INCOME TAXES

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



	Year Ended December 31,
(in millions)	2016			2015			2014
Domestic	$	(1,019	)	$	(1,623	)	$	(1,263	)
Foreign	1,196			973			754
	$	177		$	(650	)	$	(509	)

The related benefit for income taxes consisted of the following:



	Year Ended December 31,
(in millions)	2016			2015			2014
Current
Federal	$	31		$	59		$	(2	)
State	6			3			(5		)
Foreign	136			132			111
	173			194			104

Deferred
Federal	(337		)	(545		)	(458		)
State	(14		)	(41		)	(23		)
Foreign	8			(19		)	(13		)
	(343		)	(605		)	(494		)
	$	(170	)	$	(411	)	$	(390	)

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



	Year Ended December 31,
	2016		2015		2014
U.S. federal statutory income tax rate	35.0	%	(35.0	)%	(35.0	)%
State income taxes, net of federal benefit	(1.7	)%	(4.8	)%	(6.5	)%
Effect of foreign taxes	(99.1	)%	(34.4	)%	(29.1	)%
Acquisition-related	9.4	%	6.0	%	(7.5	)%
Research credit	(15.0	)%	(4.4	)%	(7.0	)%
Valuation allowance	(42.2	)%	2.3	%	4.0	%
Compensation-related	6.4	%	1.6	%	0.7	%
Non-deductible expenses	9.3	%	2.4	%	1.9	%
Uncertain domestic tax positions	5.5	%	2.7	%	2.0	%
Other, net	(3.5	)%	0.4	%	(0.2	)%
	(95.9	)%	(63.2	)%	(76.7	)%

We had net deferred tax assets of $62 million as of December 31, 2016 and net deferred tax liabilities of $264 million as of December 31, 2015. Gross deferred tax liabilities of $1.760 billion as of December 31, 2016 and $1.875 billion as of December 31, 2015 relate primarily to goodwill and intangible assets acquired in connection with our prior acquisitions. Gross deferred tax assets of $1.822 billion as of December 31, 2016 and $1.611 billion as of December 31, 2015 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.

Significant components of our deferred tax assets and liabilities are as follows:



	As of December 31,
(in millions)	2016			2015

Deferred Tax Assets:
Inventory costs and related reserves	$	37		$	49
Tax benefit of net operating loss and credits	798			742
Reserves and accruals	228			232
Restructuring-related charges	14			17
Litigation and product liability reserves	752			689
Investment write-down	17			7
Compensation related	142			138
Federal benefit of uncertain tax positions	238			197
Other	42			39
	2,268			2,110
Less valuation allowance	(446		)	(499		)
	1,822			1,611
Deferred Tax Liabilities:
Property, plant and equipment	42			44
Unrealized gains and losses on derivative financial instruments	67			82
Intangible assets	1,651			1,749
	1,760			1,875

Net Deferred Tax Assets / (Liabilities)	62			(264		)

Prepaid on intercompany profit	75			63
Net Deferred Tax Assets / (Liabilities) and Prepaid on Intercompany Profit	$	137		$	(201	)

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	2016		2015
Current deferred tax asset and prepaid on intercompany profit	Deferred income taxes	$	75	$	496
Non-current deferred tax asset	Other long-term assets	80		40
Deferred Tax Assets and Prepaid on Intercompany Profit		155		536

Current deferred tax liability	Other current liabilities	—		2
Non-current deferred tax liability	Deferred income taxes	18		735
Deferred Tax Liabilities		18		737

Net Deferred Tax Assets / (Liabilities) and Prepaid on Intercompany Profit		$	137	$	(201	)

As of December 31, 2016, we had U.S. federal and state tax net operating loss carryforwards and tax credits, the tax effect of which was $724 million. As of December 31, 2015, we had U.S. federal and state tax net operating loss carryforwards and tax credits, the tax effect of which was $500 million. In addition, we had foreign tax net operating loss carryforwards and tax credits, the tax effect of which was $172 million as of December 31, 2016, as compared to $273 million as of December 31, 2015. These tax attributes will expire periodically beginning in 2017. The tax effect of both U.S. federal and state tax net operating loss carryforwards and tax credits and foreign tax net operating loss carryforwards and tax credits as of December 31, 2015 was previously disclosed in the amounts of $624 million and $288 million, respectively. We are updating these amounts to reflect unrecognized tax benefits that reduce the amounts.

