INCOME TAXES

Our income (loss) before income taxes consisted of the following:



	Year Ended December 31,
(in millions)	2011			2010			2009
Domestic	$	(437	)	$	(1,910	)	$	(1,102	)
Foreign	1,079			847			(206		)
	$	642		$	(1,063	)	$	(1,308	)

The related provision (benefit) for income taxes consisted of the following:



	Year Ended December 31,
(in millions)	2011			2010			2009
Current
Federal	$	45		$	(83	)	$	(173	)
State	8			9			(18		)
Foreign	91			125			(2		)
	144			51			(193		)

Deferred
Federal	86			(25		)	(115		)
State	(8		)	(4		)	(15		)
Foreign	(21		)	(20		)	40
	57			(49		)	(90		)
	$	201		$	2		$	(283	)

The reconciliation of income taxes at the federal statutory rate to the actual provision (benefit) for income taxes is as follows:



	Year Ended December 31,
	2011		2010		2009
U.S. federal statutory income tax rate	35.0	%	(35.0	)%	(35.0	)%
State income taxes, net of federal benefit	0.5	%	0.3	%
State law changes on deferred tax	(1.2	)%			(2.4	)%
Effect of foreign taxes	(63.7	)%	(20.4	)%	(20.0	)%
Non-deductible acquisition expenses	(1.9	)%			0.5	%
Research credit	(3.4	)%	(6.0	)%	(1.3	)%
Valuation allowance	(2.9	)%	2.5	%	5.1	%
Divestitures	25.4	%			(4.8	)%
Goodwill impairment charges	38.0	%	59.8	%
Non-deductible expenses	5.7	%	1.8	%	1.2	%
Legal settlement					33.3	%
Other, net	(0.2	)%	(2.8	)%	1.8	%
	31.3	%	0.2	%	(21.6	)%

We had net deferred tax liabilities of $1.379 billion as of December 31, 2011 and $1.198 billion as of December 31, 2010. Gross deferred tax liabilities of $2.373 billion as of December 31, 2011 and $2.308 billion as of December 31, 2010 relate primarily to intangible assets acquired in connection with our prior acquisitions. Gross deferred tax assets of $994 million as of December 31, 2011 and $1.110 billion as of December 31, 2010 relate primarily to the establishment of inventory and product-related reserves; litigation, product liability and other reserves and accruals; stock-based compensation; net operating loss carryforwards and tax credit carryforwards; and the federal benefit of uncertain tax positions. In light of our historical financial performance and the extent of our deferred tax liabilities, we believe we will recover substantially all of these assets.

We reduce our deferred tax assets by a valuation allowance if, based upon the weight of available evidence, it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider relevant evidence, both positive and negative, to determine the need for a valuation allowance. Information evaluated includes our financial position and results of operations for the current and preceding years, the availability of deferred tax liabilities and tax carrybacks, as well as an evaluation of currently available information about future years. Significant components of our deferred tax assets and liabilities are as follows:



	As of December 31,
(in millions)	2011			2010
Deferred Tax Assets:
Inventory costs, intercompany profit and related reserves	$	181		$	207
Tax benefit of net operating loss and credits	440			590
Reserves and accruals	232			207
Restructuring-related charges and purchased research and development	20			17
Litigation and product liability reserves	53			66
Unrealized gains and losses on derivative financial instruments	22			41
Investment write-down	38			32
Stock-based compensation	219			155
Federal benefit of uncertain tax positions	141			132
Other	10			20
	1,356			1,467
Less valuation allowance	(362		)	(357		)
	994			1,110
Deferred Tax Liabilities:
Property, plant and equipment	118			97
Intangible assets	2,241			2,200
Other	14			11
	2,373			2,308
Net Deferred Tax Liabilities	$	1,379		$	1,198

Our deferred tax assets and liabilities are included in the following locations within our accompanying consolidated balance sheets (in millions):



	Location in	As of December 31,
Component	Balance Sheet	2011		2010
Current deferred tax asset	Deferred income taxes	$	458	$	429
Non-current deferred tax asset	Other long-term assets	31		19
Deferred Tax Assets		489		448
Current deferred tax liability	Other current liabilities	3		2
Non-current deferred tax liability	Deferred income taxes	1,865		1,644
Deferred Tax Liabilities		1,868		1,646
Net Deferred Tax Liabilities		$	1,379	$	1,198

