Income Taxes

2017 Tax Act

In December 2017, the President of the U.S. signed into law the Tax Cuts and Jobs Act (2017 Tax Act). The 2017 Tax Act includes significant changes to the U.S. corporate income tax system, such as the reduction in the corporate income tax rate from 35 percent to 21 percent, transition to a territorial tax system, changes to business related exclusions, deductions and credits, and modifications to international tax provisions, including a one-time repatriation transition tax (also known as the ‘Toll Tax’) on unremitted foreign earnings.

GAAP requires that the income tax accounting effects from a change in tax laws or tax rates be recognized in continuing operations in the reporting period that includes the enactment date of the change. These effects include, among other things, re-measuring deferred tax assets and liabilities, evaluating deferred tax assets for valuation allowances, and assessing the impact of the Toll Tax and certain other provisions of the 2017 Tax Act. Our accounting for the tax effects of the enactment of the 2017 Tax Act was not complete as of December 31, 2017; however, in certain cases, as described below, we have made a reasonable estimate. In other cases, we have not been able to make a reasonable estimate and continued to account for those items based on our existing accounting model under ASC 740, Income Taxes, and the provisions of the tax laws that were in effect immediately prior to enactment. For the items for which we were able to determine a reasonable estimate, we recognized a provisional amount of $1.91 billion, which is included as a component of income tax expense from continuing operations. This amount represents approximately $3.6 billion attributable to the Toll Tax, partially offset by the changes in deferred taxes resulting from the transition to a U.S. territorial tax system, including the re-measurement of deferred taxes.

Our estimate of the impact of the 2017 Tax Act is based upon our analysis and interpretations of currently available information. Uncertainties remain regarding the impact of the 2017 Tax Act due to future regulatory and rulemaking processes, prospects of additional corrective or supplemental legislation, and potential trade or other litigation. These uncertainties, along with our completion of the calculations and potential changes in our initial assumptions as new information becomes available, could cause the actual charge to ultimately differ materially from the provisional amount recorded in 2017 related to the enactment of the 2017 Tax Act.

We have included provisional amounts based upon reasonable estimates for the following:


•	Toll Tax

The 2017 Tax Act imposes a one-time Toll Tax on unremitted foreign earnings and profits (E&P) at two different tax rates, with a higher tax rate applied to amounts held in cash and liquid assets. We have not yet completed our calculations of the items composing the Toll Tax, including the total post-1986 E&P of our foreign subsidiaries and amounts held as cash and liquid assets; therefore, we recorded a provisional amount of federal and state income taxes based upon a reasonable estimate. The amount is also subject to change as we assimilate the new laws and subsequent regulations, interpretations, and guidance as they are issued. Additionally, companies have the option to elect to pay the Toll Tax in eight installments. Provisional amounts were recorded to short-term and long-term income tax payable; these amounts may change when the Toll Tax calculation is complete. The impact to state income tax expense is also subject to change based upon revisions ultimately made to the Toll Tax calculation, changes in our assumptions related to state taxation of the income used to calculate the Toll Tax, and future guidance that may be issued.


•	Re-measurement of deferred tax assets and liabilities

The 2017 Tax Act reduced the U.S. corporate income tax rate from 35 percent to 21 percent effective January 1, 2018. GAAP requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to apply when these temporary differences are to be realized or settled. As a result, we determined the amount recorded to income tax expense in continuing operations by using temporary differences that approximated our deferred tax balances at the date of enactment considering any material transactions that occurred between the enactment date and December 31, 2017. We assessed the need for valuation allowances as a result of re-measuring existing temporary differences and considering tax attribute balances; changes recorded to valuation allowances are also reflected in income tax expense from continuing operations. Re-measurement of the deferred tax assets and liabilities in addition to assessment of valuation allowances is subject to uncertainties given that approximated balances were utilized for the enactment date and tax accounting method changes may be considered.

Under GAAP, the effect of a change in tax law is recorded as a component of the income tax expense related to continuing operations in the period of enactment. Adjusting the deferred taxes for temporary differences that arose from items of income or loss that were originally recorded in other comprehensive income through continuing operations results in a disproportionate tax effect in AOCL. ASU 2018-02, Income Statement-Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, allows companies to reclassify the stranded tax effects that result from the 2017 Tax Act from AOCL to retained earnings with early adoption permitted. We early adopted the standard and recorded a provisional amount (see Note 2).