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 $76 million and $32 million of U.S. tax net operating loss and credits as of December 31, 2016 and December 31, 2015, respectively. These amounts were not included in the gross deferred tax balances as of December 31, 2016 and December 31, 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 $446 million as of December 31, 2016 and $499 million as of December 31, 2015, representing a decrease of $53 million. The decrease in the valuation allowance as of December 31, 2016, as compared to December 31, 2015, is primarily attributable to the release of valuation allowance related to certain foreign tax net operating losses which expired in 2016. The release was offset by an increase to the valuation allowance related to federal and state tax credits and state tax net operating loss carryforwards. The income tax impact of the unrealized gain or loss component of other comprehensive income and stockholders' equity was a charge of $9 million in 2016, a charge of $25 million in 2015, and a charge of $21 million in 2014.

We have not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, 2016 because we intend to permanently reinvest such earnings outside the U.S. As of December 31, 2016, the cumulative amount of excess financial reporting basis over the tax basis of investments in foreign subsidiaries that is indefinitely reinvested is approximately $9.8 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 $123 million for 2016, $7 million for 2015, and $7 million for 2014. The tax incentive for 100% exemption from income tax is expected to expire in 2023. The impact of per share earnings is $0.09 for 2016 and immaterial for 2015 and 2014.

As of December 31, 2016, we had $1.095 billion of gross unrecognized tax benefits, of which a net $1.006 billion, if recognized, would affect our effective tax rate. 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. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in millions):



	Year Ended December 31,
	2016			2015			2014

Beginning Balance	$	1,056		$	1,047		$	1,102
Additions based on positions related to the current year	47			32			44
Additions based on positions related to prior years	14			38			3
Reductions for tax positions of prior years	(17		)	(36		)	(87		)
Settlements with taxing authorities	(3		)	(18		)	(5		)
Statute of limitation expirations	(2		)	(7		)	(10		)
Ending Balance	$	1,095		$	1,056		$	1,047

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. 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. We have filed petitions with the U.S. Tax Court (Tax Court) contesting the Notices of Deficiency for the 2001 through 2007 tax years in challenge and submitted a letter to the IRS Office of Appeals (IRS Appeals) protesting the Revenue Agent Report for the 2008 through 2010 tax years and requesting an administrative appeal hearing. The issues in dispute were scheduled to be heard in Tax Court in late July 2016. On July 19, 2016, we entered into a Stipulation of Settled Issues with the IRS intended to resolve all of the aforementioned transfer pricing issues, as well as the issues related to our transaction with Abbott. The Stipulation of Settled Issues is contingent upon IRS Appeals applying the same basis of settlement to all transfer pricing issues for the Company’s 2008, 2009, and 2010 tax years, and if applicable, review by the U.S. Congress Joint Committee on Taxation. In October 2016, we reached an agreement in principle with IRS Appeals as to the resolution of the transfer pricing issues in 2008, 2009, and 2010 tax years, subject to additional calculations of tax as well as documentation to memorialize our agreement.

In the event that the conditions in the Stipulation of Settled Items are satisfied, we expect to make net tax payments to the IRS of approximately $275 million, plus interest through the date of payment. If finalized, payments related to the resolution are expected in the next nine to 18 months. We believe that our income tax reserves associated with these matters are adequate as of December 31, 2016 and we do not expect to recognize any additional charges related to resolution of this controversy. However, the final resolution of these issues is contingent and if the Stipulation of Settled Issues is not finalized, it 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 $572 million accrued for gross interest and penalties as of December 31, 2016 and $500 million as of December 31, 2015. The increase in gross interest and penalties of $72 million was recognized in our consolidated statements of operations. We recognized net tax expense related to interest and penalties of $46 million in 2016, $37 million in 2015 and $26 million in 2014.

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 approximately $758 million.