As of December 31, 2011, we had U.S. tax net operating loss carryforwards, capital loss and tax credits, the tax effect of which was $69 million, as compared to $252 million as of December 31, 2010. In addition, we had foreign tax net operating loss carryforwards and tax credits, the tax effect of which was $371 million as of December 31, 2011, as compared to $341 million as of December 31, 2010. These tax attributes will expire periodically beginning in 2012. After consideration of all positive and negative evidence, we believe that it is more likely than not that a portion of the deferred tax assets will not be realized. As a result, we established a valuation allowance of $362 million as of December 31, 2011 and $357 million as of December 31, 2010. The increase in the valuation allowance as of December 31, 2011, as compared to December 31, 2010, is attributable primarily to foreign net operating losses generated during the year, offset by the release of valuation allowances resulting from a change in judgment related to expected ability to realize certain deferred tax assets. The income tax impact of the unrealized gain or loss component of other comprehensive income was a benefit of $1 million in 2011, $16 million in 2010, and $4 million in 2009.

We do not provide income taxes on unremitted earnings of our foreign subsidiaries where we have indefinitely reinvested such earnings in our foreign operations. We do not believe it is practical to estimate the amount of income taxes payable on the earnings that are indefinitely reinvested in foreign operations. Unremitted earnings of our foreign subsidiaries that we have indefinitely reinvested in foreign operations were $10.346 billion as of December 31, 2011 and $9.193 billion as of December 31, 2010.

As of December 31, 2011, we had $952 million of gross unrecognized tax benefits, of which a net $847 million, if recognized, would affect our effective tax rate. As of December 31, 2010, we had $965 million of gross unrecognized tax benefits, of which a net $859 million, if recognized, would affect our effective tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in millions):



	Year Ended December 31,
	2011			2010			2009
Beginning Balance	$	965		$	1,038		$	1,107
Additions based on positions related to the current year	68			55			31
Additions based on positions related to prior years	12			44			17
Reductions for tax positions of prior years	(36		)	(124		)	(32		)
Settlements with taxing authorities	(42		)	(35		)	(65		)
Statute of limitation expirations	(15		)	(13		)	(20		)
Ending Balance	$	952		$	965		$	1,038

We are subject to U.S. Federal income tax as well as income tax of multiple state and foreign jurisdictions. We have concluded all U.S. federal income tax matters through 2000 and substantially all material state, local and foreign income tax matters through 2001.

We have received Notices of Deficiency from the IRS reflecting proposed audit adjustments for Guidant Corporation for its 2001 through 2006 tax years and Boston Scientific Corporation for its 2006 and 2007 tax years. Subsequent to issuing these Notices, the IRS conceded a portion of its original assessment. The total incremental tax liability now asserted by the IRS for the applicable periods is $1.162 billion plus interest. The primary issue in dispute for all years is the transfer pricing in connection with the technology license agreements between domestic and foreign subsidiaries of Guidant. In addition, the IRS has proposed adjustments in connection with the financial terms of our Transaction Agreement with Abbott Laboratories pertaining to the sale of Guidant's vascular intervention business to Abbott in April 2006. We do not agree with the transfer pricing methodologies applied by the IRS or its resulting assessment and we believe that the IRS has exceeded its authority by attempting to adjust the terms of our negotiated third-party agreement with Abbott. In addition, we believe that the IRS positions with regard to these matters are inconsistent with the applicable tax laws and the existing Treasury regulations.

We believe we have meritorious defenses for our tax filings and we have filed, or will timely file, petitions with the U.S. Tax Court contesting the Notices of Deficiency for the tax years in challenge. No payments on the net assessment would be required until the dispute is definitively resolved, which, based on experiences of other companies, could take several years. We believe that our income tax reserves associated with these matters are adequate and the final resolution will not have a material impact on our financial condition or results of operations. However, final resolution is uncertain and could have a material impact on our financial condition or results of operations.

We recognize interest and penalties related to income taxes as a component of income tax expense. We had $303 million accrued for gross interest and penalties as of December 31, 2011 and $285 million as of December 31, 2010. The increase in gross interest and penalties was the result of $48 million recognized in our consolidated statements of operations offset by a $30 million reduction, due primarily to the resolution of uncertain tax positions resulting from the IRS issuing Closing Agreements for various issues. We recognized $18 million of interest and penalties related to income taxes in 2011, released $14 million in 2010 and recognized $31 million in 2009.

It is reasonably possible that within the next 12 months we will resolve multiple issues including transfer pricing, research and development credits and transactional related issues with foreign, federal and state taxing authorities, in which case we could record a reduction in our balance of unrecognized tax benefits of up to $26 million