Income Taxes

Due to the timing of the enactment and the complexity involved in applying the provisions of the 2017 Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our financial statements as of December 31, 2017. The provisional effect on deferred tax assets and liabilities of the change in tax rates was recognized in earnings in the period ended December 31, 2017, which was when the change was enacted. As part of the 2017 Tax Act's change to a quasi-territorial system, a transition tax was imposed on our accumulated foreign earnings, partially offset by foreign tax credits, which was also recognized in the period ended December 31, 2017.

The estimate recorded as of December 31, 2017 was updated as of September 30, 2018 based upon our decision to elect not to apply our existing net operating losses, or NOLs, against the accumulated earnings that were subject to the transition tax. The election did not have an impact on our total income tax expense but did result in significant changes to the makeup of our tax carryforwards. The change included an increase to our available NOLs by $222 million, offset by a decrease in our existing foreign tax credits, or FTCs, by $78 million. In addition, due to the accelerated use of FTCs, our valuation allowance related to our FTCs was reduced by $31 million.

The 2017 Tax Act made significant changes to how foreign tax credits may be realized to offset future tax liabilities. Further clarity may change our anticipated realization of our foreign tax credits. As we collect and prepare necessary data and interpret the 2017 Tax Act and any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we may make additional adjustments to the provisional amounts.

Our income tax expense and effective tax rate for the three and nine months ended September 30 were as follows:



	Three months ended September 30,						Nine months ended September 30,
(dollars in millions)	2018			2017			2018			2017
Income tax expense	$	15		$	27		$	37		$	76
Effective tax rate	20.5		%	29.0		%	19.6		%	31.3		%

The income tax expense for all periods presented reflects taxes from federal, foreign, state and local jurisdictions. Our effective tax rates were lower than the U.S. statutory rate primarily because of earnings realized in countries that had lower statutory tax rates and our equity method income, which is presented net of tax. Our effective tax rate in the future will depend on, among other things, the portion of our profits earned within and outside the United States.

As of September 30, 2018, we had federal NOL carryforwards of approximately $564 million, which included a $222 million increase based on provisional adjustments related to the 2017 Tax Act, that are available to offset future federal taxable income and will expire in the years 2030 through 2032, none of which are currently subject to Internal Revenue Code limitations under Section 382. In addition, as of that date, we had federal alternative minimum tax credit carryforwards of approximately $19 million that are available to reduce future regular federal income taxes with the full benefit being realized by 2022 as described in the 2017 Tax Act. We had FTC carryforwards of $148 million, which included a decrease of $78 million based on provisional adjustments related to the 2017 Tax Act, which are available to offset future federal tax liabilities and expire in the years 2022 through 2027. In order to fully realize these U.S. federal net deferred tax assets, taxable income of approximately $1.361 billion would need to be generated during the period before their expiration based on our interpretation of the 2017 Tax Act.

As of September 30, 2018, we had a deferred tax asset of $161 million related to our state NOLs and tax credit carryforwards. The NOLs will expire if unused in years 2018 through 2034. To the extent that we do not generate sufficient state taxable income within the statutory carryforward periods to utilize the NOL and tax credit carryforwards in these states, they will expire unused.

As of September 30, 2018, the valuation allowance against our deferred tax assets was $142 million, a $33 million reduction compared to $175 million at December 31, 2017. The reduction primarily related to the accelerated use of our FTCs to offset the transition tax related to the 2017 Tax Act.

The Internal Revenue Code imposes limitations on a corporation’s ability to utilize NOLs if it experiences an “ownership change” which can result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percentage points over a three-year period. If we were to experience an ownership change, utilization of our NOLs would be subject to an annual limitation that may be carried over to later years within the allowed NOL carryforward period. Over the entire carryforward period, we may not be able to use all our NOLs due to the aforementioned annual limitation. If an ownership change had occurred as of September 30, 2018, our annual U.S. federal NOL utilization would have been limited to approximately $139 million per year.