INCOME TAXES

12 Months Ended

Dec. 31, 2018

Note 5. Income Taxes

Income before taxes
			Years Ended December 31,
			2018		2017		2016
	U.S.	$	2,919	$	2,873	$	2,981
	Non-U.S.		4,568		4,077		3,471
		$	7,487	$	6,950	$	6,452

Tax expense (benefit)
			Years Ended December 31,
			2018		2017		2016
	Tax expense (benefit) consists of
	Current:
	U.S. Federal	$	(21)	$	2,061	$	869
	U.S. State		89		62		97
	Non-U.S.		1,177		787		559
		$	1,245	$	2,910	$	1,525
	Deferred:
	U.S. Federal	$	396	$	190	$	40
	U.S. State		8		139		17
	Non-U.S.		(990)		2,123		21
			(586)		2,452		78
		$	659	$	5,362	$	1,603

	Years Ended December 31,
	2018		2017		2016
The U.S. federal statutory income tax rate is reconciled to our effective income tax rate as follows:
U.S. federal statutory income tax rate	21.0	%	35.0	%	35.0	%
Taxes on non-U.S. earnings⁽¹⁾⁽²⁾	0.2		(12.8)		(8.0)
U.S. state income taxes⁽¹⁾	1.6		1.4		1.1
Reserves for tax contingencies	0.3		1.6		1.2
Employee share-based payments	(0.7)		(2.9)		(2.0)
U.S. Tax Reform	(5.8)		56.0		-
Reduction of taxes on unremitted earnings	(14.2)		-		-
Separation tax costs	5.5		-		-
All other items—net	0.9		(1.1)		(2.5)
	8.8	%	77.2	%	24.8	%
(1) Net of changes in valuation allowance
(2) Includes U.S. taxes on non-U.S. earnings

The effective tax rate decreased by 68.4 percentage points in 2018 compared to 2017. The decrease was primarily attributable to internal restructuring initiatives that resulted in a reduction of accrued withholding taxes of approximately $1.1 billion related to unremitted foreign earnings. In addition, we recorded a tax benefit of approximately $440 million as a reduction to our 2017 provisional estimate of impacts from U.S. Tax Reform, which was partially offset by $411 million of tax costs associated with the internal restructuring of the Homes and Global Distribution business and Transportation Systems business in advance of their spin-offs. The Company’s non-U.S. effective tax rate was 4.1%, a decrease of approximately 67.3 percentage points compared to 2017. The year over year decrease in the foreign effective tax rate was primarily attributable to the impact of the Company's internal restructuring initiatives and the reduction of accrued withholding taxes on unremitted foreign earnings, partially offset by the spin-off transactions.

The effective tax rate increased by 52.4 percentage points in 2017 compared to 2016. The increase was primarily attributable to the provisional impact of U.S. Tax Reform, partially offset by increased tax benefits from foreign tax credits and for employee share-based payments. The Company’s non-U.S. effective tax rate was 71.4%, an increase of approximately 54.7 percentage points compared to 2016. The year-over-year increase in the non-U.S. effective tax rate was primarily driven by the Company’s change in assertion regarding foreign unremitted earnings, increased expense for reserves in various jurisdictions and increased withholding taxes, partially offset by higher earnings in low tax rate jurisdictions.

Deferred tax assets (liabilities)

The tax effects of temporary differences and tax carryforwards which give rise to future income tax benefits and payables are as follows:

	December 31,
Deferred tax assets:	2018		2017
Postretirement benefits other than pensions		120		177
Asbestos and environmental		589		570
Employee compensation and benefits		262		218
Other accruals and reserves		336		376
Net operating and capital losses		688		632
Tax credit carryforwards		154		510
Gross deferred tax assets		2,149		2,483
Valuation allowance		(689)		(663)
Total deferred tax assets	$	1,460	$	1,820

Deferred tax liabilities:
Pension……………………………………………….	$	(40)	$	(40)
Property, plant and equipment		(422)		(439)
Intangibles		(1,553)		(1,326)
Unremitted earnings of foreign subsidiaries		(616)		(2,151)
Other asset basis differences		(110)		(210)
Other		(50)		(67)
Total deferred tax liabilities		(2,791)		(4,233)
Net deferred tax liability	$	(1,331)	$	(2,413)

Our gross deferred tax assets include $794 million related to non-U.S. operations comprised principally of net operating losses, capital loss and tax credit carryforwards (mainly in Canada, France, Germany, Luxembourg and the United Kingdom) and deductible temporary differences. We maintain a valuation allowance of $686 million against a portion of the non-U.S. gross deferred tax assets. The change in the valuation allowance resulted in increases of $57 million, $4 million and $69 million to income tax expense in 2018, 2017 and 2016. In the event we determine that we will not be able to realize our net deferred tax assets in the future, we will reduce such amounts through an increase to income tax expense in the period such determination is made. Conversely, if we determine that we will be able to realize net deferred tax assets in excess of the carrying amounts, we will decrease the recorded valuation allowance through a reduction to income tax expense in the period that such determination is made.

As of December 31, 2018, we have recorded a $616 million deferred tax liability on all of our unremitted foreign earnings based on estimated earnings and profits of approximately $20.5 billion as of the balance sheet date.

