17. Income Taxes

The domestic and international components of pre-tax income are as follows:


	2018		2017		2016
	($ in millions)
Domestic	$	629	$	432	$	779
International		84		146		225
Total pre-tax income	$	713	$	578	$	1,004

Domestic pre-tax income includes the results of non-U.S. businesses that are operated in branches owned directly by the U.S. which, therefore, are subject to U.S. income tax.

The income tax provision consists of the following:


	2018		2017		2016
Current:	($ in millions)
Federal	$	91	$	129	$	249
State and local		42		18		44
International		30		42		48
Total current tax provision		163		189		341
Deferred:
Federal		(4)		98		(6)
State and local		1		5		1
International		12		2		4
Total deferred tax provision		9		105		(1)
Total income tax provision	$	172	$	294	$	340

Public Law 115-97, informally known as the Tax Cuts and Jobs Act (the “Tax Act”), was enacted on December 22, 2017. The Tax Act lowered the U.S. statutory income tax rate from 35 percent to 21 percent, imposed a one-time transition tax on the Company’s foreign earnings, which previously had been deferred from U.S. income tax, and created a modified territorial system. During the fourth quarter of 2017, the Company recognized a $99 million provisional charge for the mandatory deemed repatriation of foreign sourced net earnings and a corresponding change in the permanent reinvestment assertion under ASC 740-30. During 2018, the Company finalized its assessment of the income tax effects of the Tax Act and included measurement period adjustments that reduced the provisional amounts by $28 million. These adjustments represented a $21 million reduction in the deemed repatriation tax and a $7 million benefit related to IRS accounting method changes and timing difference adjustments. Any further guidance issued after 2018 may result in changes to the Company’s provision for income tax in the period such guidance is effective.

The Tax Act included a provision effective in 2018 to tax global intangible low-taxed income (“GILTI”) of the Company’s foreign subsidiaries. The Company has adopted an accounting policy to treat GILTI tax as a current period expense. The GILTI tax expense for 2018 was not significant.

Following enactment of the Tax Act and the one-time transition tax, our historical foreign earnings are not subject to additional U.S. federal tax upon repatriation. Further, no additional U.S. federal tax will be due upon repatriation of current foreign earnings because they are either exempt or subject to U.S. tax as earned. At February 2, 2019, the Company had accumulated undistributed foreign earnings of approximately $835 million. This amount consists of historical earnings that were previously taxed under the Tax Act and post-Tax Act earnings. Investments in our foreign subsidiaries, including working capital, will continue to be permanently reinvested. Cash balances in excess of working capital needs are considered to be available for repatriation to the United States and foreign withholding taxes will be accrued as necessary on these amounts. The Company has not recorded a deferred tax liability for the difference between the financial statement carrying amount and the tax basis of its investments in foreign subsidiaries. The determination of any unrecorded deferred tax liability on this amount is not practicable due to the uncertainty of how these investments would be recovered.

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:


	2018		2017		2016
Federal statutory income tax rate (1)	21.0	%	33.7	%	35.0	%
Deemed repatriation tax	(2.7)		17.1		—
Increase in valuation allowance	2.4		1.6		—
State and local income taxes, net of federal tax benefit	4.7		2.0		3.1
International income taxed at varying rates	1.6		(2.3)		(3.7)
Foreign tax credits	(2.1)		(2.6)		(1.9)
Domestic/foreign tax settlements	(0.7)		(0.2)		(0.1)
Federal tax credits	(0.2)		(0.2)		(0.2)
Other, net	0.1		1.7		1.7
Effective income tax rate	24.1	%	50.8	%	33.9	%

(1)

In accordance with Section 15 of the Internal Revenue Code, the tax rate for 2017 represented a blended rate of 33.7 percent, calculated by applying a prorated percentage of the number of days prior to and subsequent to the January 1, 2018 effective date.

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 liabilities are as follows:


	2018		2017
Deferred tax assets:	($ in millions)
Tax loss/credit carryforwards and capital loss	$	39	$	23
Employee benefits		38		16
Property and equipment		35		54
Goodwill and other intangible assets		24		—
Straight-line rent		47		44
Other		25		27
Total deferred tax assets	$	208	$	164
Valuation allowance		(33)		(17)
Total deferred tax assets, net	$	175	$	147
Deferred tax liabilities:
Merchandise inventories	$	77	$	79
Goodwill and other intangible assets		—		20
Other		17		15
Total deferred tax liabilities	$	94	$	114
Net deferred tax asset	$	81	$	33
Balance Sheet caption reported in:
Deferred taxes	$	87	$	48
Other liabilities		(6)		(15)
	$	81	$	33

Based upon the level of historical taxable income and projections for future taxable income, which are based upon the Company’s long-range strategic plans, management believes it is more likely than not that the Company will realize the benefits of deductible differences, net of the valuation allowances at February 2, 2019, over the periods in which the temporary differences are anticipated to reverse. 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 February 2, 2019, the Company has a valuation allowance of $33 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. A valuation allowance of $28 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 these entities, the Company believes it is more likely than not that the benefit of these loss carryforwards will not be realized. During 2018, we established a valuation allowance of $3 million for foreign taxes assessed at rates in excess of the U.S. federal tax rate for which no U.S. foreign tax credit is available. An additional valuation allowance of $2 million relates to the deferred tax assets arising from a capital loss associated with an impairment of the Northern Group note receivable recorded in 2008. The Company does not anticipate realizing capital gains to utilize the capital loss associated with the note receivable impairment.

At February 2, 2019, the Company has U.S. state operating loss carryforwards with a potential tax benefit of $1 million that expire between 2020 and 2037. The Company will have, when realized, a capital loss with a potential benefit of $2 million arising from a note receivable. This loss will carryforward for 5 years after realization. The Company has international minimum tax credit carryforwards with a potential tax benefit of $4 million and operating loss carryforwards with a potential tax benefit of $29 million, a portion of which will expire between 2019 and 2027 and a portion of which will never expire. The state and international operating loss carryforwards do not include unrecognized tax benefits. The Company also has foreign tax credit carryforwards with a potential tax benefit of $3 million that expire in 2028.

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 2016 and 2017 U.S. Federal income tax filings are under examination by the Internal Revenue Service. The Company expects to conclude both examinations in the first quarter of 2019. The Company is participating in the IRS’s Compliance Assurance Process (“CAP”) for 2018, which is expected to conclude during 2019. The Company has started the CAP for 2019. Due to the recent utilization of net operating loss carryforwards, the Company is subject to state and local tax examinations effectively including years from 2001 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 February 2, 2019 and February 3, 2018, the Company had $34 million and $44 million, respectively, of gross unrecognized tax benefits, and $34 million and $44 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 income, accrued interest, and penalties were not significant for any of the periods presented. The following table summarizes the activity related to unrecognized tax benefits:


	2018		2017		2016
	($ in millions)
Unrecognized tax benefits at beginning of year	$	44	$	38	$	38
Foreign currency translation adjustments		(3)		4		1
Increases related to current year tax positions		2		3		8
Increases related to prior period tax positions		9		1		1
Decreases related to prior period tax positions		(13)		—		(2)
Settlements		(3)		(1)		(7)
Lapse of statute of limitations		(2)		(1)		(1)
Unrecognized tax benefits at end of year	$	34	$	44	$	38

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 during 2019 are not expected to be significant 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 consequences of these settlements. In addition, to the extent there are settlements in the future for certain foreign unrecognized tax benefits, the transition tax may also be revised accordingly.