•	Unremitted foreign earnings, executive compensation, and uncertain tax positions

A provisional amount was recorded to reflect foreign withholding taxes and state income taxes for future repatriation of non-indefinitely reinvested earnings; no additional amount was recorded for outside basis differences in our foreign subsidiaries. We have made assumptions related to the creditability of those foreign withholding taxes; therefore, these amounts may change upon completion of our calculations.

The 2017 Tax Act includes changes to the taxation of executive compensation. We have recorded a provisional amount based upon our estimates, interpretations of the new law, and external guidance. The provisional amount recorded could change based upon revisions to any of those assumptions.

Relative to the provisional amounts recorded as a result of the 2017 Tax Act, we also recorded a provisional amount related to changes in uncertain tax positions. Future changes to the provisional amounts recorded, in addition to future changes to income tax expense for items for which reasonable estimates were not made, could change the recorded amount. The estimates and assumptions used to record a provisional amount for uncertain tax positions could also change upon completion of our calculations and upon revisions related to subsequent regulations, interpretations, and guidance, if and when issued.

We could not make a reasonable estimate; therefore, we did not record a provisional amount for the following items:

•

The 2017 Tax Act includes an international tax provision for the taxation of Global Intangible Low-Taxed Income (GILTI) effective January 1, 2018. Questions have surfaced as to whether the income taxes related to GILTI should be recorded in the period the tax arises or whether deferred taxes should be established for basis differences that upon reversal might be subject to GILTI. ASC 740 does not provide clear guidance on this topic and companies are allowed to make an accounting policy election. We have recorded no provisional amount for GILTI deferred taxes as more time is needed to analyze the data in order to make an accounting policy election.


•	The 2017 Tax Act includes significant changes to the U.S. international tax provisions, including GILTI, Base Erosion Anti-abuse Tax, and Foreign Derived Intangible Income. For purposes of analyzing valuation allowances for net operating loss and tax credit carryforwards, we recorded no provisional amount for release of valuation allowances as more time is needed to analyze the data.

We will continue to assess the impact of the 2017 Tax Act on our consolidated financial statements during the measurement period, which should be no longer than one year from the 2017 Tax Act enactment date. As discussed above, the 2017 Tax Act included numerous changes to the U.S. tax system. We have made a good faith effort to identify items for which no reasonable estimate was made; however, additional items requiring accounting may be identified as we complete our analysis and new information becomes available. Therefore, no reasonable estimate has been made for items in the new tax law that have not been identified.

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.

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:



	2017			2016			2015
Current:
Federal	$	(100.6	)	$	(57.0	)	$	660.5
Foreign	38.5			378.9			422.0
State	4.0			(125.0		)	47.5
2017 Tax Act - provisional	3,247.5			—			—
Total current tax expense	3,189.4			196.9			1,130.0
Deferred:
Federal	801.5			517.0			(689.6		)
Foreign	(256.3		)	(83.3		)	(66.0		)
State	0.4			5.8			7.2
2017 Tax Act - provisional	(1,333.5		)	—			—
Total deferred tax (benefit) expense	(787.9		)	439.5			(748.4		)
Income taxes	$	2,401.5		$	636.4		$	381.6

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



	2017			2016
Deferred tax assets:
Compensation and benefits	$	1,021.7		$	1,126.0
Tax loss carryforwards and carrybacks	501.4			327.3
Tax credit carryforwards and carrybacks	473.0			458.9
Purchases of intangible assets	443.1			620.3
Product return reserves	88.4			128.1
Other comprehensive loss on hedging transactions	68.9			123.3
Debt	53.5			95.3
Contingent consideration	41.8			142.7
Other	555.8			587.3
Total gross deferred tax assets	3,247.6			3,609.2
Valuation allowances	(709.1		)	(648.3		)
Total deferred tax assets	2,538.5			2,960.9
Deferred tax liabilities:
Inventories	(654.8		)	(955.5		)
Intangibles	(314.6		)	(604.2		)
Property and equipment	(282.1		)	(398.6		)
Prepaid employee benefits	(231.5		)	(265.3		)
Financial instruments	(41.5		)	(279.3		)
Unremitted earnings	(16.6		)	(673.6		)
Total deferred tax liabilities	(1,541.1		)	(3,176.5		)
Deferred tax assets (liabilities) - net	$	997.4		$	(215.6	)

Deferred tax assets and liabilities reflect the provisional impact of re-measurement resulting from the 2017 Tax Act.