As of December 31, 2018, our net operating loss, capital loss and tax credit carryforwards were as follows:

			Net Operating
	Expiration		and Capital Loss		Tax Credit
Jurisdiction	Period		Carryforwards		Carryforwards
U.S. Federal	2038	$	9	$	22
U.S. State	2038		406		18
Non-U.S.	2038		310		117
Non-U.S.	Indefinite		2,353		-
		$	3,078	$	157

Many jurisdictions impose limitations on the timing and utilization of net operating loss and tax credit carryforwards. In those instances, whereby there is an expected permanent limitation on the utilization of the net operating loss or tax credit carryforward, the deferred tax asset and amount of the carryforward have been reduced.

	2018		2017		2016
Change in unrecognized tax benefits:
Balance at beginning of year	$	947	$	877	$	765
Gross increases related to current period tax positions		370		94		96
Gross increases related to prior periods tax positions		82		153		88
Gross decreases related to prior periods tax positions		(201)		(91)		(33)
Decrease related to resolutions of audits with tax authorities		(40)		(76)		(3)
Expiration of the statute of limitations for the assessment of taxes		(50)		(54)		(10)
Foreign currency translation		(19)		44		(26)
Balance at end of year	$	1,089	$	947	$	877

As of December 31, 2018, 2017, and 2016 there were $ 1,089 million, $ 947 million and $ 877 million of unrecognized tax benefits that if recognized would be recorded as a component of Tax expense.

The following table summarizes tax years that remain subject to examination by major tax jurisdictions as of December 31, 2018:

	Open Tax Years
	Based on Originally Filed Returns
Jurisdiction	Examination in	Examination not yet
Jurisdiction	progress	initiated
U.S. Federal	2015 - 2016	2015, 2017 - 2018
U.S. State	2011 - 2017	2012 - 2018
Australia	N/A	2016 - 2018
Canada⁽¹⁾	2010 - 2016	2017 - 2018
China	2003 - 2017	2018
France	2008 - 2017	2018
Germany⁽¹⁾	2007 - 2018	N/A
India	1998 - 2016	2017 - 2018
Switzerland⁽¹⁾	2013 - 2014	2017 - 2018
United Kingdom	2013 - 2017	2018

(1) Includes provincial or similar local jurisdictions, as applicable.

Based on the outcome of these examinations, or as a result of the expiration of statute of limitations for specific jurisdictions, it is reasonably possible that certain unrecognized tax benefits for tax positions taken on previously filed tax returns will materially change from those recorded as liabilities in our financial statements. In addition, the outcome of these examinations may impact the valuation of certain deferred tax assets (such as net operating losses) in future periods.

Unrecognized tax benefits for examinations in progress were $304 million, $487 million and $398 million, as of December 31, 2018, 2017, and 2016. Estimated interest and penalties related to the underpayment of income taxes are classified as a component of Tax expense in the Consolidated Statement of Operations and totaled $45 million, $28 million and $18 million for the years ended December 31, 2018, 2017, and 2016. Accrued interest and penalties were $426 million, $423 million and $395 million, as of December 31, 2018, 2017, and 2016.

U.S. Tax Reform

During the quarter ending December 31, 2018, the Company completed the accounting for the tax effects of U.S. Tax Reform which amounted to a total tax charge of approximately $3.5 billion, most of which was recorded as a provisional estimate at the end of 2017. During 2018, we reduced our provisional estimate by approximately $440 million as a reduction to Tax expense.

Corporate Tax Rate Change – The Company recorded a total tax benefit of approximately $190 million due to the decrease in the corporate statutory tax rate from 35% to 21%. This includes a measurement period adjustment of approximately $90 million recorded during 2018 as a reduction to Tax expense. The change in the provisional estimate primarily relates to information contained in tax returns that were filed during the quarter ending December 31, 2018, some of which require approval from U.S. tax authorities. The tax benefit from the change in tax rates results from the Company’s deferred tax liability position for the excess of its net book value over its tax basis of its U.S. assets and liabilities that will generate future taxable income in excess of book income. This additional taxable income will be subject to tax at a lower corporate tax rate, consequently reducing the Company’s deferred tax liability.

Mandatory Transition Tax – The Company recorded a total tax charge of approximately $1,950 million due to the imposition of the mandatory transition tax (“MTT”) on the deemed repatriation of undistributed foreign earnings. This includes a measurement period adjustment of approximately $50 million recorded during 2018 as an increase to Tax expense. The change in the provisional estimate primarily relates to updated amounts from tax returns that were finalized during 2018, computations based on 2018 testing dates and guidance from the taxing authorities that was received during the year. The Company has elected to pay the MTT liability over a period of eight years.

Undistributed Foreign Earnings – The Company recorded a total tax charge of approximately $1,700 million due to the Company’s intent to no longer permanently reinvest the historical unremitted earnings of its foreign affiliates that existed as of December 31, 2017. This includes a measurement period adjustment of approximately $400 million recorded during 2018 as a reduction to Tax expense. The change in the provisional estimate primarily relates to updated amounts from tax returns that were finalized during 2018, the application of foreign tax credits based on guidance issued during the year and changes to the applicable withholding tax rates in local jurisdictions. During 2018, the Company executed various internal restructuring initiatives that reduced the taxes on unremitted foreign earnings by approximately $1.1 billion that was recorded as a reduction to Tax expense.

Global Intangible Low Taxed Income – U.S. Tax Reform imposes a U.S. tax on global intangible low taxed income (“GILTI”) that is earned by certain foreign affiliates owned by a U.S. shareholder. GILTI is generally intended to impose tax on the earnings of a foreign corporation that are deemed to exceed a certain threshold return relative to the underlying business investment. The Company has made a policy election to treat future taxes related to GILTI as a current period expense in the reporting period in which the tax is incurred.