Income Taxes

Income tax expense consists of:



(In thousands)	2013			2012		2011
Current tax expense:
U.S.	$	21,869		$	2,622	$	21,618
State	220			245		235
Foreign	5,093			23,419		40,771

Total current tax expense	27,182			26,286		62,624

Deferred taxes:
U.S.	3,961			8,824		21,024
State	—			—		(22		)
Foreign	(380		)	—		(5,345		)

Total deferred tax expense	3,581			8,824		15,657

Total income tax expense	$	30,763		$	35,110	$	78,281

Deferred income tax assets were as follows:



(In thousands)	December 31, 2013			December 31, 2012
Deferred income on sales to distributors	$	14,178		$	14,246
Deferred compensation	24,596			24,664
Stock-based compensation	17,568			16,923
Other accrued expenses and reserves	32,419			33,821
Net operating loss carryforwards	11,339			—
Tax credit carryforwards	35,899			21,829

Gross deferred tax assets	135,999			111,483
Valuation allowance	(24,498		)	(18,430		)
Deferred tax assets, net of valuation allowance	111,501			93,053

Amortization of acquisition-related intangible assets	(9,536		)	(1,183		)
Depreciation and amortization	(13,732		)	(15,739		)

Net deferred tax assets	$	88,233		$	76,131

The American Taxpayer Relief Act of 2012, which was enacted on January 2, 2013, extends the federal R&D tax credit retroactively for two years from January 1, 2012 through December 31, 2013. The federal R&D tax credit has not been extended beyond 2013. As of December 31, 2013, we had $6.9 million of federal R&D tax credit carryforwards. The federal R&D tax credit carryforwards will begin to expire in the year 2024. We also had $24.5 million of California R&D tax credit carryforwards. The California R&D tax credits can be carried forward indefinitely; however, we have provided a full valuation allowance for deferred tax assets related to the California R&D tax credits that are not expected to be realized.

As of December 31, 2013, we had $9.2 million and $24.6 million of U.S. federal and foreign net operating loss carryforwards, respectively, to offset our future taxable income. The U.S. federal net operating loss carryfowards were from one of our 2013 Acquisitions and will begin to expire in the year 2034, if not utilized. The foreign net operating loss carryforwards were from one of our 2013 Acquisitions and can be carried forward indefinitely. We expect both the U.S. federal and foreign net operating loss carryforwards to be fully realizable in the future.

Under the provisions of Section 382 of the Internal Revenue Code, a change of control may impose an annual limitation on the amount of the Company's net operating loss and tax credit carryforwards that can be used to reduce future tax liabilities. As a result of the acquired tax attributes, our tax attributes are subject to an annual limitation of approximately $0.9 million per year for federal purposes.

The valuation allowance of $24.5 million as of December 31, 2013 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)	2013			2012			2011
Tax expense at U.S. statutory rates	$	164,790		$	207,171		$	297,151
State taxes, net of federal benefit	203			203			203
Foreign tax rate differential	(148,438		)	(165,572		)	(225,234		)
Executive compensation deduction limitation	2,217			2,346			3,237
Research and development tax credits	(28,538		)	(20,487		)	(16,649		)
Interest on unrecognized gross tax benefits	5,149			(1,968		)	7,520
Deferred tax asset valuation allowance	6,068			7,532			8,198
Foreign dividends	27,707			—			—
Other, net	1,605			5,885			3,855

Total income tax expense	$	30,763		$	35,110		$	78,281

During the fourth quarter of fiscal 2013 we recorded a deferred charge for the deferral of income tax expense on intercompany profits that resulted from the sale of our newly acquired intellectual property rights from an Altera U.S. entity to one of our foreign subsidiaries. The deferred charge is included in Other current assets and Other assets, net on our consolidated balance sheets. As of December 31, 2013, the deferred charge balance in Other current assets was $2.2 million, and $18.9 million in Other assets, net. The deferred charge will be amortized on a straight-line basis as a component of income tax expense over ten years, based on the economic life of the intellectual property and is not expected to have a material impact on our effective tax rate.

