Income Taxes

Income tax expense consists of:



(In thousands)	2012		2011			2010
Current tax expense:
United States (“U.S.”)	$	2,622	$	21,618		$	30,305
State	245		235			1,224
Foreign	23,419		40,771			19,158

Total current tax expense	26,286		62,624			50,687

Deferred taxes:
U.S.	8,824		21,024			11,252
State	—		(22		)	23,004
Foreign	—		(5,345		)	—

Total deferred tax expense	8,824		15,657			34,256

Total income tax expense	$	35,110	$	78,281		$	84,943

Deferred income tax assets were as follows:



(In thousands)	December 31, 2012			December 31, 2011
Deferred income on sales to distributors	$	14,246		$	13,710
Acquisition costs	1,480			2,894
Deferred compensation	24,664			24,523
Stock compensation	16,923			18,506
Other accrued expenses and reserves	31,158			32,501
Tax credits	21,829			13,640

Gross deferred tax assets	110,300			105,774
Valuation Allowance	(18,430		)	(10,898		)
Deferred tax assets, net of valuation allowance	91,870			94,876

Depreciation and amortization	(15,739		)	(9,832		)

Net deferred tax assets	$	76,131		$	85,044

As of December 31, 2012, we had $17.4 million of California research and development tax credit carry forwards. The California credits can be carried forward indefinitely.

The valuation allowance of $18.4 million as of December 31, 2012 primarily relates to a California law change providing the option to elect the single sales factor apportionment method to attribute taxable income to California for tax years beginning on or after January 1, 2011. The single sales method became mandatory for tax years beginning on or after January 1, 2013. We expect that the income subject to tax in California will be lower than under prior tax law and therefore realization of our California deferred tax assets is no longer more likely than not to occur.

The provisions related to the tax accounting for stock-based compensation prohibit the recognition of a deferred tax asset for an excess benefit that has not yet been realized. As a result, we will only recognize an excess benefit from stock-based compensation in additional paid-in-capital if an incremental tax benefit is realized after all other tax attributes currently available to us have been utilized. In addition, we have elected to account for the indirect benefits of stock-based compensation such as the R&D tax credit through the consolidated statements of comprehensive income.

The items accounting for the difference between income taxes computed at the federal statutory rate and income tax expense are as follows:



(In thousands)	2012			2011			2010
Tax expense at U.S. statutory rates	$	207,171		$	297,151		$	303,849
State taxes, net of federal benefit	203			203			27,058
Foreign tax rate differential	(165,572		)	(225,234		)	(240,873		)
Executive compensation deduction limitation	2,346			3,237			1,277
Research tax credits	(20,487		)	(16,649		)	(12,951		)
Interest on unrecognized gross tax benefits	(1,968		)	7,520			4,477
Deferred tax asset valuation allowance	7,532			8,198			2,700
Other, net	5,885			3,855			(594		)

Total income tax expense	$	35,110		$	78,281		$	84,943

We file income tax returns with the Internal Revenue Service (“IRS”) and in various U.S. states and foreign jurisdictions. In 2008, the IRS completed field examinations of our tax returns for 2002 through 2004 and proposed an additional tax liability of $34.5 million, excluding interest. We contested this proposed additional tax liability in the IRS Office of Appeals and resolved several of the issues. On December 8, 2011, the IRS issued a Statutory Notice of Deficiency, revising the assessment of additional taxes for 2002 through 2004 to $19.8 million, excluding interest. The Notice relates primarily to inter-company adjustments between related companies, computational adjustments to the research and development ("R&D") credit and reductions to the benefits of tax credit carrybacks and carryforwards to subsequent years. On March 6, 2012, we filed a petition in the U.S. Tax Court to request a redetermination of the tax deficiency regarding certain IRS adjustments for 2004. We deposited $18.0 million as a cash bond with IRS in 2008, and converted this amount to tax payments in March 2012. On May 8, 2012, the IRS filed its petition response in the U.S. Tax Court, in which the IRS conceded the R&D credit adjustment for 2004. In June 2012, the federal statute of limitations for the 2002 and 2003 tax years expired.

