INCOME TAXES

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



	Year Ended December 31,
(in millions)	2014			2013			2012
Domestic	$	(1,263	)	$	(774	)	$	(1,265	)
Foreign	754			551			(2,842		)
	$	(509	)	$	(223	)	$	(4,107	)

The related benefit for income taxes consisted of the following:



	Year Ended December 31,
(in millions)	2014			2013			2012
Current
Federal	$	(2	)	$	46		$	33
State	(5		)	(9		)	—
Foreign	111			105			139
	104			142			172

Deferred
Federal	(458		)	(212		)	(204		)
State	(23		)	(17		)	(7		)
Foreign	(13		)	(15		)	—
	(494		)	(244		)	(211		)
	$	(390	)	$	(102	)	$	(39	)

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



	Year Ended December 31,
	2014		2013		2012
U.S. federal statutory income tax rate	(35.0	)%	(35.0	)%	(35.0	)%
State income taxes, net of federal benefit	(6.5	)%	(7.9	)%	(0.2	)%
Effect of foreign taxes	(29.1	)%	(63.4	)%	(3.7	)%
Acquisition-related	(7.5	)%	3.5	%	—	%
Research credit	(7.0	)%	(12.2	)%	—	%
Valuation allowance	4.0	%	(12.0	)%	0.3	%
Goodwill impairment charges	—	%	65.2	%	36.4	%
Compensation-related	0.7	%	1.7	%	0.3	%
Non-deductible expenses	1.9	%	9.0	%	(0.2	)%
Uncertain domestic tax positions	2.0	%	7.0	%	0.8	%
Other, net	(0.2	)%	(1.9	)%	0.3	%
	(76.7	)%	(46.0	)%	(1.0	)%

We had net deferred tax liabilities of $799 million as of December 31, 2014 and $1.140 billion as of December 31, 2013. Gross deferred tax liabilities of $2.096 billion as of December 31, 2014 and $2.203 billion as of December 31, 2013 relate primarily to intangible assets acquired in connection with our prior acquisitions. Gross deferred tax assets of $1.297 billion as of December 31, 2014 and $1.063 billion as of December 31, 2013 relate primarily to the establishment of inventory and product-related reserves; litigation, product liability and other reserves and accruals; compensation related accruals; net operating loss carryforwards and tax credit carryforwards; and the federal benefit of uncertain tax positions.

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)	2014			2013
				(restated)
Deferred Tax Assets:
Inventory costs and related reserves	$	46		$	50
Tax benefit of net operating loss and credits	525			647
Reserves and accruals	232			221
Restructuring-related charges and purchased research and development	20			17
Litigation and product liability reserves	556			198
Investment write-down	4			15
Compensation related	150			143
Federal benefit of uncertain tax positions	178			166
Other	36			39
	1,747			1,496
Less valuation allowance	(450		)	(433		)
	1,297			1,063
Deferred Tax Liabilities:
Property, plant and equipment	67			78
Unrealized gains and losses on derivative financial instruments	146			80
Intangible assets	1,883			2,045
	2,096			2,203

Net Deferred Tax Liabilities	799			1,140

Prepaid on intercompany profit	69			66
Total Net Deferred Tax Liabilities and Prepaid on Intercompany Profit	$	730		$	1,074

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



	Location in	As of December 31,
Component	Balance Sheet	2014		2013
Current deferred tax asset and prepaid on intercompany profit	Deferred and prepaid income taxes	$	447	$	288
Non-current deferred tax asset	Other long-term assets	39		42
Deferred Tax Assets and Prepaid on Intercompany Profit		486		330

Current deferred tax liability	Other current liabilities	2		2
Non-current deferred tax liability	Deferred income taxes	1,214		1,402
Deferred Tax Liabilities		1,216		1,404

