Note 3—Income Taxes

Consolidated pre-tax income consists of the following:


	For the Year
	2012		2011		2010
	(In thousands)
US operations	$	104,707	$	169,706	$	124,160
Foreign operations		840,338		800,967		722,665

	$	945,045	$	970,673	$	846,825

The provision (benefit) for current and deferred income taxes consists of the following:


	For the Year
	2012			2011			2010
	(In thousands)
Current
Federal	$	69,639		$	15,933		$	14,057
State		8,660			5,268			8,686
Foreign		126,465			131,596			143,090

		204,764			152,797			165,833

Deferred
Federal		(26,489	)		49,853			(10,894	)
State		520			(2,629	)		10,599
Foreign		(10,214	)		2,144			(3,576	)

		(36,183	)		49,368			(3,871	)

Provision for income taxes	$	168,581		$	202,165		$	161,962

Deferred income taxes are provided principally for tax credit carryforwards, research and development expenses, net operating loss carryforwards, employee compensation-related expenses and certain other reserves that are recognized in different years for financial statement and income tax reporting purposes. Mattel’s deferred income tax assets (liabilities) are composed of the following:


	December 31,
	2012			2011
	(In thousands)
Tax credit carryforwards	$	59,372		$	124,404
Research and development expenses		181,449			183,270
Loss carryforwards		131,989			54,351
Allowances and reserves		229,056			133,068
Deferred compensation		118,878			100,122
Postretirement benefits		72,912			76,587
Other		67,942			56,185

Gross deferred income tax assets		861,598			727,987

Intangible assets		(279,592	)		(132,320	)
Other		(8,262	)		(10,563	)

Gross deferred income tax liabilities		(287,854	)		(142,883	)

Deferred income tax asset valuation allowances		(67,705	)		(42,286	)

Net deferred income tax assets	$	506,039		$	542,818

Net deferred income tax assets are reported in the consolidated balance sheets as follows:


	December 31,
	2012			2011
	(In thousands)
Prepaid expenses and other current assets	$	253,664		$	110,422
Other noncurrent assets		374,667			473,832
Accrued liabilities		(152	)		(194	)
Other noncurrent liabilities		(122,140	)		(41,242	)

	$	506,039		$	542,818

As of December 31, 2012, Mattel has federal and foreign loss carryforwards totaling $442.0 million and tax credit carryforwards of $59.4 million, which excludes carryforwards that do not meet the threshold for recognition in the financial statements. Utilization of these loss and tax credit carryforwards is subject to annual limitations. Mattel’s loss and tax credit carryforwards expire in the following periods:


	Loss Carryforwards		Tax Credit Carryforwards
	(In millions)
2013 – 2017	$	66.2	$	21.4
Thereafter		83.5		33.7
No expiration date		292.3		4.3

Total	$	442.0	$	59.4

Management considered all available evidence under existing tax law and anticipated expiration of tax statutes and determined that a valuation allowance of $59.3 million was required as of December 31, 2012 for those loss and tax credit carryforwards that are not expected to provide future tax benefits. In addition, management determined that a valuation allowance of $8.4 million was required as of December 31, 2012 for those deferred tax assets for which there is not sufficient evidence as to its ultimate utilization, primarily related to certain foreign affiliates. Changes in the valuation allowance for 2012 include increases in the valuation allowance for 2012 foreign losses without benefits, increases in the valuation allowances for certain deferred tax assets acquired in the acquisition of HIT Entertainment and decreases in the valuation allowance for expiration and projected utilization of tax loss and tax credit carryforwards. Management believes it is more-likely-than-not that Mattel will generate sufficient taxable income in the appropriate future periods to realize the benefit of the remaining net deferred income tax assets of $506.0 million. Changes in enacted tax laws, audits in various jurisdictions around the world, settlements or acquisitions, could negatively impact Mattel’s ability to fully realize all of the benefits of its remaining net deferred tax assets.

Differences between the provision for income taxes at the US federal statutory income tax rate and the provision in the consolidated statements of operations are as follows:


	For the Year
	2012			2011			2010
	(In thousands)
Provision at US federal statutory rates	$	330,766		$	339,736		$	296,389
(Decrease) increase resulting from:
Foreign earnings taxed at different rates, including withholding taxes		(157,488	)		(139,476	)		(138,352	)
Foreign losses without income tax benefit		1,047			2,883			5,398
State and local taxes, net of US federal benefit		6,856			4,833			12,535
Adjustments to previously accrued taxes		(16,000	)		(6,800	)		(638	)
Foreign tax credit benefit, net of cost to repatriate foreign earnings		—			—			(16,200	)
Other		3,400			989			2,830

Provision for income taxes	$	168,581		$	202,165		$	161,962

In assessing whether uncertain tax positions should be recognized in its financial statements, Mattel first determines whether it is more-likely-than-not (a greater than 50 percent likelihood) that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, Mattel presumes that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. For tax positions that meet the more-likely-than-not recognition threshold, Mattel measures the amount of benefit recognized in the financial statements at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Mattel recognizes unrecognized tax benefits in the first financial reporting period in which information becomes available indicating that such benefits will more-likely-than-not be realized.

Mattel records unrecognized tax benefits for US federal, state, local, and foreign tax positions related primarily to transfer pricing, tax credits claimed, tax nexus, and apportionment. For each reporting period, management applies a consistent methodology to measure unrecognized tax benefits and all unrecognized tax benefits are reviewed periodically and adjusted as circumstances warrant. Mattel’s measurement of its unrecognized tax benefits is based on management’s assessment of all relevant information, including prior audit experience, the status of current audits, conclusions of tax audits, lapsing of applicable statutes of limitations, identification of new issues, and any administrative guidance or developments.