We file income tax returns with the IRS and in various U.S. states and foreign jurisdictions. On December 8, 2011 and January 23, 2012, the IRS issued Statutory Notices of Deficiency (the “Notices”) determining that additional taxes of $19.8 million for 2002 through 2004 and an additional $21.4 million were due for 2005 through 2007, excluding interest. The IRS’s determinations relate primarily to inter-company transactions, computational adjustments to the R&D credit, and reductions to the benefits of tax credit carry backs and carry forwards. We deposited $18.0 million as a cash bond with the IRS in 2008 and converted this amount to tax payments in March 2012. On March 6, 2012 and April 20, 2012, we filed petitions challenging the two Notices in the U.S. Tax Court. The petitions request redetermination of the deficiencies produced by the IRS’s adjustments. The IRS has filed responses to our petitions, in which the IRS conceded the R&D credit adjustment for 2004. The Tax Court has consolidated the two cases and a judge has been assigned. The federal statute of limitations for the 2002 and 2003 tax years has expired, and the ongoing Tax Court litigation concerns only the 2004 through 2007 years.

On January 31, 2013, the IRS conceded one of the adjustments at issue in the litigation for the 2004 through 2007 tax years. The conceded adjustment related to certain inter-company services transactions. The concession only impacted our 2007 tax year. As a result of this concession, we recognized a tax and interest benefit of $6.8 million in 2013 due to the release of certain tax reserves. Altera and the IRS have filed cross motions for partial summary judgment on the largest adjustment still at issue, which is related to the treatment of stock-based compensation in an inter-company cost-sharing transaction. As part of the partial motion for summary judgment process, both sides filed briefs on May 28, 2013, July 25, 2013 and September 9, 2013. We expect to present additional legal arguments related to certain affirmative adjustments raised by Altera in the litigation. The parties filed a Joint Status Report addressing these affirmative adjustments with the Tax Court on February 5, 2014. 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 or financial position.

On April 19, 2013, the IRS notified us that we would be audited for each of the 2010 and 2011 tax years. We believe we have made adequate tax payments or accrued adequate amounts for our tax liabilities for 2010 and 2011 and that the outcome of the audit will not have a material adverse effect on our consolidated operating results or financial position.

During the third quarter of 2013, we reversed $30.3 million of liabilities for uncertain tax positions upon the expiration of foreign and domestic statutes of limitation and related interest mostly relating to the expiration of federal statute of limitations for the 2008 and 2009 tax years. The resulting decrease in our effective tax rate in the third quarter of 2013 was substantially offset by $27.7 million of tax accrued on foreign dividends.

Other significant jurisdictions in which we are or may be subject to examination for fiscal years 2002 forward include China (including Hong Kong), Denmark, 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 2013, 2012 and 2011 were as follows:



(In millions)	2013			2012			2011
Balance at beginning of year	$	296.4		$	306.5		$	263.3
Additions based on tax positions related to the current year	67.3			45.1			51.1
Additions for tax positions of prior years	2.7			4.8			5.7
Reductions for tax positions of prior years	(42.3		)	(60.0		)	(13.6		)
Balance at end of year	$	324.1		$	296.4		$	306.5

As of December 31, 2013 and December 31, 2012, the total amount of unrecognized tax benefit that, if recognized, would impact the effective tax rate was $301.3 million and $275.9 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 expense of $0.1 million in 2013. The net expense of $0.1 million is primarily due to $3.9 million in interest and penalty expenses related to general unrecognized tax benefits, offset by the reversal of $3.8 million of interest and penalties associated with the reversal of uncertain tax positions resulting from the IRS conceding an adjustment for certain 2007 inter-company transactions in our 2004 through 2007 litigation, changes in estimates for certain foreign jurisdictions, and the expiration of foreign and domestic statutes of limitation. We recognized a net benefit of $6.0 million and a net expense of $4.8 million in 2012 and 2011, respectively. The balance of accrued and unpaid interest and penalties was $48.8 million as of December 31, 2013 and 2012.

In connection with one of our acquisitions in 2013, we are indemnified by the selling company for certain potential tax obligations arising prior to the acquisition. We have recognized a tax indemnification receivable of $6.5 million in Other assets, net in our consolidated balance sheets. We do not expect any significant effect on earnings or cash flows related to these potential tax obligations.

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



(In thousands)	2013		2012		2011
U.S.	$	79,160	$	26,216	$	94,930
Foreign	391,668		565,701		754,062

Income before income taxes	$	470,828	$	591,917	$	848,992

Aggregate unremitted earnings of our foreign subsidiaries were $3.1 billion as of December 31, 2013. These earnings, which reflect full provisions for foreign income taxes, are indefinitely invested in foreign operations. If these earnings were remitted to our U.S. entities, 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.