| NOTE 14. | INCOME TAXES |
Income before income taxes included the following (dollars in millions):
| Years ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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U.S. income |
$ | 491 | $ | 309 | $ | 261 | ||||||
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Foreign income |
36 | 32 | 28 | |||||||||
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Total |
$ | 527 | $ | 341 | $ | 289 | ||||||
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The provision for income tax expense was estimated as follows (dollars in millions):
| Years ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Estimated current income taxes: |
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U.S. federal |
$ | 61 | $ | 2 | $ | 3 | ||||||
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Foreign |
7 | 8 | 6 | |||||||||
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U.S. state and local |
5 | 2 | 2 | |||||||||
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Total Current |
73 | 12 | 11 | |||||||||
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Deferred income tax (credit) expense, net: |
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U.S. federal |
(44 | ) | 107 | 90 | ||||||||
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Foreign |
1 | — | — | |||||||||
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U.S. state and local |
(7 | ) | 7 | 6 | ||||||||
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Total Deferred |
(50 | ) | 114 | 96 | ||||||||
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Total income tax expense |
$ | 23 | $ | 126 | $ | 107 | ||||||
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On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was enacted into law. The Tax Act makes broad and complex changes to the U.S. tax code that impact the Company, most notably a reduction of the U.S. corporate income tax rate from 35% to 21% for tax years beginning after December 31, 2017. The Tax Act also makes other changes including, but not limited to, the acceleration of depreciation for certain assets placed into service after September 27, 2017 as well as a one-time deemed repatriation tax on undistributed foreign earnings and profits. Beginning in 2018, the Tax Act makes other changes impacting the Company such as additional limitations on executive compensation, the repeal of the domestic manufacturing deduction and qualifications around certain research and development expenditures.
On December 22, 2017, the United States Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. The Company recognized the income tax effects of the Tax Act for the year ended December 31, 2017, the reporting period in which the Tax Act was signed into law, in accordance with SAB 118. As such, the Company’s financial results reflect the income tax effects of the Tax Act and provisional amounts for those specific income tax effects of the Tax Act that could be reasonably estimated.
In accordance with SAB 118, the Company recorded a $157 million deferred tax benefit related to the re-measurement of certain deferred tax assets and liabilities and $5 million of tax expense recorded in connection with the transition tax on the mandatory deemed repatriation of foreign earnings and profits for the year ended December 31, 2017.
A reconciliation of the provision for income tax expense compared with the amounts at the U.S. federal statutory rate is as follows (dollars in millions):
| Years ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Tax at U.S. statutory income tax rate |
$ | 185 | $ | 120 | $ | 101 | ||||||
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Impact related to Tax Act |
(155 | ) | — | — | ||||||||
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Tax credits |
(21 | ) | — | — | ||||||||
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Foreign rate differential |
(5 | ) | (5 | ) | (3 | ) | ||||||
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Non-deductible expenses |
7 | 5 | 4 | |||||||||
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Valuation allowance |
3 | 1 | (1 | ) | ||||||||
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State tax expense |
10 | 6 | 5 | |||||||||
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Adjustment to deferred tax expense |
— | — | 1 | |||||||||
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Other adjustments |
(1 | ) | (1 | ) | — | |||||||
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Total income tax expense |
$ | 23 | $ | 126 | $ | 107 | ||||||
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The effective tax rate for the year ended December 31, 2017 was 4%, as compared with 37% in 2017. The lower rate is principally due to $155 million of tax benefit recorded in connection with the Tax Act, largely due to the $157 million decrease in net deferred tax liabilities to reflect the decrease in the corporate income tax rate from 35% to 21%.
Deferred income tax assets and liabilities as of December 31, 2017 and 2016 reflect the effect of temporary differences between amounts of assets, liabilities and equity for financial reporting purposes and the bases of such assets, liabilities and equity as measured by tax laws, as well as tax loss and tax credit carry forwards. Net deferred tax assets and liabilities are classified as non-current in the consolidated statements of financial position. As described above, the deferred tax assets and liabilities are measured based on the enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. As such, the Company re-measured its deferred tax assets and liabilities as a direct result of the enactment of the Tax Act. The primary impact of the re-measurement was a reduction in deferred tax assets and liabilities in connection with the reduction of the U.S. corporate income tax rate from 35% to 21%.
