NOTE 8. INCOME TAXES

The components of income (loss) from continuing operations before income taxes consisted of the following:


(In millions)	2016		2015			2014
United States	$	445	$	122		$	(286	)
Foreign		14		(7	)		(5	)

Total income (loss) from continuing operations before income taxes	$	459	$	115		$	(291	)

The income tax expense related to income (loss) from continuing operations consisted of the following:


(In millions)	2016			2015			2014
Current:
Federal	$	17		$	18		$	(2	)
State		6			4			(1	)
Foreign		3			1			3
Deferred :
Federal		(210	)		(1	)		—
State		(37	)		2			3
Foreign		1			(1	)		(1	)

Total income tax expense (benefit)	$	(220	)	$	23		$	2

The following is a reconciliation of income taxes at the U.S. Federal statutory rate to the provision for income taxes:


(In millions)	2016			2015			2014
Federal tax computed at the statutory rate	$	160		$	40		$	(102	)
State taxes, net of Federal benefit		(20	)		5			1
Foreign income taxed at rates other than Federal		—			6			8
Increase (decrease) in valuation allowance		(349	)		(46	)		85
Non-deductible Merger expenses		—			11			—
Other non-deductible expenses		3			4			13
Non-taxable income and additional deductible expenses		(13	)		(2	)		(2	)
Change in unrecognized tax benefits		(3	)		—			—
Tax expense from intercompany transactions		—			6			—
Subpart F and dividend income, net of foreign tax credits		2			1			2
Other items, net		—			(2	)		(3	)

Income tax expense (benefit)	$	(220	)	$	23		$	2

The effective tax rate for 2016 was primarily impacted by the change in the Company’s U.S. federal and state valuation allowance. In 2016, the Company experienced a lower than expected effective rate due to the realization of certain deferred tax assets during the year whose benefits were limited in prior periods due to the valuation allowance. In addition, the Company recognized a discrete non-cash income tax benefit for the reversal of the majority of the remaining U.S. federal and state valuation allowance. The effective tax rate for 2016 was also impacted by the deductibility of certain formerly non-deductible expenses primarily related to the Staples Acquisition. In 2015, the Company incurred charges related to certain Staples Acquisition expenses that are not deductible for tax purposes, which increased the effective tax rate for 2015. With the termination of the merger agreement in 2016, a large portion of these expenses became deductible in 2016, resulting in a lower effective tax rate for 2016. In addition, the 2015 effective tax rate includes U.S. income tax expense on a foreign exchange gain associated with the restructuring of certain intercompany financing. In 2014, the Company recognized income tax expense on a pretax loss due to deferred tax benefits not being recognized on pretax losses in certain tax jurisdictions with valuation allowances, while income tax expense was recognized in tax jurisdictions with pretax income.

The Company operates in several foreign jurisdictions with income tax rates that differ from the U.S. Federal statutory rate, which resulted in an expense for all years presented in the effective tax rate reconciliation. Significant foreign tax jurisdictions for which the Company realized such expense are Canada and Puerto Rico after the sale of the other international operations.

Due to valuation allowances against the Company’s deferred tax assets, no income tax benefit was initially recognized in the 2015 or 2014 Consolidated Statement of Operations related to stock-based compensation expense due to the Company’s inability to utilize them to offset current income taxes payable. However, due to the profitable tax-paying position in the U.S. in 2015, the Company realized an income tax benefit of $3 million for the utilization of net operating loss carryforwards that had resulted from excess stock-based compensation deductions for which no benefit was previously recorded. The Company also realized an income tax benefit of $2 million for excess stock-based compensation deductions resulting from the exercise and vesting of equity awards during 2016 and $7 million for excess stock-based compensation deductions resulting from the exercise and vesting of equity awards during 2015. These income tax benefits were recorded as increases to additional paid-in capital in 2015 and 2016.

The components of deferred income tax assets and liabilities consisted of the following:


(In millions)	December 31, 2016			December 26, 2015
U.S. and foreign loss carryforwards	$	275		$	79
Deferred rent credit		61			68
Pension and other accrued compensation		134			200
Accruals for facility closings		29			43
Inventory		20			19
Self-insurance accruals		29			33
Deferred revenue		24			45
U.S. and foreign income tax credit carryforwards		197			223
Allowance for bad debts		5			12
Accrued expenses		28			32
Basis difference in fixed assets		69			73
Other items, net		5			—

Gross deferred tax assets		876			827
Valuation allowance		(140	)		(522	)

Deferred tax assets		736			305

Internal software		5			5
Installment gain on sale of timberlands		260			263
Deferred Subpart F income		—			27
Undistributed foreign earnings		8			2

Deferred tax liabilities		273			297

Net deferred tax assets	$	463		$	8

As of December 31, 2016 and December 26, 2015, deferred income tax liabilities amounting to $3 million and $2 million, respectively, are included in Deferred income taxes and other long-term liabilities.

