17. Income Taxes

Following are the domestic and international components of pre-tax income:


	2014		2013		2012
	(in millions)
Domestic	$	654	$	558	$	508
International		155		105		99
Total pre-tax income	$	809	$	663	$	607

The income tax provision consists of the following:


	2014		2013		2012
	(in millions)
Current:
Federal	$	195	$	164	$	152
State and local		34		26		22
International		40		25		16
Total current tax provision		269		215		190
Deferred:
Federal		16		13		13
State and local		3		5		5
International		1		1		2
Total deferred tax provision		20		19		20
Total income tax provision	$	289	$	234	$	210

Provision has been made in the accompanying Consolidated Statements of Operations for additional income taxes applicable to dividends received or expected to be received, if any, from international subsidiaries. The amount of unremitted earnings of international subsidiaries for which no such tax is provided and which is considered to be permanently reinvested in the subsidiaries totaled $999 million and $890 million at January 31, 2015 and February 1, 2014, respectively. The determination of the amount of the deferred tax liability related to permanently reinvested earnings is not practicable.

A reconciliation of the significant differences between the federal statutory income tax rate and the effective income tax rate on pre-tax income is as follows:


	2014			2013			2012
Federal statutory income tax rate		35.0	%		35.0	%		35.0	%
State and local income taxes, net of federal tax benefit		3.2			3.5			3.2
International income taxed at varying rates		(1.9	)		(1.6	)		(0.4	)
Foreign tax credits		(2.5	)		(2.5	)		(1.8	)
Domestic/foreign tax settlements		(0.6	)		(1.1	)		(2.2	)
Federal tax credits		(0.2	)		(0.2	)		(0.2	)
Other, net		2.7			2.2			1.0
Effective income tax rate		35.7	%		35.3	%		34.6	%

Deferred income taxes are provided for the effects of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for income tax purposes. Items that give rise to significant portions of the Company’s deferred tax assets and deferred tax liabilities are as follows:


	2014			2013
	(in millions)
Deferred tax assets:
Tax loss/credit carryforwards and capital loss	$	9		$	12
Employee benefits		65			55
Property and equipment		137			147
Straight-line rent		33			30
Goodwill and other intangible assets		—			6
Other		38			33
Total deferred tax assets		282			283
Valuation allowance		(6	)		(6	)
Total deferred tax assets, net	$	276		$	277
Deferred tax liabilities:
Merchandise inventories		96			85
Goodwill and other intangible assets		17			—
Other		1			11
Total deferred tax liabilities	$	114		$	96
Net deferred tax asset	$	162		$	181
Balance Sheet caption reported in:
Deferred taxes	$	221		$	241
Other current assets		3			4
Accrued and other current liabilities		(48	)		(46	)
Other liabilities		(14	)		(18	)
	$	162		$	181

Based upon the level of historical taxable income and projections for future taxable income, which are based upon the Company’s strategic long-range plans, over the periods in which the temporary differences are anticipated to reverse, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowances at January 31, 2015. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.

As of January 31, 2015, the Company has a valuation allowance of $6 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. A valuation allowance of $3 million relates to the deferred tax assets arising from a capital loss associated with an impairment of the Northern Group note receivable in 2008. The Company does not anticipate realizing capital gains to utilize the capital loss associated with the note receivable impairment. A valuation allowance of $2 million was recorded against tax loss carryforwards of certain foreign entities. Based on the history of losses and the absence of prudent and feasible business plans for generating future taxable income in certain foreign entities, the Company believes it is more likely than not that the benefit of these loss carryforwards will not be realized. Additionally, the Company recorded an unrealized loss related to its investment in an auction rate security. This loss, if and when recognized for tax purposes, would be a capital loss. The Company has not identified any reliable sources of future capital gains that would be generated to absorb this potential loss. In recognition of this risk, the Company has a valuation allowance of $1 million for any loss that would be recognized upon disposition of this security.

At January 31, 2015, the Company has state operating loss carryforwards with a potential tax benefit of $2 million that expire between 2015 and 2034. The Company will have, when realized, a capital loss with a potential benefit of $3 million arising from a note receivable. This loss will carryforward for 5 years after realization. The Company has U.S. state credits of $1 million that expire in 2024. The Company has international operating loss carryforwards with a potential tax benefit of $3 million, a portion of which will expire between 2015 and 2034 and a portion of which will never expire. The state and international operating loss carryforwards do not include unrecognized tax benefits.

The Company operates in multiple taxing jurisdictions and is subject to audit. Audits can involve complex issues that may require an extended period of time to resolve. A taxing authority may challenge positions that the Company has adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax positions for such transactions and records reserves for those differences.

The Company’s U.S. Federal income tax filings have been examined by the Internal Revenue Service through 2013. The Company is participating in the IRS’s Compliance Assurance Process (“CAP”) for 2014, which is expected to conclude during 2015. The Company has started the CAP for 2015. Due to the recent utilization of net operating loss carryforwards, the Company is subject to state and local tax examinations effectively including years from 1996 to the present. To date, no adjustments have been proposed in any audits that will have a material effect on the Company’s financial position or results of operations.

At January 31, 2015 and February 1, 2014, the Company had $40 million and $48 million, respectively of gross unrecognized tax benefits, and $39 million and $46 million, respectively, of net unrecognized tax benefits that would, if recognized, affect the Company’s annual effective tax rate. The Company has classified certain income tax liabilities as current or noncurrent based on management’s estimate of when these liabilities will be settled. Interest expense and penalties related to unrecognized tax benefits are classified as income tax expense. Interest expense for 2014 was not significant. The Company recognized $1 million of interest income, in 2013 and 2012. The total amount of accrued interest and penalties was $2 million in 2014 and 2013, and $3 million in 2012.

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


	2014			2013			2012
	(in millions)
Unrecognized tax benefits at beginning of year	$	48		$	54		$	65
Foreign currency translation adjustments		(6	)		(4	)		1
Increases related to current year tax positions		3			3			4
Increases related to prior period tax positions		1			4			3
Decreases related to prior period tax positions		(1	)		(2	)		(3	)
Settlements		(1	)		(7	)		(15	)
Lapse of statute of limitations		(4	)		—			(1	)
Unrecognized tax benefits at end of year	$	40		$	48		$	54

It is reasonably possible that the liability associated with the Company’s unrecognized tax benefits will increase or decrease within the next twelve months. These changes may be the result of foreign currency fluctuations, ongoing audits or the expiration of statutes of limitations. Settlements could increase earnings in an amount ranging from $0 to $5 million based on current estimates. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. Although management believes that adequate provision has been made for such issues, the ultimate resolution could have an adverse effect on the earnings of the Company. Conversely, if these issues are resolved favorably in the future, the related provision would be reduced, generating a positive effect on earnings. Due to the uncertainty of amounts and in accordance with its accounting policies, the Company has not recorded any potential impact of these settlements.