Note 13: Income Taxes

Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S. and be taxable. When foreign earnings are expected to be indefinitely reinvested outside the U.S., no accrual for U.S. income taxes is provided.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate resolution.

Following is the composition of income tax expense:



	2016			2015			2014
Current:
Federal	$	(57.0	)	$	660.5		$	168.9
Foreign	378.9			422.0			406.2
State	(125.0		)	47.5			(2.1		)
Total current tax expense	196.9			1,130.0			573.0
Deferred:
Federal	517.0			(689.6		)	(83.3		)
Foreign	(83.3		)	(66.0		)	120.2
State	5.8			7.2			(0.1		)
Total deferred tax (benefit) expense	439.5			(748.4		)	36.8
Income taxes	$	636.4		$	381.6		$	609.8

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



	2016			2015
Deferred tax assets:
Compensation and benefits	$	1,126.0		$	1,034.6
Purchases of intangible assets	620.3			613.8
Tax credit carryforwards and carrybacks	458.9			294.2
Tax loss carryforwards and carrybacks	327.3			247.8
Contingent consideration	142.7			214.6
Product return reserves	128.1			212.1
Other comprehensive loss on hedging transactions	123.3			129.7
Debt	95.3			111.3
Other	587.3			679.4
Total gross deferred tax assets	3,609.2			3,537.5
Valuation allowances	(648.3		)	(590.3		)
Total deferred tax assets	2,960.9			2,947.2
Deferred tax liabilities:
Inventories	(955.5		)	(771.3		)
Unremitted earnings	(673.6		)	(218.8		)
Intangibles	(604.2		)	(792.3		)
Property and equipment	(398.6		)	(411.6		)
Financial instruments	(279.3		)	(144.0		)
Prepaid employee benefits	(265.3		)	(317.8		)
Total deferred tax liabilities	(3,176.5		)	(2,655.8		)
Deferred tax assets (liabilities) - net	$	(215.6	)	$	291.4

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.

At December 31, 2016, based on filed tax returns we have tax credit carryforwards and carrybacks of $738.4 million available to reduce future income taxes; $178.7 million, if unused, will expire by 2026; $53.6 million, if unused, will expire by 2036. The remaining portion of the tax credit carryforwards is related to federal tax credits of $96.1 million, international tax credits of $106.2 million, and state tax credits of $303.8 million, all of which are substantially reserved.

At December 31, 2016, based on filed tax returns we had net operating losses and other carryforwards for international and U.S. federal income tax purposes of $856.0 million: $142.6 million will expire by 2021; $462.5 million will expire between 2022 and 2036; and $250.9 million of the carryforwards will never expire. Net operating losses and other carryforwards for international and U.S. federal income tax purposes are partially reserved. Deferred tax assets related to state net operating losses of $102.0 million and other state carryforwards of $5.0 million are fully reserved.

Domestic and Puerto Rican companies contributed approximately 70 percent, 35 percent, and 20 percent for the years ended December 31, 2016, 2015, and 2014, respectively, to consolidated income before income taxes. We have a subsidiary operating in Puerto Rico under a tax incentive grant effective through the end of 2016. A similar, new tax incentive grant began in 2017 and will be in effect for 15 years.

At December 31, 2016, U.S. income taxes have not been provided on approximately $28.0 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 U.S. 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 were as follows:



	2016		2015		2014
Cash payments of income taxes	$	700.6	$	969.0	$	729.7

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:



	2016			2015			2014
Income tax at the U.S. federal statutory tax rate	$	1,180.9		$	976.5		$	1,050.1
Add (deduct):
International operations, including Puerto Rico	(313.7		)	(565.2		)	(344.8		)
General business credits	(58.3		)	(69.2		)	(44.3		)
Other	(172.5		)	39.5			(51.2		)
Income taxes	$	636.4		$	381.6		$	609.8

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



	2016			2015			2014
Beginning balance at January 1	$	1,066.6		$	1,338.8		$	1,136.4
Additions based on tax positions related to the current year	73.4			131.3			126.4
Additions for tax positions of prior years	14.8			116.6			132.6
Reductions for tax positions of prior years	(15.2		)	(45.2		)	(32.1		)
Settlements	(171.9		)	(446.2		)	(4.2		)
Lapses of statutes of limitation	(110.0		)	(4.0		)	(3.5		)
Changes related to the impact of foreign currency translation	(4.3		)	(24.7		)	(16.8		)
Ending balance at December 31	$	853.4		$	1,066.6		$	1,338.8

The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate was $382.8 million and $404.1 million at December 31, 2016 and 2015, 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 2009.

The U.S. examination of tax years 2010-2012 commenced during the fourth quarter of 2013. In December 2015, we executed a closing agreement with the Internal Revenue Service which effectively settled certain matters for tax years 2010-2012. Accordingly, we reduced our gross uncertain tax positions by approximately $320 million in 2015. During 2016, we effectively settled the remaining matters related to tax years 2010-2012. As a result of this resolution, our gross uncertain tax positions were further reduced by approximately $140 million, and our consolidated results of operations benefited from an immaterial reduction in income tax expense. During 2016, we made cash payments of approximately $150 million related to tax years 2010-2012 after application of available tax credit carryforwards and carrybacks. The U.S. examination of tax years 2013-2015 began in 2016. Because the examination of tax years 2013-2015 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. We recognized income tax (benefit) expense related to interest and penalties as follows:



	2016			2015		2014
Income tax (benefit) expense	$	(52.5	)	$	13.2	$	35.9

At December 31, 2016 and 2015, our accruals for the payment of interest and penalties totaled $134.9 million and $216.3 million, respectively.