FACEBOOK INC

Income Taxes

The components of income before provision for income taxes for the years ended December 31, 2017, 2016, and 2015 are as follows (in millions):



	Year Ended December 31,
	2017		2016		2015
Domestic	$	7,079	$	6,368	$	2,802
Foreign	13,515		6,150		3,392
Income before provision for income taxes	$	20,594	$	12,518	$	6,194

The provision for income taxes consisted of the following (in millions):



	Year Ended December 31,
	2017			2016			2015
Current:
Federal	$	4,455		$	2,384		$	3,012
State	190			179			183
Foreign	389			195			123
Total current tax expense	5,034			2,758			3,318
Deferred:
Federal	(296		)	(414		)	(800		)
State	(33		)	(18		)	(17		)
Foreign	(45		)	(25		)	5
Total deferred tax benefit	(374		)	(457		)	(812		)
Provision for income taxes	$	4,660		$	2,301		$	2,506

A reconciliation of the U.S. federal statutory income tax rate of 35.0% to our effective tax rate is as follows (in percentages):



	Year Ended December 31,
	2017		2016		2015
U.S. federal statutory income tax rate	35.0	%	35.0	%	35.0	%
State income taxes, net of federal benefit	0.6		1.0		2.0
Research tax credits	(0.9	)	(0.7	)	(1.4	)
Share-based compensation	0.4		1.0		2.2
Excess tax benefits related to share-based compensation⁽¹⁾	(5.8	)	(7.0	)	—
Effect of non-U.S. operations	(18.6	)	(12.8	)	(0.9	)
Effect of U.S. tax law change ⁽²⁾	11.0		—		—
Other	0.9		1.9		3.5
Effective tax rate	22.6	%	18.4	%	40.4	%


(1)	Starting in 2016, excess tax benefits from share-based award activity are reflected as a reduction of the provision for income taxes, whereas they were previously recognized in equity.

(2)

Due to the Tax Act which was enacted in December 2017, provisional mandatory transition tax on accumulated foreign earnings was accrued as of December 31, 2017. In addition, deferred taxes were derecognized for previous estimated tax liabilities that would arise upon repatriation of a portion of these earnings in the foreign jurisdictions. Our U.S. deferred tax assets and liabilities as of December 31, 2017 were re-measured from 35% to 21%.The provisional effects of the Tax Act are $2.53 billion of current income tax expense and $257 million of deferred income tax benefit for the year ended December 31, 2017.

Our deferred tax assets (liabilities) are as follows (in millions):



	December 31,
	2017			2016
Deferred tax assets:
Net operating loss carryforward	$	1,300		$	1,252
Tax credit carryforward	509			268
Share-based compensation	385			684
Accrued expenses and other liabilities	381			339
Other	131			149
Total deferred tax assets	2,706			2,692
Less: valuation allowance	(438		)	(240		)
Deferred tax assets, net of valuation allowance	2,268			2,452

Deferred tax liabilities:
Depreciation and amortization	(622		)	(535		)
Purchased intangible assets	(309		)	(706		)
Deferred taxes on foreign income	(88		)	(357		)
Total deferred tax liabilities	(1,019		)	(1,598		)
Net deferred tax assets	$	1,249		$	854

The Tax Act reduces the U.S. statutory corporate tax rate from 35% to 21% for our tax years beginning in 2018, which resulted in the re-measurement of the federal portion of our deferred tax assets as of December 31, 2017 from 35% to the new 21% tax rate. The valuation allowance was approximately $438 million and $240 million as of December 31, 2017 and 2016, respectively, mostly related to state tax credits that we do not believe will ultimately be realized.

As of December 31, 2017, the U.S. federal and state net operating loss carryforwards were $5.36 billion and $2.50 billion, which will begin to expire in 2033 and 2032, respectively, if not utilized. We have federal and state tax credit carryforwards of $142 million and $1.38 billion, respectively, which will begin to expire in 2033 and 2032, respectively, if not utilized.

Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50% over a three-year period.

The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and eliminates US taxes on foreign subsidiary distribution. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes.

The following table reflects changes in the gross unrecognized tax benefits (in millions):



	Year Ended December 31,
	2017			2016			2015
Gross unrecognized tax benefits-beginning of period	$	3,309		$	3,017		$	1,682
Increases related to prior year tax positions	72			32			322
Decreases related to prior year tax positions	(34		)	(36		)	(52		)
Increases related to current year tax positions	536			307			1,066
Decreases related to settlements of prior year tax positions	(13		)	(11		)	(1		)
Gross unrecognized tax benefits-end of period	$	3,870		$	3,309		$	3,017

During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2017 and 2016 was $154 million and $80 million, respectively.

If the balance of gross unrecognized tax benefits of $3.87 billion as of December 31, 2017 were realized in a future period, this would result in a tax benefit of $2.67 billion within our provision of income taxes at such time.

We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2011 through 2013 tax years and Ireland for our 2012 through 2015 tax years. Our 2014 and subsequent years remain open to examination by the IRS. Our 2016 and subsequent years remain open to examination in Ireland.

In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated aggregate amount of approximately $3.0 billion to $5.0 billion in excess of originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the United States Tax Court challenging the Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability of $3.0 billion to $5.0 billion in excess of the originally filed U.S. return, plus interest and penalties. If the IRS prevails in the assessment of additional tax due based on its position, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. As of December 31, 2017, we have not resolved this matter and proceedings continue in the United States Tax Court. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations.

We believe that adequate amounts have been reserved for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. Although the timing of the resolution, settlement, and closure of any audits is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. However, we do not anticipate a significant impact to such amounts within the next 12 months.