In addition, in 2010 the IRS completed field examinations for 2005 through 2007 and proposed an additional tax liability of $34.2 million, excluding interest. On January 23, 2012, the IRS issued a Statutory Notice of Deficiency, revising the assessment of additional taxes for 2005 through 2007 to $21.4 million, excluding interest. The Notice relates primarily to inter-company adjustments between related companies and reductions to the benefits of tax credit carrybacks and carryforwards to subsequent years. On April 20, 2012, we filed a petition in the U.S. Tax Court to request a redetermination of the tax deficiencies regarding certain IRS adjustments for 2005 through 2007. On June 21, 2012, the IRS filed its petition response in the U.S. Tax Court.

On August 15, 2012, the case for the 2004 tax year was combined with that for the 2005 through 2007 tax years. A judge has been assigned to our case and a motion for continuance has been granted. We believe we have made adequate tax payments or accrued adequate amounts for our tax liabilities for 2004 through 2007 and that the outcome of the above matters will not have a material adverse effect on our consolidated operating results, cash flows or financial position.

On January 31, 2013, the IRS conceded an adjustment for certain inter-company transactions in our litigation over the 2004 through 2007 tax years. The concession only impacted our 2007 tax year. Our other inter-company transactions continue to be subject to litigation for 2004 through 2007. As a result of this concession, we expect to recognize a tax and interest benefit of $7.5 million during the three months ending March 29, 2013 due to the release of certain tax reserves. We expect to present our legal arguments on other inter-company transactions that are subject to ligation to the U.S. Tax Court by the end of 2013.

Other significant jurisdictions in which we are or may be subject to examination for fiscal years 2002 forward include China (including Hong Kong), Ireland, Malaysia, Japan, Canada, United Kingdom and the state of California. We believe we have made adequate tax payments and/or accrued adequate amounts such that the outcome of these audits will have no material adverse effect on our consolidated operating results. Due to the potential resolution of various tax examinations, and the expiration of various statutes of limitations, it is possible that our gross unrecognized tax benefits may change within the next twelve months. However, given the number of years remaining subject to examination and the number of matters being examined, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits.

The aggregate changes in the balance of gross unrecognized tax benefits for 2012, 2011 and 2010 were as follows:



(In millions)	2012			2011			2010
Balance at beginning of year	$	306.5		$	263.3		$	244.1
Additions based on tax positions related to the current year	45.1			51.0			39.9
Additions for tax positions of prior years	4.8			5.7			—
Reductions for tax positions of prior years	(60.0		)	(13.6		)	(20.7		)
Balance at end of year	$	296.4		$	306.5		$	263.3

As of December 31, 2012 and December 31, 2011, the total amount of unrecognized tax benefit that, if recognized, would impact the effective tax rate was $275.9 million and $284.9 million, respectively. These amounts are presented net of federal benefits for the deduction of interest and other deductible items.

Estimated interest and penalties related to unrecognized tax benefits are recognized in tax expense. We recognized a net benefit of $6.0 million in 2012. The net benefit of $6.0 million is comprised of a $5.6 million interest and penalty accrual, offset by the reversal of $11.6 million of interest and penalties associated with the reversal of uncertain tax positions upon the expiration of the federal statute of limitations, settlement with certain foreign jurisdictions, and the Statutory Notice of Deficiency received from the IRS for 2005 through 2007. We recognized $4.8 million and $2.9 million of interest and penalties in 2011 and 2010, respectively. The balance of accrued and unpaid interest and penalties was $48.8 million and $54.8 million as of December 31, 2012 and 2011, respectively.

U.S. and foreign components of income before income taxes were:



(In thousands)	2012		2011		2010
U.S.	$	26,216	$	94,930	$	116,362
Foreign	565,701		754,062		751,465

Income before income taxes	$	591,917	$	848,992	$	867,827

Aggregate unremitted earnings of our foreign subsidiaries were $2.7 billion as of December 31, 2012. These earnings, which reflect full provisions for foreign income taxes, are indefinitely invested in foreign operations. If these earnings were remitted to the U.S., they would be subject to domestic and/or foreign taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.

The American Taxpayer Relief Act of 2012, which was enacted on January 2, 2013, extends the federal research tax credit retroactively for two years from January 1, 2012 through December 31, 2013. The tax benefit from the extension of the federal research tax credit of $10.6 million will be reflected in the income tax provision in the quarter ending March 29, 2013.