably possible changes in unrecognized tax benefits that could occur within the next 12 months related to these years, nor is it possible to estimate reliably the total future cash flows related to these unrecognized tax benefits.

We recognize both accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ended December 31, 2012, 2011, and 2010, we recognized income tax expense (benefit) of $42.3 million, $(47.3) million, and $38.3 million, respectively, related to interest and penalties. At December 31, 2012 and 2011, our accruals for the payment of interest and penalties totaled $187.5 million and $134.6 million, respectively. Substantially all of the expense (benefit) and accruals relate to interest.