As of December 31, 2017, the Company had approximately $62 million of undistributed earnings in foreign subsidiaries which were subject to the one-time repatriation tax on foreign earnings required by the Tax Act. As a result, the Company recorded a charge of $5 million for the one-time repatriation tax, to be paid to the U.S. Government over the next eight years. The Company has not recognized any deferred tax liabilities associated with earnings in foreign subsidiaries, except for its subsidiaries located in China and Hong Kong, as they are intended to be permanently reinvested and used to support foreign operations. The deferred tax liabilities, if recorded, related to unremitted earnings that are indefinitely reinvested are not material. The Company has recorded a deferred tax liability of $2 million for the tax liability associated with the remittance of previously taxed income and unremitted earnings for its subsidiaries located in China and Hong Kong, which in previous periods had been considered indefinitely reinvested.
Temporary differences and carryforwards that gave rise to deferred tax assets and liabilities included the following (dollars in millions):
| As of December 31, 2017 |
As of December 31, 2016 |
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Deferred tax assets: |
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Intangibles |
$ | 35 | $ | 64 | ||||
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Deferred revenue |
25 | 35 | ||||||
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Other accrued liabilities |
18 | 34 | ||||||
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Operating loss carryforwards |
12 | 14 | ||||||
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Warranty accrual |
11 | 22 | ||||||
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Stock-based compensation |
6 | 8 | ||||||
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Sales allowances and rebates |
6 | 7 | ||||||
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Inventories |
5 | 6 | ||||||
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Technology-related investments |
4 | 9 | ||||||
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Capital loss carryforwards |
3 | — | ||||||
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Environmental remediation |
3 | 5 | ||||||
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Unrealized loss on interest rate derivatives |
1 | 11 | ||||||
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Post-retirement |
— | 12 | ||||||
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Tax credits |
— | 8 | ||||||
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Other |
4 | 8 | ||||||
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Total Deferred tax assets |
133 | 243 | ||||||
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Valuation allowances |
(9 | ) | (5 | ) | ||||
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Deferred tax liabilities: |
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Goodwill |
(287 | ) | (409 | ) | ||||
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Trade name |
(96 | ) | (122 | ) | ||||
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Property, plant and equipment |
(7 | ) | (15 | ) | ||||
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Post-retirement |
(4 | ) | — | |||||
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Other |
(3 | ) | (2 | ) | ||||
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Total Deferred tax liabilities |
(397 | ) | (548 | ) | ||||
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Net Deferred tax liability |
$ | (273 | ) | $ | (310 | ) | ||
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The estimated net operating loss carryforwards as of December 31, 2017 relate solely to U.S. state net operating loss carryforwards. Substantially all state operating loss carryforwards will not expire until 2027-2032.
Management has determined, based on an evaluation of available objective and subjective evidence, that it is more likely than not that certain foreign deferred tax assets and an anticipated capital loss carryforward will not be realized; therefore these deferred tax assets are offset with a valuation allowance of $9 million and $5 million as of December 31, 2017 and 2016, respectively.
In accordance with the FASB’s authoritative accounting guidance on accounting for income taxes, the Company records uncertain tax positions on the basis of a two-step process whereby (1) it is determined whether it is more likely than not that the tax position will be sustained based on the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is greater than 50% likely to be realized upon ultimate settlement with the related tax authority. Based upon this process, the Company has recognized a liability for uncertain tax benefits as of December 31, 2017 and 2016. Management does not anticipate any material changes in the balance within the coming year. The change in the liability for unrecognized tax benefits are as follows (dollars in millions):
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December 31, 2015 |
$ | 2 | ||
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Increases in unrecognized tax benefits as a result of current year activity |
— | |||
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December 31, 2016 |
$ | 2 | ||
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Increases in unrecognized tax benefits as a result of current year activity |
— | |||
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December 31, 2017 |
$ | 2 | ||
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For the years ended December 31, 2017, 2016 and 2015, the Company recognized no interest and penalties in the Consolidated Statements of Comprehensive Income because either no uncertain tax positions were identified or the penalties and interest anticipated were not material in all the periods presented. The Company follows a policy of recording any interest or penalties in Income tax expense.
Management does not anticipate any significant changes in unrecognized tax benefits within the coming year. There was $2 million as of both December 31, 2017 and 2016 of unrecognized tax benefits that, if recognized, would affect the annual effective tax rate. All of the Company’s returns, once filed, will remain subject to examination by the various taxing authorities for the duration of the applicable statute of limitations (generally three years from the earlier of the date of filing or the due date of the return).