Income Taxes
Earnings Before Income Tax Expense
|
| | | | | | | | | | | |
years ended December 31 (in millions) | 2017 |
| 2016 |
| 2015 |
Domestic | $ | (2,678 | ) | | $ | (1,651 | ) | | $ | (1,038 | ) |
Foreign | 10,405 |
| | 9,535 |
| | 7,683 |
|
Total earnings before income tax expense | $ | 7,727 |
| | $ | 7,884 |
| | $ | 6,645 |
|
Income Tax Expense
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| | | | | | | | | | | |
years ended December 31 (in millions) | 2017 | | 2016 | | 2015 |
Current | | | | | |
Domestic | $ | 6,204 |
| | $ | 2,229 |
| | $ | 1,036 |
|
Foreign | 376 |
| | 498 |
| | 313 |
|
Total current taxes | $ | 6,580 |
| | $ | 2,727 |
| | $ | 1,349 |
|
Deferred | | | | | |
Domestic | $ | (4,898 | ) | | $ | (792 | ) | | $ | 141 |
|
Foreign | 736 |
| | (4 | ) | | 11 |
|
Total deferred taxes | $ | (4,162 | ) | | $ | (796 | ) | | $ | 152 |
|
Total income tax expense | $ | 2,418 |
| | $ | 1,931 |
| | $ | 1,501 |
|
Impacts Related to U.S. Tax Reform
The Tax Cuts and Jobs Act (the “Act”) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system. The Act reduces the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed and creates new taxes on certain foreign sourced earnings. These changes are effective beginning in 2018.
Prior to the enactment of the Act, the company did not provide deferred income taxes on undistributed earnings of foreign subsidiaries that were indefinitely reinvested for continued use in foreign operations. Due to the provision of the Act that requires a one-time deemed repatriation of earnings of foreign subsidiaries, the company no longer considers those earnings to be indefinitely reinvested. The transition tax expense on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries was $4.5 billion, generally payable in eight annual installments.
Additionally, the company remeasured certain deferred tax assets and liabilities based on tax rates at which they are expected to reverse in the future. The net tax benefit of U.S. tax reform from the remeasurement of deferred taxes related to the Act and foreign tax law changes was $3.6 billion.
Given the complexity of the Act and anticipated guidance from the U.S. Treasury about implementing the Act, the company’s analysis and accounting for the tax effects of the Act is preliminary. As a direct result of the Act, the company recorded $4.5 billion of transition tax expense, as well as $4.1 billion of net tax benefit for deferred tax remeasurement. Both of these amounts are provisional estimates, as the company has not fully completed its analysis and calculation of foreign earnings subject to the transition tax or its analysis of certain other aspects of the Act that could result in adjustments to the remeasurement of deferred tax balances. Upon completion of the analysis in 2018, these estimates may be adjusted through income tax expense in the consolidated statement of earnings.
Effective Tax Rate Reconciliation
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| | | | | | | | |
years ended December 31 | 2017 |
| 2016 |
| 2015 |
Statutory tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
Effect of foreign operations | (12.2 | ) | | (10.3 | ) | | (9.4 | ) |
U.S. tax credits | (4.0 | ) | | (4.4 | ) | | (4.5 | ) |
Impacts related to U.S. tax reform | 12.0 |
| | — |
| | — |
|
Tax law change related to foreign currency | — |
| | 2.4 |
| | — |
|
All other, net | 0.5 |
| | 1.8 |
| | 1.5 |
|
Effective tax rate | 31.3 | % | | 24.5 | % | | 22.6 | % |
The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2017, 2016 and 2015 differed from the statutory tax rate principally due to changes in enacted tax rates and laws, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities and the cost of repatriation decisions. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes.
The effective income tax rate in 2017 included impacts related to U.S. tax reform. In addition, in 2017, the company recognized a net tax benefit of $91 million related to the resolution of various tax positions pertaining to prior years.
The effective income tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations.
The effective income tax rate in 2015 included a tax benefit of $103 million from a reduction of state valuation allowances.