A reconciliation of unrecognized tax benefits is as follows:


	2012			2011			2010
	(In millions)
Unrecognized tax benefits at January 1	$	262.6		$	252.6		$	230.0
Increases for positions taken in current year		14.8			13.5			14.8
Increases for positions taken in a prior year		21.0			2.3			14.9
Decreases for positions taken in a prior year		(0.7	)		(1.0	)		(4.3	)
Decreases for settlements with taxing authorities		(0.8	)		(1.4	)		(1.7	)
Decreases for lapses in the applicable statute of limitations		(11.3	)		(3.4	)		(1.1	)

Unrecognized tax benefits at December 31	$	285.6		$	262.6		$	252.6

Of the $285.6 million of unrecognized tax benefits as of December 31, 2012, $277.2 million would impact the effective tax rate if recognized; however, a valuation allowance would likely be recorded against certain capital losses included in this amount.

During 2012, Mattel recognized $1.6 million of interest and penalties related to unrecognized tax benefits, which is reflected in provision for income taxes in the consolidated statements of operations. As of December 31, 2012, Mattel had accrued $10.3 million in interest and penalties related to unrecognized tax benefits. Of this balance, $9.8 million would impact the effective tax rate if recognized.

In the normal course of business, Mattel is regularly audited by federal, state, local and foreign tax authorities. In the first quarter of 2012, the IRS issued a Revenue Agent’s Report (“RAR”) related to its examination of Mattel’s 2008 and 2009 federal income tax returns. In the second quarter of 2012, Mattel submitted a written protest for all unresolved issues to the IRS Office of Appeals. The first appeals meeting is scheduled to be held in March 2013. We anticipate the appeals process will involve multiple meetings before these disputed issues are resolved. Mattel continues to believe in its interpretations of the relevant legal, administrative, and other applicable guidance on the tax issues disputed by the IRS. However, if the disputed issues are resolved in a manner inconsistent with Mattel’s expectations, such an outcome could have a material impact on our financial statements. While it is reasonably possible that a significant increase or decrease in Mattel’s unrecognized tax benefits may occur in the next twelve months related to the IRS appeals, given the uncertainty regarding timing and possible outcomes of the appeals process, a current estimate of the range of reasonably possible outcomes cannot be made at this time.

Mattel files multiple state and local income tax returns and remains subject to examination in various of these jurisdictions, including California for the 2008 through 2012 tax years, New York for the 2007 through 2012 tax years, and Wisconsin for the 2008 through 2012 tax years. Mattel files multiple foreign income tax returns and remains subject to examination in major foreign jurisdictions, including Hong Kong and Venezuela for the 2006 through 2012 tax years, Brazil, Mexico and Netherlands for the 2007 through 2012 tax years. Based on the current status of state and foreign audits, Mattel may recognize a benefit of up to approximately $11 million related to the settlement of tax audits and/or the expiration of statutes of limitations in the next twelve months. The ultimate settlement of any particular issue with the applicable taxing authority could have a material impact on Mattel’s consolidated financial statements.

In 2012, income was positively impacted by net tax benefits of $16.0 million, primarily related to reassessments of prior years’ tax liabilities based on the status of current audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes. In 2011, income was positively impacted by net tax benefits of $6.8 million, primarily related to reassessments of prior years’ tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes. In 2010, income was positively impacted by net tax benefits of $16.8 million. The August 2010 enactment of the foreign tax credit provisions in the Education Jobs and Medicaid Assistance Act (“EJMA”) will impair Mattel’s ability to utilize certain foreign tax credits expected to be generated in future years, which will provide Mattel with greater capacity in future years to utilize excess foreign tax credit carryforwards from prior years. As a result of the EJMA and other elements of Mattel’s current US tax position, Mattel formalized a plan to repatriate earnings from certain foreign subsidiaries in order to be able to fully utilize excess foreign tax credit carryforwards from prior years. The combination of these events resulted in the recognition of a discrete gross tax benefit of $59.1 million related to the anticipated utilization of excess foreign tax credits carryforwards, for which a valuation allowance had previously been provided, partially offset by a discrete tax expense of $42.9 million related to the incremental cost to repatriate earnings from certain foreign subsidiaries for which taxes had not been previously provided. In addition, Mattel also recognized discrete tax benefits of $0.6 million related to reassessments of prior years’ tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes.

On January 2, 2013, The American Taxpayer Relief Act (“Tax Act”) was signed into law. As a result of certain provisions of the Tax Act, Mattel’s provision for income taxes for the three months ended March 31, 2013 will be positively impacted by approximately $4 million to $5 million, primarily related to the extension of certain 2012 business tax credits.

The cumulative amount of undistributed earnings of foreign subsidiaries that Mattel intends to indefinitely reinvest and upon which no deferred US income taxes have been provided is approximately $5.2 billion as of December 31, 2012. Management periodically reviews the undistributed earnings of its foreign subsidiaries and reassesses the intent to indefinitely reinvest such earnings.

The additional US income tax on unremitted foreign earnings, if repatriated, would be offset in part by foreign tax credits. The extent of this offset would depend on many factors, including the method of distribution, and specific earnings distributed.

US GAAP requires that windfall income tax benefits related to the exercise of nonqualified stock options and vesting of other stock compensation awards be credited to additional paid-in capital in the period in which such amounts reduce current taxes payable. The exercise of nonqualified stock options and vesting of other stock compensation awards resulted in an increase to additional paid-in capital for related windfall income tax benefits totaling $35.8 million, $24.2 million, and $7.5 million, in 2012, 2011, and 2010, respectively.