INCOME TAXES

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



	Year Ended December 31,
(in millions)	2015			2014			2013
Domestic	$	(1,623	)	$	(1,263	)	$	(774	)
Foreign	973			754			551
	$	(650	)	$	(509	)	$	(223	)

The related benefit for income taxes consisted of the following:



	Year Ended December 31,
(in millions)	2015			2014			2013
Current
Federal	$	59		$	(2	)	$	46
State	3			(5		)	(9		)
Foreign	132			111			105
	194			104			142

Deferred
Federal	(545		)	(458		)	(212		)
State	(41		)	(23		)	(17		)
Foreign	(19		)	(13		)	(15		)
	(605		)	(494		)	(244		)
	$	(411	)	$	(390	)	$	(102	)

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



	Year Ended December 31,
	2015		2014		2013
U.S. federal statutory income tax rate	(35.0	)%	(35.0	)%	(35.0	)%
State income taxes, net of federal benefit	(4.8	)%	(6.5	)%	(7.9	)%
Effect of foreign taxes	(34.4	)%	(29.1	)%	(63.4	)%
Acquisition-related	6.0	%	(7.5	)%	3.5	%
Research credit	(4.4	)%	(7.0	)%	(12.2	)%
Valuation allowance	2.3	%	4.0	%	(12.0	)%
Goodwill impairment charges	—	%	—	%	65.2	%
Compensation-related	1.6	%	0.7	%	1.7	%
Non-deductible expenses	2.4	%	1.9	%	9.0	%
Uncertain domestic tax positions	2.7	%	2.0	%	7.0	%
Other, net	0.4	%	(0.2	)%	(1.9	)%
	(63.2	)%	(76.7	)%	(46.0	)%

We had net deferred tax liabilities of $264 million as of December 31, 2015 and $799 million as of December 31, 2014. Gross deferred tax liabilities of $1.875 billion as of December 31, 2015 and $2.096 billion as of December 31, 2014 relate primarily to intangible assets acquired in connection with our prior acquisitions. Gross deferred tax assets of $1.611 billion as of December 31, 2015 and $1.297 billion as of December 31, 2014 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)	2015			2014

Deferred Tax Assets:
Inventory costs and related reserves	$	49		$	46
Tax benefit of net operating loss and credits	742			525
Reserves and accruals	232			232
Restructuring-related charges	17			20
Litigation and product liability reserves	689			556
Investment write-down	7			4
Compensation related	138			150
Federal benefit of uncertain tax positions	197			178
Other	39			36
	2,110			1,747
Less valuation allowance	(499		)	(450		)
	1,611			1,297
Deferred Tax Liabilities:
Property, plant and equipment	44			67
Unrealized gains and losses on derivative financial instruments	82			146
Intangible assets	1,749			1,883
	1,875			2,096

Net Deferred Tax Liabilities	264			799

Prepaid on intercompany profit	63			69
Total Net Deferred Tax Liabilities and Prepaid on Intercompany Profit	$	201		$	730

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	2015		2014
Current deferred tax asset and prepaid on intercompany profit	Deferred income taxes	$	496	$	447
Non-current deferred tax asset	Other long-term assets	40		39
Deferred Tax Assets and Prepaid on Intercompany Profit		536		486

Current deferred tax liability	Other current liabilities	2		2
Non-current deferred tax liability	Deferred income taxes	735		1,214
Deferred Tax Liabilities		737		1,216

Net Deferred Tax Liabilities and Prepaid on Intercompany Profit		$	201	$	730

As of December 31, 2015, we had U.S. tax net operating loss carryforwards and tax credits, the tax effect of which was $624 million, as compared to $335 million as of December 31, 2014. In addition, we had foreign tax net operating loss carryforwards and tax credits, the tax effect of which was $288 million as of December 31, 2015, as compared to $304 million as of December 31, 2014. These tax attributes will expire periodically beginning in 2016.

The current accounting standard for stock-based compensation prohibits the recognition of windfall tax benefits from stock-based compensation deducted for tax return purposes until realized through a reduction of income taxes payable. We have $32 million and $2 million of U.S. tax net operating loss as of December 31, 2015 and December 31, 2014 respectively, which will be recognized through additional paid in capital upon realization of the tax benefit through reduction of income tax payable. These amounts were not included in the gross deferred taxes as of December 31, 2015 and December 31, 2014.

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 $499 million as of December 31, 2015 and $450 million as of December 31, 2014, representing an increase of $49 million. The increase in the valuation allowance as of December 31, 2015, as compared to December 31, 2014, is attributable primarily to increases in certain deferred tax assets that are not more likely than not realizable. The income tax impact of the unrealized gain or loss component of other comprehensive income and stockholders' equity was a charge of $25 million in 2015, a charge of $21 million in 2014, and a charge of $76 million in 2013.

We have not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, 2015 because we intend to permanently reinvest such earnings outside the U.S. As of December 31, 2015, the cumulative amount of excess financial reporting basis over the tax basis of investments in foreign subsidiaries that is indefinitely reinvested is approximately $8.9 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 2015, $7 million for 2014, and $6 million for 2013. The tax incentive for 100% exemption from income tax is expected to expire in 2023. The impact of per share earnings is immaterial for 2015, 2014 and 2013.

As of December 31, 2015, we had $1.056 billion of gross unrecognized tax benefits, of which a net $900 million, if recognized, would affect our effective tax rate. 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. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in millions):



	Year Ended December 31,
	2015			2014			2013

Beginning Balance	$	1,047		$	1,102		$	1,088
Additions based on positions related to the current year	32			44			59
Additions based on positions related to prior years	38			3			43
Reductions for tax positions of prior years	(36		)	(87		)	(42		)
Settlements with taxing authorities	(18		)	(5		)	(15		)
Statute of limitation expirations	(7		)	(10		)	(31		)
Ending Balance	$	1,056		$	1,047		$	1,102

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 Internal Revenue Service (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. The total incremental tax liability 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 associated 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. In addition to the Notices of Deficiency, during 2014, we received a Revenue Agent Report from the IRS reflecting significant proposed audit adjustments to our 2008, 2009, and 2010 tax years based upon the same transfer pricing methodologies that the IRS applied to our 2001 through 2007 tax years.

We do not agree with the transfer pricing methodologies applied by the IRS or its resulting assessment. 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 petitions with the U.S. Tax Court contesting the Notices of Deficiency for the 2001 - 2007 tax years in challenge. We currently expect the trial in this matter to begin in the second half of 2016. Furthermore, we have submitted a letter to the IRS protesting the Revenue Agent Report for the 2008 - 2010 tax years and requesting an administrative appeal hearing. We do not believe that the IRS will hear our appeal until the Tax Court case is concluded.

No payments on the net assessments would be required until the dispute is definitively resolved, which, based on experiences of other companies, could take several years. We believe our income tax reserves associated with these matters are adequate as of December 31, 2015. However, final resolution is uncertain and could have a material impact on our financial condition, results of operations, or cash flows.

We recognize interest and penalties related to income taxes as a component of income tax expense. We had $500 million accrued for gross interest and penalties as of December 31, 2015 and $443 million as of December 31, 2014. The increase in gross interest and penalties was the result of $57 million recognized in our consolidated statements of operations. We recognized $37 million of interest and penalties related to income taxes in 2015, recognized $26 million in 2014 and recognized $22 million in 2013.

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 $13 million.