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, 2017, based on filed tax returns we have tax credit carryforwards and carrybacks of $692.0 million available to reduce future income taxes; $148.9 million, if unused, will expire by 2027. The remaining portion of the tax credit carryforwards is related to federal tax credits of $101.0 million, international tax credits of $129.0 million, and state tax credits of $313.1 million, all of which are substantially reserved.

At December 31, 2017, based on filed tax returns we had net operating losses and other carryforwards for international and U.S. federal income tax purposes of $3.21 billion: $6.5 million will expire by 2022; $640.5 million will expire between 2023 and 2037; and $2.56 billion 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 $113.2 million and other state carryforwards of $2.5 million are fully reserved.

Domestic and Puerto Rican companies contributed approximately 15 percent, 70 percent, and 35 percent for the years ended December 31, 2017, 2016, and 2015, 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 2031.

The 2017 Tax Act introduces international tax provisions that fundamentally change the U.S. taxation of foreign earnings. As a result, U.S. taxes previously accrued on unremitted foreign earnings have been reversed, and a provisional amount has been recorded to reflect amounts for foreign withholding taxes and state income taxes that would be owed upon future distributions of unremitted earnings of foreign subsidiaries that are not indefinitely reinvested. At December 31, 2017, due to the 2017 Tax Act, substantially all of the unremitted earnings of foreign subsidiaries are considered to not be indefinitely reinvested for continued use in our foreign operations. For the amount considered to be indefinitely reinvested, the amount of foreign withholding taxes and state income taxes that would be owed upon distribution is immaterial.

Cash payments of income taxes were as follows:



	2017		2016		2015
Cash payments of income taxes	$	246.5	$	700.6	$	969.0

The 2017 Tax Act provides an election to taxpayers subject to the Toll Tax to make payments over an eight year period with the first payment due on the original filing due date of the 2017 federal income tax return. We intend to make this election; therefore, future cash payments of income taxes will include the Toll Tax installments.

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:



	2017			2016			2015
Income tax at the U.S. federal statutory tax rate	$	769.1		$	1,180.9		$	976.5
Add (deduct):
International operations, including Puerto Rico	(428.9		)	(313.7		)	(565.2		)
General business credits	(66.8		)	(58.3		)	(69.2		)
2017 Tax Act - provisional	1,914.0			—			—
Non-deductible acquired IPR&D - CoLucid (Note 3)	300.1			—			—
Other	(86.0		)	(172.5		)	39.5
Income taxes	$	2,401.5		$	636.4		$	381.6

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



	2017			2016			2015
Beginning balance at January 1	$	853.4		$	1,066.6		$	1,338.8
Additions based on tax positions related to the current year	133.8			73.4			131.3
Additions for tax positions of prior years	97.5			14.8			116.6
Reductions for tax positions of prior years	(59.3		)	(15.2		)	(45.2		)
Settlements	(2.4		)	(171.9		)	(446.2		)
Lapses of statutes of limitation	(19.3		)	(110.0		)	(4.0		)
Changes related to the impact of foreign currency translation	10.8			(4.3		)	(24.7		)
Ending balance at December 31	$	1,014.5		$	853.4		$	1,066.6

The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate was $670.9 million and $382.8 million at December 31, 2017 and 2016, 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 2010.

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. While we believe it is reasonably possible that this audit could reach resolution within the next 12 months, the IRS examination of tax years 2013-2015 remains ongoing. Therefore, it is not possible to reasonably estimate the change to unrecognized tax benefits and the related future cash flows.

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:



	2017		2016			2015
Income tax (benefit) expense	$	27.4	$	(52.5	)	$	13.2

At December 31, 2017 and 2016, our accruals for the payment of interest and penalties totaled $170.7 million and $134.9 million, respectively.