Note 3—Income Taxes

Consolidated pre-tax income consists of the following:


	For the Year
	2013		2012		2011
	(In thousands)
US operations	$	231,372	$	104,707	$	169,706
Foreign operations		867,756		840,338		800,967

	$	1,099,128	$	945,045	$	970,673

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


	For the Year
	2013			2012			2011
	(In thousands)
Current
Federal	$	38,227		$	69,639		$	15,933
State		6,447			8,660			5,268
Foreign		130,878			126,465			131,596

		175,552			204,764			152,797

Deferred
Federal		30,342			(26,489	)		49,853
State		(512	)		520			(2,629	)
Foreign		(10,198	)		(10,214	)		2,144

		19,632			(36,183	)		49,368

Provision for income taxes	$	195,184		$	168,581		$	202,165

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,
	2013			2012
	(In thousands)
Tax credit carryforwards	$	77,396		$	59,372
Research and development expenses		187,477			181,449
Loss carryforwards		124,201			131,989
Allowances and reserves		202,141			229,056
Deferred compensation		111,850			118,878
Postretirement benefits		37,479			72,912
Other		66,599			67,942

Gross deferred income tax assets		807,143			861,598

Intangible assets		(282,737	)		(279,592	)
Other		(5,555	)		(8,262	)

Gross deferred income tax liabilities		(288,292	)		(287,854	)

Deferred income tax asset valuation allowances		(64,641	)		(67,705	)

Net deferred income tax assets	$	454,210		$	506,039

The table of deferred tax assets and liabilities as shown above does not include deferred tax assets for net operating losses as of December 31, 2013 that arose directly from tax deductions attributable to windfall income tax benefits. Additional paid-in-capital will be increased by $4.6 million when the deferred tax assets are realized. Mattel uses tax law ordering when determining when excess tax benefits have been realized.

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


	December 31,
	2013			2012
	(In thousands)
Prepaid expenses and other current assets	$	195,872		$	253,664
Other noncurrent assets		373,638			374,667
Accrued liabilities		(109	)		(152	)
Other noncurrent liabilities		(115,191	)		(122,140	)

	$	454,210		$	506,039

As of December 31, 2013, Mattel has federal and foreign loss carryforwards totaling $445.8 million and tax credit carryforwards of $77.4 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 thousands)
2014 – 2018	$	60,363	$	27,678
Thereafter		180,756		43,502
No expiration date		204,681		6,220

Total	$	445,800	$	77,400

Management considered all available evidence under existing tax law and anticipated expiration of tax statutes and determined that a valuation allowance of $56.8 million was required as of December 31, 2013 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 $7.8 million was required as of December 31, 2013 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 2013 include increases in the valuation allowance for 2013 foreign losses without benefits, decreases in the valuation allowances for certain deferred tax assets, and decreases in the valuation allowance for expirations, projected utilization of tax loss and tax credit carryforwards and changes in tax rates. 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 $454.2 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
	2013			2012			2011
	(In thousands)
Provision at US federal statutory rate	$	384,695		$	330,766		$	339,736
(Decrease) increase resulting from:
Foreign earnings taxed at different rates, including withholding taxes		(165,768	)		(157,488	)		(139,476	)
Foreign losses without income tax benefit		3,215			1,047			2,883
State and local taxes, net of US federal benefit		4,854			6,856			4,833
Adjustments to previously accrued taxes		(32,200	)		(16,000	)		(6,800	)
Other		388			3,400			989

Provision for income taxes	$	195,184		$	168,581		$	202,165

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 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:


	For the Year
	2013			2012			2011
	(In thousands)
Unrecognized tax benefits at January 1	$	285,560		$	262,560		$	252,570
Increases for positions taken in current year		12,997			14,800			13,480
Increases for positions taken in a prior year		14,289			21,030			2,280
Decreases for positions taken in a prior year		(186,555	)		(700	)		(980	)
Decreases for settlements with taxing authorities		(5,135	)		(800	)		(1,390	)
Decreases for lapses in the applicable statute of limitations		(9,786	)		(11,330	)		(3,400	)

Unrecognized tax benefits at December 31	$	111,370		$	285,560		$	262,560

Of the $111.4 million of unrecognized tax benefits as of December 31, 2013, $106.9 million would impact the effective tax rate if recognized.

During 2013, Mattel recognized $1.0 million of interest and penalties related to unrecognized tax benefits, which are reflected in provision for income taxes in the consolidated statements of operations. As of December 31, 2013, Mattel accrued $6.1 million in interest and penalties related to unrecognized tax benefits. Of this balance, $5.4 million would impact the effective tax rate if recognized.

In August 2013, Mattel reached a settlement with the Internal Revenue Service (“IRS”) Office of Appeals regarding all unresolved issues in the IRS’s examination of Mattel’s 2008 and 2009 federal income tax returns. As a result, Mattel’s total unrecognized tax benefits decreased by $190.0 million. A majority of the decrease related to a capital loss for which Mattel recognized no financial statement benefit.

In the normal course of business, Mattel is regularly audited by federal, state, local and foreign tax authorities. The IRS is currently auditing Mattel’s 2010 and 2011 federal income tax returns. The IRS audit plan calls for the completion of the current examination in the first quarter of 2014. 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 this IRS audit, 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 2013 tax years, New York for the 2007 through 2013 tax years, and Wisconsin for the 2008 through 2013 tax years. Mattel files multiple foreign income tax returns and remains subject to examination in major foreign jurisdictions, including Hong Kong for the 2007 through 2013 tax years, Brazil, Mexico and Netherlands for the 2008 through 2013 tax years. Based on the current status of state and foreign audits, Mattel believes it is reasonably possible that in the next 12 months, the total unrecognized tax benefits could decrease by approximately $17 million related to the settlement of tax audits and/or the expiration of statutes of limitations. The ultimate settlement of any particular issue with the applicable taxing authority could have a material impact on Mattel’s consolidated financial statements.

The income tax provision included net tax benefits of $32.2 million, $16.0 million, and $6.8 million in 2013, 2012, and 2011, respectively, 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.

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 $5.9 billion as of December 31, 2013. Management periodically reviews the undistributed earnings of its foreign subsidiaries and reassesses the intent to indefinitely reinvest such earnings. It is not practicable for Mattel to determine the deferred tax liability associated with these undistributed earnings due to the availability of foreign tax credits, the complexity of our international holding company structure, the rules governing the utilization of foreign tax credits, and the interplay between utilization of such foreign tax credits and Mattel’s other significant tax attributes.

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 $50.4 million, $35.8 million, and $24.2 million in 2013, 2012, and 2011, respectively.