Net Deferred Tax Liabilities and Prepaid on Intercompany Profit		$	730	$	1,074

As of December 31, 2014, we had U.S. tax net operating loss carryforwards and tax credits, the tax effect of which was $335 million, as compared to $351 million as of December 31, 2013. In addition, we had foreign tax net operating loss carryforwards and tax credits, the tax effect of which was $304 million as of December 31, 2014, as compared to $313 million as of December 31, 2013. These tax attributes will expire periodically beginning in 2015. 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 $450 million as of December 31, 2014 and $433 million as of December 31, 2013, representing an increase of $17 million. The increase in the valuation allowance as of December 31, 2014, as compared to December 31, 2013, is attributable primarily due to increase in certain deferred tax assets that are more likely than not that we will not be realizable. The income tax impact of the unrealized gain or loss component of other comprehensive income and stockholders' equity was a charge of $21 million in 2014, a charge of $76 million in 2013, and a charge of $70 million in 2012.

We have not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, 2014 because we intend to permanently reinvest such earnings outside the U.S. As of December 31, 2014, the cumulative amount of excess financial reporting basis over the tax basis of investments in foreign subsidiaries that is indefinitely reinvested is approximately $7.7 billion. Generally, such amounts become subject to U.S. taxation upon the remittance of dividends and under certain other circumstances. It is not practicable to estimate the amount of deferred tax liability related to investments in these foreign subsidiaries.

We obtain tax incentives through Free Trade Zone Regime offered in Costa Rica which allows 100% exemption from income tax in the first eight years of operations and 50% exemption in the following four years. This tax incentive resulted in income tax savings of $7 million for 2014, $6 million for 2013, and $7 million for 2012. The tax incentive for 100% exemption from income tax is expected to expire in 2023. The impact of per share earnings is immaterial for 2014, 2013 and 2012.

As of December 31, 2014, we had $1.047 billion of gross unrecognized tax benefits, of which a net $903 million, if recognized, would affect our effective tax rate. As of December 31, 2013, we had $1.102 billion of gross unrecognized tax benefits, of which a net $941 million, if recognized, would affect our effective tax rate. As of December 31, 2012, we had $1.088 billion of gross unrecognized tax benefits, of which a net $919 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,
	2014			2013			2012
				(restated)			(restated)
Beginning Balance	$	1,102		$	1,088		$	1,022
Additions based on positions related to the current year	44			59			54
Additions based on positions related to prior years	3			43			45
Reductions for tax positions of prior years	(87		)	(42		)	(28		)
Settlements with taxing authorities	(5		)	(15		)	(1		)
Statute of limitation expirations	(10		)	(31		)	(4		)
Ending Balance	$	1,047		$	1,102		$	1,088

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, all foreign income tax matters through 2002 and substantially all material state and local income tax matters through 2005.

We have received Notices of Deficiency from the IRS reflecting proposed audit adjustments for Guidant 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. The IRS is currently examining the 2008 through 2010 tax years of Boston Scientific. During 2014, we received a Revenue Agent Report from the Internal Revenue Service (IRS) reflecting significant proposed audit adjustments for our 2008, 2009, and 2010 tax years based upon the same transfer pricing methodologies that are currently being contested in the U.S. Tax Court for our tax years 2001-2007. As with prior years, we disagree with the transfer pricing methodologies being applied by the IRS and we expect to contest any adjustments received through appropriate IRS and judicial procedures, as appropriate. We believe our income tax reserves associated with these matters are adequate as of December 31, 2014. However, final resolution is uncertain and could have a material impact on our financial condition, results of operations, or cash flows. Also, in connection with the IRS issues, a number of agreed adjustments were contained in the IRS report, however no tax was paid on these amounts as there are outstanding tax receivables from the IRS that are currently being withheld due to the U.S. Tax Court case. As these agreed items are no longer uncertain, the amounts were reclassified from our uncertain tax positions to long-term, which are netted against the longer term receivables.

We recognize interest and penalties related to income taxes as a component of income tax expense. We had $443 million accrued for gross interest and penalties as of December 31, 2014 and $402 million as of December 31, 2013. The increase in gross interest and penalties was the result of $41 million recognized in our consolidated statements of operations. We recognized $26 million of interest and penalties related to income taxes in 2014, recognized $22 million in 2013 and recognized $34 million in 2012.

It is reasonably possible that within the next 12 months we will resolve multiple issues including transfer pricing 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 $8 million.