Income Taxes

Our provision (benefit) for income taxes consists of (table in thousands):



	2012			2011			2010
Federal:
Current	$	792,148		$	488,031		$	518,309
Deferred	(79,943		)	14,333			4,170
	712,205			502,364			522,479
State:
Current	74,064			70,676			49,488
Deferred	(12,308		)	(45,272		)	(20,419		)
	61,756			25,404			29,069
Foreign:
Current	168,959			101,101			120,287
Deferred	(25,322		)	11,516			(33,538		)
	143,637			112,617			86,749
Total provision for income taxes	$	917,598		$	640,385		$	638,297

In 2012, 2011 and 2010, we were able to utilize net operating loss carryforwards and tax credit carryforwards to reduce the current portion of our tax provision by $58.8 million, $19.5 million and $46.9 million, respectively.

The effective income tax rate is based upon the income for the year, the composition of the income in different countries, effect of tax law changes and adjustments, if any, for the potential tax consequences, benefits or resolutions of tax audits. A reconciliation of our income tax provision to the statutory federal tax rate is as follows:



	2012		2011		2010
Statutory federal tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal taxes	1.3	%	0.7	%	1.0	%
Resolution of uncertain tax positions	(0.5	)%	(1.7	)%	(0.6	)%
Tax rate differential for international jurisdictions and other international related tax items	(13.6	)%	(14.4	)%	(12.2	)%
U.S. tax credits	(0.2	)%	(2.8	)%	(3.3	)%
Changes in valuation allowance	—	%	—	%	(0.6	)%
International reorganization of acquired companies	0.3	%	—	%	3.2	%
Permanent items	1.5	%	2.5	%	2.5	%
Other	0.3	%	0.4	%	(0.5	)%
	24.1	%	19.7	%	24.5	%

Substantially all the tax rate differential for international jurisdictions was driven by earnings of our Irish subsidiaries.

In 2010, a reorganization of international operations was effected which included the transfer of certain assets of Isilon, Archer Technologies and Bus-Tech into the single EMC international holding company, which negatively impacted the rate by 3.2 percentage points.

On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law. Some of the provisions were retroactive to January 1, 2012 including an extension of the U.S. federal tax credit for increasing research activities through December 31, 2013. Because the extension was enacted after December 31, 2012, our 2012 effective tax rate does not reflect our estimated 2012 federal tax credit for increasing research activities even though it will be reported on our 2012 federal income tax returns. Had the extension been enacted prior to January 1, 2013, our overall tax provision would have been approximately $66.5 million lower reducing our effective tax rate from 24.1% to 22.4%. We expect that our income tax provision for the first quarter of 2013 will include the estimated 2012 federal tax credit for increasing research activities as a discrete tax benefit which will reduce our effective tax rate for the quarter and to a lesser extent our annual effective tax rate for 2013.

The components of the current and non-current deferred tax assets and liabilities are as follows (table in thousands):



	December 31, 2012						December 31, 2011
	Deferred Tax Asset			Deferred Tax Liability			Deferred Tax Asset			Deferred Tax Liability
Current:
Accounts and notes receivable	$	67,798		$	—		$	86,400		$	—
Inventory	64,452			—			91,374			—
Accrued expenses	291,358			—			281,071			—
Deferred revenue	386,021			—			274,463			—
Equity	98,383			—			75,782			—
Credit carryforwards	4,860			—			8,363			—
Net operating losses	28,903			—			35,395			—
Total current	941,775			—			852,848			—
Property, plant and equipment, net	—			(286,061		)	—			(246,377		)
Intangible and other assets, net	—			(662,665		)	—			(609,813		)
Equity	143,784			—			238,184			—
Deferred revenue	71,509			—			—			(10,992		)
Other non-current liabilities	—			(53,758		)	—			(55,938		)
Credit carryforward	63,275			—			64,569			—
Net operating losses	98,859			—			121,146			—
Other comprehensive loss	119,526			—			134,157			—
Total non-current	496,953			(1,002,484		)	558,056			(923,120		)
Gross deferred tax assets and liabilities	1,438,728			(1,002,484		)	1,410,904			(923,120		)
Valuation allowance	(4,350		)	—			(5,293		)	—
Total deferred tax assets and liabilities	$	1,434,378		$	(1,002,484	)	$	1,405,611		$	(923,120	)

At December 31, 2012 and 2011, net non-current state and foreign deferred tax assets of $65.0 million and $81.5 million, respectively, were included in other non-current assets on the balance sheet. We made minor classification revisions of certain amounts between deferred tax assets and liabilities in the 2011 deferred tax balances to conform with the 2012 presentation.

