Income Taxes

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



	2015			2014			2013
Federal:
Current	$	673		$	955		$	698
Deferred	(152		)	(308		)	(163		)
	521			647			535
State:
Current	65			81			84
Deferred	(58		)	(70		)	(23		)
	7			11			61
Foreign:
Current	206			228			192
Deferred	(24		)	(18		)	(16		)
	182			210			176
Total provision for income taxes	$	710		$	868		$	772

In 2015, 2014 and 2013, we were able to utilize net operating loss carryforwards and tax credit carryforwards to reduce the current portion of our tax provision by $57 million, $34 million and $54 million, respectively.

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



	2015		2014		2013
Statutory federal tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal taxes	0.6	%	1.2	%	0.7	%
Accounting for historical uncertain tax positions	(0.1	)%	1.1	%	(0.4	)%
Tax rate differential for international jurisdictions and other international related tax items	(12.8	)%	(11.6	)%	(15.3	)%
U.S. tax credits	(2.7	)%	(1.9	)%	(3.8	)%
Change in valuation allowance	0.6	%	(2.3	)%	0.7	%
U.S. domestic production activities deduction	(1.4	)%	(1.8	)%	(1.5	)%
International reorganization of acquired companies	—	%	—	%	0.6	%
Permanent items	4.3	%	3.9	%	3.8	%
Other	1.1	%	(0.5	)%	0.2	%
	24.6	%	23.1	%	20.0	%

Substantially all the tax rate differential for international jurisdictions was driven by earnings of our Irish subsidiaries. Changes in valuation allowance are due to our assessment of the realizability of deferred tax assets related to certain state tax credit carryforwards and foreign net operating loss carryforwards. Based on our 2014 assessment, we released our partial valuation allowance against deferred tax assets for certain state tax credit carryforwards provided in prior years in 2014.

On December 18, 2015, the Consolidated Appropriations Act, 2016 was signed into law. Some of the provisions were retroactive to January 1, 2015 including a permanent extension of the U.S. federal tax credit for increasing research activities. Our 2015 effective income tax rate reflects our estimated 2015 federal tax credit for increasing research activities.

On December 19, 2014, the Tax Increase Prevention Act was signed into law. Some of the provisions were retroactive to January 1, 2014 including an extension of the U.S. federal tax credit for increasing research activities through December 31, 2014. Our 2014 effective income tax rate reflects our estimated 2014 federal tax credit for increasing research activities.

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 2013 income tax provision included the federal tax credit for increasing research activities for 2012 as well as for 2013, which reduced our 2013 effective income tax rate by 3.5%.

The components of the deferred tax assets and liabilities are as follows (table in millions):



	December 31, 2015						December 31, 2014
	Deferred Tax Asset			Deferred Tax Liability			Deferred Tax Asset			Deferred Tax Liability

Accounts and notes receivable	$	55		$	—		$	58		$	—
Inventory	70			—			73			—
Accrued expenses	295			—			275			—
Deferred revenue	987			—			833			—
Property, plant and equipment, net	—			(325		)	—			(322		)
Intangible and other assets, net	—			(569		)	—			(597		)
Equity	252			—			257			—
Other non-current liabilities	—			(8		)	27			—
Credit carryforwards	281			—			256			—
Net operating losses	137			—			115			—
Other comprehensive loss	133			—			103			—
Gross deferred tax assets and liabilities	2,210			(902		)	1,997			(919		)
Valuation allowance	(144		)	—			(126		)	—
Total deferred tax assets and liabilities	$	2,066		$	(902	)	$	1,871		$	(919	)

In November 2015, the FASB issued new accounting guidance on the balance sheet classification of deferred taxes which requires that all deferred taxes be presented as non-current. We elected to early adopt this new accounting guidance for the year ended December 31, 2015 and applied it retrospectively to all years presented in this document. As a result of adopting this guidance, we reclassified current deferred income tax assets and liabilities to non-current deferred income tax assets and liabilities. This resulted in $1,070 million being reclassified from deferred income taxes (current asset), $156 million being reclassified from other assets, net and $274 million being reclassified from deferred income taxes (non-current liability) to deferred income taxes (non-current asset) on the consolidated balance sheets for the year ended December 31, 2014.

We have gross federal, state and foreign net operating loss carryforwards of $250 million, $250 million and $224 million, respectively, at December 31, 2015. 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 2016 if not utilized, while others have an unlimited carryforward period. We have provided a valuation allowance of $3 million and $30 million for deferred tax assets related to state and foreign net operating loss carryforwards, respectively, that are not expected to be realized.

We have federal, state and foreign tax credit carryforwards of $4 million, $413 million and $8 million, respectively, at December 31, 2015. 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 not utilized, while others have an unlimited carryforward period. We have provided a full valuation allowance of $111 million for deferred tax assets related to Massachusetts research and development tax credit carryforwards that are not expected to be realized.

Deferred income taxes have not been provided on basis differences related to investments in foreign subsidiaries. These basis differences were approximately $11.8 billion at December 31, 2015 and consisted primarily of undistributed earnings permanently invested in these entities. 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 2015, 2014 and 2013 was $1.6 billion, $1.8 billion and $2.3 billion, respectively. Income before income taxes from domestic operations for 2015, 2014 and 2013 was $1.2 billion, $2.0 billion and $1.6 billion, respectively.

At December 31, 2015, our total cash, cash equivalents, and short-term and long-term investments were $14.8 billion. This balance includes approximately $7.5 billion held by VMware, of which $5.8 billion is held outside of the U.S., and $6.1 billion held by EMC in entities outside of the U.S. 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. Under the terms of the Merger Agreement, EMC is required to provide Denali with access to EMC’s cash to help fund the Merger consideration. At this time, EMC has not finalized its plan to access such cash and has not determined if there would be a need to repatriate cash to meet the requirements of the Merger. If these overseas funds are required to be repatriated to the U.S. in accordance with the Merger Agreement, we may be required to accrue and pay U.S. taxes to repatriate these funds.

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



	2015			2014			2013
Unrecognized tax benefits, beginning of year	$	383		$	266		$	270
Tax positions related to current year:
Additions	104			63			37
Reductions	—			—			—
Tax positions related to prior years:
Additions	128			91			10
Reductions	(54		)	(31		)	(33		)
Settlements	(13		)	(1		)	(5		)
Lapses in statutes of limitations	(20		)	(5		)	(13		)
Unrecognized tax benefits, end of year	$	528		$	383		$	266

As a result of new information obtained during 2015, we have recorded additional unrecognized tax benefits for uncertain taxation of intercompany transactions on the consolidated balance sheet. These additional unrecognized tax benefits do not have a significant impact on the consolidated results of operations of the current accounting period and are not expected to have a significant impact on the consolidated results of operations of future accounting periods.

As of December 31, 2015, 2014 and 2013, $350 million, $316 million and $261 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, which is expected to be completed in early 2016. In the first quarter of 2015, the IRS commenced a federal income tax audit for the tax year 2011, which is still ongoing. 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 2004. 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 consolidated balance sheets. We anticipate that several of these audits may be finalized within the next twelve 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 consolidated results of operations or financial position.

We recognize interest expense and penalties related to income tax matters in income tax expense. For 2015, 2014 and 2013, $11 million, $9 million and $9 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 $54 million, $51 million and $42 million as of December 31, 2015, 2014 and 2013, respectively.