Note 14: Income Taxes

Following is the composition of income tax expense:



	2013			2012		2011
Current:
Federal	$	259.1		$	596.8	$	671.4
Foreign	553.2			540.6		759.5
State	126.3			56.2		(22.9		)
Total current tax expense	938.6			1,193.6		1,408.0
Deferred:
Federal	297.0			87.0		(398.5		)
Foreign	(28.2		)	29.9		(34.7		)
State	(2.9		)	9.1		27.0
Total deferred tax expense (benefit)	265.9			126.0		(406.2		)
Income taxes	$	1,204.5		$	1,319.6	$	1,001.8

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



	2013			2012
Deferred tax assets:
Compensation and benefits	$	639.8		$	1,081.8
Tax credit carryforwards and carrybacks	494.6			703.2
Purchases of intangible assets	418.8			366.8
Product return reserves	313.7			153.8
Tax loss carryforwards and carrybacks	311.7			370.1
Debt	110.0			232.8
Contingencies	106.0			113.2
Intercompany profit in inventories	104.5			159.6
Sale of intangibles	76.5			278.6
Other	518.5			361.5
Total gross deferred tax assets	3,094.1			3,821.4
Valuation allowances	(647.1		)	(675.8		)
Total deferred tax assets	2,447.0			3,145.6
Deferred tax liabilities:
Unremitted earnings	(898.3		)	(920.4		)
Inventories	(685.6		)	(573.4		)
Intangibles	(598.9		)	(708.8		)
Prepaid employee benefits	(446.2		)	—
Property and equipment	(379.1		)	(407.1		)
Financial instruments	(109.6		)	(257.0		)
Total deferred tax liabilities	(3,117.7		)	(2,866.7		)
Deferred tax assets (liabilities) - net	$	(670.7	)	$	278.9

At December 31, 2013 and 2012, 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 $494.6 million available to reduce future income taxes; $2.9 million will be carried back; $183.8 million of the tax credit carryforwards will expire between 2023 and 2033; and $4.9 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 $105.3 million, and state tax credits of $117.4 million, all of which are substantially reserved.

At December 31, 2013, based on filed tax returns we had net operating losses and other carryforwards for international and U.S. income tax purposes of $662.5 million: $262.8 million will expire by 2018; $356.8 million will expire between 2018 and 2033; and $42.9 million of the carryforwards will never expire. Other carryforwards for international and U.S. federal income tax purposes are substantially reserved. Deferred tax assets related to state net operating losses of $81.0 million and $9.8 million of other state carryforwards are substantially reserved.

Domestic and Puerto Rican companies contributed approximately 61 percent, 54 percent, and 24 percent for the years ended December 31, 2013, 2012, and 2011, 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, 2013, U.S. income taxes have not been provided on approximately $23.74 billion of unremitted earnings of foreign subsidiaries as we consider these unremitted earnings to be indefinitely invested for continued use in our foreign operations. Additional tax provisions will be required if these earnings are repatriated in the future to the United States. Due to complexities in the tax laws and assumptions that we would have to make, it is not practicable to determine the amount of the related unrecognized deferred income tax liability.

Cash payments of income taxes totaled $1.26 billion, $992.0 million, and $942.8 million, for the years ended December 31, 2013, 2012, and 2011, 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:



	2013			2012			2011
Income tax at the U.S. federal statutory tax rate	$	2,061.3		$	1,892.9		$	1,872.3
Add (deduct):
International operations, including Puerto Rico	(778.3		)	(593.8		)	(796.7		)
General business credits	(175.6		)	(11.2		)	(80.8		)
IRS audit conclusion	(7.9		)	—			(85.3		)
Other	105.0			31.7			92.3
Income taxes	$	1,204.5		$	1,319.6		$	1,001.8

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. Therefore, the research tax credits for the years 2012 and 2013 are both included in 2013 with general business credits.

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



	2013			2012			2011
Beginning balance at January 1	$	1,534.3		$	1,369.3		$	1,714.3
Additions based on tax positions related to the current year	142.5			144.8			89.4
Additions for tax positions of prior years	251.5			70.1			390.0
Reductions for tax positions of prior years	(358.2		)	(38.5		)	(492.3		)
Settlements	(404.9		)	(9.2		)	(326.3		)
Lapses of statutes of limitation	(24.9		)	(4.6		)	(2.6		)
Changes related to the impact of foreign currency translation	(3.9		)	2.4			(3.2		)
Ending balance at December 31	$	1,136.4		$	1,534.3		$	1,369.3

The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate was $523.3 million and $928.1 million at December 31, 2013 and 2012, 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 most 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.

During 2013, we reached resolution on the remaining matters related to tax years 2008–2009 that were not settled as part of a previous examination. Considering the impact of this resolution on periods that have not yet been examined, as well as its impact on tax asset carryforwards, there was an immaterial benefit to our consolidated results of operations. We made cash payments of approximately $135 million related to tax years 2008–2009 after application of available tax credit carryforwards and carrybacks. The examination of tax years 2010-2012 commenced during the fourth quarter of 2013. Because the examination of tax years 2010-2012 is still in the early stages, the resolution of matters in this audit period will likely extend beyond the next 12 months.

We recognize both accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ended December 31, 2013, 2012, and 2011, we recognized income tax expense (benefit) of $(10.9) million, $42.3 million, and $(47.3) million, respectively, related to interest and penalties. At December 31, 2013 and 2012, our accruals for the payment of interest and penalties totaled $161.5 million and $187.5 million, respectively.