Deferred Tax Assets and Liabilities
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| | | | | | | |
as of December 31 (in millions) | 2017 | | 2016 |
Deferred tax assets | | | |
Compensation and employee benefits | $ | 556 |
| | $ | 718 |
|
Accruals and reserves | 315 |
| | 425 |
|
Chargebacks and rebates | 305 |
| | 473 |
|
Deferred revenue | 219 |
| | 391 |
|
Net operating losses and other credit carryforwards | 208 |
| | 151 |
|
Other | 429 |
| | 289 |
|
Total deferred tax assets | 2,032 |
| | 2,447 |
|
Valuation allowances | (108 | ) | | (76 | ) |
Total net deferred tax assets | 1,924 |
| | 2,371 |
|
Deferred tax liabilities | | | |
Excess of book basis over tax basis of intangible assets | (3,762 | ) | | (5,487 | ) |
Excess of book basis over tax basis in investments | (181 | ) | | (3,367 | ) |
Other | (203 | ) | | (182 | ) |
Total deferred tax liabilities | (4,146 | ) | | (9,036 | ) |
Net deferred tax liabilities | $ | (2,222 | ) | | $ | (6,665 | ) |
The decreases in deferred tax assets and liabilities were primarily due to the enactment of the U.S. tax reform that reduced the U.S. federal corporate tax rate from 35% to 21% and created a territorial tax system, which will generally allow repatriation of future foreign sourced earnings without incurring additional U.S. taxes. The Act also created a minimum tax on certain foreign sourced earnings. The taxability of the foreign sourced earnings and the applicable tax rates are dependent on future events. While the company is still evaluating its accounting policy for the minimum tax on foreign sourced earnings, the provisional estimates of the tax effects of the Act were reported on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense.
As of December 31, 2017, gross state net operating losses were $1.2 billion and tax credit carryforwards were $228 million. The state tax carryforwards expire between 2018 and 2038. As of December 31, 2017, foreign net operating loss carryforwards were $209 million. Foreign net operating loss carryforwards of $155 million expire between 2018 and 2027 and the remaining do not have an expiration period.
The company had valuation allowances of $108 million as of December 31, 2017 and $76 million as of December 31, 2016. These were principally related to state net operating losses and credit carryforwards that are not expected to be realized.
Current income taxes receivable were $2.1 billion as of December 31, 2017 and $347 million as of December 31, 2016 and were included in prepaid expenses and other on the consolidated balance sheets.
Unrecognized Tax Benefits
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| | | | | | | | | | | |
years ended December 31 (in millions) | 2017 | | 2016 | | 2015 |
Beginning balance | $ | 1,168 |
| | $ | 954 |
| | $ | 421 |
|
Increase due to current year tax positions | 1,768 |
| | 118 |
| | 187 |
|
Increase due to prior year tax positions | 16 |
| | 111 |
| | 369 |
|
Decrease due to prior year tax positions | (2 | ) | | (7 | ) | | (15 | ) |
Settlements | (233 | ) | | — |
| | — |
|
Lapse of statutes of limitations | (16 | ) | | (8 | ) | | (8 | ) |
Ending balance | $ | 2,701 |
| | $ | 1,168 |
| | $ | 954 |
|
AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation.
If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $2.6 billion in 2017 and $1.1 billion in 2016. Of the unrecognized tax benefits recorded in the table above as of December 31, 2017, AbbVie would be indemnified for approximately $85 million. The “Increases due to current year tax positions” in the table above includes amounts related to federal, state and international tax items, including a provisional estimate of the remeasurement of unrecognized tax benefits related to earnings of foreign subsidiaries following the enactment of U.S. tax reform in 2017. The "Increase due to prior year tax positions" in the table above includes amounts relating to federal, state and international items as well as prior positions acquired through business development activities during the year. Uncertain tax positions are generally included as a long-term liability on the consolidated balance sheets.
AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $24 million in 2017, $35 million in 2016 and $13 million in 2015, for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $120 million at December 31, 2017, $112 million at December 31, 2016 and $83 million at December 31, 2015.
The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next twelve months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next twelve months up to $31 million. All significant federal, state, local and international matters have been concluded for years through 2008. The company believes adequate provision has been made for all income tax uncertainties.