We have gross federal, state and foreign net operating loss carryforwards of $247.0 million, $349.9 million and $58.5 million, respectively, at December 31, 2012. Portions of these carryforwards are subject to annual limitations, including Section 382 of the Internal Revenue Code of 1986 (“Code”), as amended, for U.S. tax purposes and similar provisions under other countries’ tax laws. Certain of these net operating loss carryforwards will begin to expire in 2014 if not utilized, while others have an unlimited carryforward period.

We have federal and state credit carryforwards of $5.6 million and $62.5 million, respectively, at December 31, 2012. Portions of these carryforwards are subject to annual limitations, including Section 382 of the Code, as amended, for U.S. tax purposes and similar provisions under other countries’ tax laws. Certain of these credit carryforwards will begin to expire in 2019 if unutilized, while others have an unlimited carryforward period.

The valuation allowance decreased from $5.3 million at December 31, 2011 to $4.4 million at December 31, 2012. The decrease was attributable to a certain subsidiary’s foreign tax credit carryforward. The valuation allowance at December 31, 2012 relates to foreign net operating loss carryforwards.

Deferred income taxes have not been provided on basis differences related to investments in foreign subsidiaries. These basis differences were approximately $8.1 billion and $6.4 billion at December 31, 2012 and 2011, respectively, and consisted primarily of undistributed earnings permanently invested in these entities. The change in the basis difference in 2012 was mainly attributable to income earned in the current year. At December 31, 2012, our total cash, cash equivalents, and short-term and long-term investments were $11.4 billion. This balance includes approximately $4.6 billion held by VMware, of which $3.0 billion is held overseas, and $2.7 billion held by EMC in overseas entities. If these overseas funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable. Income before income taxes from foreign operations for 2012, 2011 and 2010 was $1.9 billion, $1.8 billion and $1.2 billion, respectively. Income before income taxes from domestic operations for 2012, 2011 and 2010 was $1.9 billion, $1.5 billion and $1.4 billion, respectively.

During the second quarter of 2012, we determined that since VMware's initial public offering in 2007, we incorrectly recorded deferred tax liabilities on the gains and losses associated with changes in the non-controlling interest. These deferred tax liabilities were recorded as a reduction to additional paid-in capital and therefore had no impact on our previously reported consolidated income statements. The error resulted in an overstatement of our deferred tax liability and an understatement of our additional paid-in capital of $352.6 million in our December 31, 2011 consolidated balance sheet. These corrections did not impact our income tax provision in any current or prior period. See Note A.

The following is a rollforward of our gross consolidated liability for unrecognized income tax benefits for the three years ended December 31:



	2012			2011			2010
Unrecognized tax benefits, beginning of year	$	196.8		$	230.3		$	197.1
Tax positions related to current year:
Additions	24.7			42.0			47.6
Reductions	(1.1		)	(1.8		)	—
Tax positions related to prior years:
Additions	64.4			14.0			23.7
Reductions	(3.9		)	(71.0		)	(20.2		)
Settlements	(0.3		)	(3.3		)	(5.0		)
Lapses in statutes of limitations	(10.7		)	(13.4		)	(12.9		)
Unrecognized tax benefits, end of year	$	269.9		$	196.8		$	230.3

As of December 31, 2012, 2011 and 2010, $255.1 million, $187.1 million and $217.3 million, respectively, of the unrecognized tax benefits, if recognized, would have been recorded as a reduction to income tax expense. The remainder would be an adjustment to shareholders’ equity.

We are routinely under audit by the Internal Revenue Service (the “IRS”). We have concluded all U.S. federal income tax matters for years through 2008. The IRS commenced a federal income tax audit for the tax years 2009 and 2010 in the third quarter of 2012. The current federal income tax audit is in the early stage for information gathering and it is not expected to be completed until or after 2014. We also have income tax audits in process in numerous state, local and international jurisdictions. In our international jurisdictions that comprise a significant portion of our operations, the years that may be examined vary, with the earliest year being 2003. Based on the timing and outcome of examinations of EMC, the result of the expiration of statutes of limitations for specific jurisdictions or the timing and result of ruling requests from taxing authorities, it is reasonably possible that the related unrecognized tax benefits could change from those recorded in our statement of financial position. We anticipate that several of these audits may be finalized within the next 12 months. While we expect the amount of unrecognized tax benefits to change in the next twelve months, we do not expect the change to have a significant impact on our results of operations or financial position.

The $71.0 million reduction during 2011 for tax positions related to prior years is principally due to the resolution of certain transfer pricing matters, inclusive of the completion of audits in certain foreign jurisdictions and the completion of the 2007 and 2008 U.S. federal income tax audits.

We recognize interest expense and penalties related to income tax matters in income tax expense. For 2012, 2011 and 2010, $3.6 million, $1.2 million and $1.1 million, respectively, in interest expense was recognized. In addition to the unrecognized tax benefits noted above, the gross balance of the accrued interest and penalties were $35.0 million, $31.6 million and $30.5 million as of December 31, 2012, 2011 and 2010, respectively.