Note 9 – Income Taxes

Our provision for federal and foreign income tax expense for continuing operations consisted of the following (in millions):


	2016			2015			2014
Federal income tax expense (benefit):
Current	$	1,327		$	1,573		$	1,770
Deferred		(231	)		(473	)		(351)
Total federal income tax expense		1,096			1,100			1,419
Foreign income tax expense (benefit):
Current		56			39			13
Deferred		(19	)		34			(8)
Total foreign income tax expense		37			73			5
Total income tax expense	$	1,133		$	1,173		$	1,424

State income taxes are included in our operations as general and administrative costs and, under U.S. Government regulations, are allowable costs in establishing prices for the products and services we sell to the U.S. Government. Therefore, a substantial portion of state income taxes is included in our net sales and cost of sales. As a result, the impact of certain transactions on our operating profit and of other matters presented in these consolidated financial statements is disclosed net of state income taxes. Our total net state income tax expense was $112 million for 2016, $106 million for 2015, and $149 million for 2014.

Our reconciliation of the 35% U.S. federal statutory income tax rate to actual income tax expense for continuing operations is as follows (dollars in millions):


	2016				2015				2014
	Amount		Rate		Amount		Rate		Amount		Rate
Income tax expense at the U.S. federal statutory tax rate		$1,710		35.0%		$1,505		35.0%		$1,637		35.0%
Adoption of stock-based compensation ASU		(152)		(3.1)		—		—		—		—
U.S. manufacturing deduction benefit		(117)		(2.4)		(123)		(2.9)		(124)		(2.6)
Research and development tax credit		(107)		(2.2)		(70)		(1.6)		(63)		(1.3)
Tax deductible dividends		(92)		(1.9)		(87)		(2.0)		(82)		(1.8)
Other, net		(109)		(2.2)		(52)		(1.2)		56		1.1
Income tax expense		$1,133		23.2%		$1,173		27.3%		$1,424		30.4%

In 2016, we early adopted the accounting standard update for employee share-based payment awards. Accordingly, we recognized additional income tax benefits of $152 million during the year ended December 31, 2016. The 2016 income tax rate also benefited from the nontaxable gain recorded in connection with the consolidation of AWE.

We recognized tax benefits of $107 million in 2016, $70 million in 2015, and $63 million in 2014 from U.S. research and development (R&D) tax credits, including benefits attributable to prior periods. In December 2015, the R&D tax credit was permanently extended and reinstated, retroactive to the beginning of 2015, which reduced income tax expense by approximately $70 million. In 2014, the R&D tax credit was temporarily reinstated for one year, retroactive to the beginning of 2014, which reduced income tax expense by approximately $45 million.

We receive a tax deduction for dividends paid on shares of our common stock held by certain of our defined contribution plans with an employee stock ownership plan feature. The amount of the tax deduction has increased as we increased our dividend over the last three years, partially offset by a decline in the number of shares in these plans.

As a result of a decision in 2015 to divest our LMCFT business (see “Note 3 – Acquisitions and Divestitures), we recorded an asset impairment charge of approximately $90 million. This charge was partially offset by a net deferred tax benefit of about $80 million. The net impact of the resulting tax benefit reduced the effective income tax rate by 1.2 percentage points in 2015.

We participate in the IRS Compliance Assurance Process program. Examinations of the years 2015 and 2016 remain under IRS review.

The primary components of our federal and foreign deferred income tax assets and liabilities at December 31 were as follows (in millions):


	2016			2015
Deferred tax assets related to:
Accrued compensation and benefits	$	1,012		$	919
Pensions ^(a)		5,197			4,462
Other postretirement benefit obligations		302			375
Contract accounting methods		878			1,039
Foreign company operating losses and credits		30			62
Other		327			418
Valuation allowance ^(b)		(15	)		(73)
Deferred tax assets, net		7,731			7,202
Deferred tax liabilities related to:
Goodwill and purchased intangibles		378			274
Property, plant and equipment		346			457
Exchanged debt securities and other ^(c)		418			408
Deferred tax liabilities		1,142			1,139
Net deferred tax assets	$	6,589		$	6,063

^(a)	The increase in 2016 was primarily due to the reduction in the discount rate used to measure our postretirement benefit plans (see “Note 11 – Postretirement Plans”).

^(b)	A valuation allowance was provided against certain foreign company deferred tax assets arising from carryforwards of unused tax benefits.

^(c)	Includes deferred taxes associated with the exchange of debt securities in prior years.

As of December 31, 2016 and 2015, our liabilities associated with unrecognized tax benefits are not material.

We and our subsidiaries file income tax returns in the U.S. Federal jurisdiction and various foreign jurisdictions. With few exceptions, the statute of limitations is no longer open for U.S. Federal or non-U.S. income tax examinations for the years before 2013, other than with respect to refunds.

U.S. income taxes and foreign withholding taxes have not been provided on earnings of $386 million, $310 million, and $249 million that have not been distributed by our non-U.S. companies as of December 31, 2016, 2015, and 2014. Our intention is to permanently reinvest these earnings, thereby indefinitely postponing their remittance to the U.S. If these earnings had been remitted, we estimate that the additional income taxes after foreign tax credits would have been approximately $64 million in 2016, $49 million in 2015, and $52 million in 2014.

Our federal and foreign income tax payments, net of refunds received, were $1.3 billion in 2016, $1.8 billion in 2015, and $1.5 billion in 2014. Our 2014 net payments reflect a $200 million refund from the IRS primarily attributable to our tax-deductible discretionary pension contributions during the fourth quarter of 2013.