As of December 31, 2016, the Company has utilized all of its U.S. Federal net operating loss (“NOL”) carryforwards. The Company has $91 million of foreign and $1.2 billion of state NOL carryforwards. Of the foreign NOL carryforwards, $35 million can be carried forward indefinitely, none will expire in 2017 and the remaining balance will expire between 2018 and 2036. Of the state NOL carryforwards, $37 million will expire in 2017, and the remaining balance will expire between 2018 and 2036. The Company has capital loss carryover available to offset future capital gains generated of $555 million which expires in 2021. The Company also has $89 million of U.S. Federal alternative minimum tax credit carryforwards, which can be used to reduce future regular federal income tax, if any, over an indefinite period. Additionally, the Company has $96 million of U.S. Federal foreign tax credit carryforwards, which expire between 2019 and 2026, and $13 million of state and foreign tax credit carryforwards, $3 million of which can be carried forward indefinitely, and the remaining balance will expire between 2023 and 2027.

As of December 31, 2016, the Company has not triggered an “ownership change” as defined in Internal Revenue Code Section 382 or other similar provisions that would limit the use of NOL and tax credit carryforwards. However, if the Company were to experience an ownership change in future periods, the Company’s deferred tax assets and income tax expense may be negatively impacted. Deferred income taxes have been provided on all undistributed earnings of foreign subsidiaries.

The following summarizes the activity related to valuation allowances for deferred tax assets:


(In millions)	2016			2015			2014
Beginning balance	$	522		$	571		$	448
Additions, charged to expense		—			—			123
Reductions		(382	)		(49	)		—

Ending balance	$	140		$	522		$	571

The Company has significant deferred tax assets in the U.S. against which valuation allowances have been established to reduce such deferred tax assets to the amount that is more likely than not to be realized. The establishment of valuation allowances requires significant judgment and is impacted by various estimates. Both positive and negative evidence, as well as the objectivity and verifiability of that evidence, is considered in determining the appropriateness of recording a valuation allowance on deferred tax assets. An accumulation of recent pre-tax losses is considered strong negative evidence in that evaluation. As of the third quarter of 2016, the Company concluded that it was more likely than not that a benefit from a substantial portion of its U.S. federal and state deferred tax assets would be realized. This conclusion was based on a detailed evaluation of all available positive and negative evidence and the weight of such evidence, the current financial position and results of operations for the current and preceding years, and the expectation of continued earnings. The Company determined that approximately $382 million of its U.S. federal and state valuation allowance should be reversed in 2016.

After the 2016 reversal, the Company will have a U.S. valuation allowance for certain U.S. federal credits and certain state tax attributes. The remaining valuation allowances relate to deferred tax assets that require certain types of income or for income to be earned in certain jurisdictions in order to be realized. It is reasonably possible that a portion of the remaining valuation allowance may be released in the future based upon continued profitability. The Company will continue to assess the realizability of its deferred tax assets in the U.S. and remaining foreign jurisdictions in future periods.

The Company’s total valuation allowance decreased by $382 million during 2016. The Company recognized income tax benefit of $349 million associated with the release of valuation allowances in the U.S. federal and state jurisdictions in 2016 because the realizability of the related deferred tax assets was more likely than not.

The following table summarizes the activity related to unrecognized tax benefits:


(In millions)	2016			2015			2014
Beginning balance	$	18		$	22		$	15
Increase related to current year tax positions		1			1			6
Increase related to prior year tax positions		—			1			4
Decrease related to prior year tax positions		—			(5	)		(2	)
Decrease related to lapse of statute of limitations		—			(1	)		—
Decrease related to settlements with taxing authorities		(5	)		—			(1	)

Ending balance	$	14		$	18		$	22

Due to the completion of the Internal Revenue Service (“IRS”) examination for 2014, the Company’s balance of unrecognized tax benefits decreased by $4 million during 2016, which did impact income tax expense by $3 million due to an offsetting change in valuation allowance. Included in the balance of $14 million at December 31, 2016, are $7 million of unrecognized tax benefits that, if recognized, would affect the effective tax rate. The difference of $7 million primarily results from tax positions which if sustained would be offset by changes in valuation allowance. It is not anticipated that certain tax positions will be resolved within the next 12 months, which would decrease the Company’s balance of unrecognized tax benefits. Additionally, the Company anticipates that it is reasonably possible that new issues will be raised or resolved by tax authorities that may require changes to the balance of unrecognized tax benefits; however, an estimate of such changes cannot reasonably be made.

The Company recognizes interest related to unrecognized tax benefits in interest expense and penalties in the provision for income taxes. The Company recognized interest and penalty expense of $3 million and $2 million in 2016 and 2015, respectively. The Company recognized a net interest and penalty benefit of $9 million in 2014 due to settlements reached with certain taxing authorities. The Company had approximately $6 million accrued for the payment of interest and penalties as of December 31, 2016, which is not included in the table above.

The Company files a U.S. federal income tax return and other income tax returns in various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal and state and local income tax examinations for years before 2014 and 2009, respectively. During 2015, the IRS examination of the OfficeMax 2012 U.S. federal income tax return concluded, which resulted in a $6 million decrease in tax credit carryforwards. Such decrease had no impact on income tax expense due to an offsetting change in valuation allowance. The acquired OfficeMax U.S. consolidated group is no longer subject to U.S. federal and state and local income tax examinations for years before 2013 and 2006, respectively. The U.S. federal income tax returns for 2015 are currently under review. Generally, the Company is subject to routine examination for years 2008 and forward in its international tax jurisdictions.