Income Taxes
Income from continuing operations before income taxes included income from domestic operations of $8.3 billion, $12.0 billion, and $10.7 billion for the years ended December 31, 2015, 2016, and 2017, and income from foreign operations of $11.4 billion, $12.1 billion, and $16.5 billion for the years ended December 31, 2015, 2016, and 2017.
The provision for income taxes consists of the following (in millions):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2015 |
| 2016 |
| 2017 |
Current: | | | | | |
Federal and state | $ | 2,838 |
| | $ | 3,826 |
| | $ | 12,608 |
|
Foreign | 723 |
| | 966 |
| | 1,746 |
|
Total | 3,561 |
| | 4,792 |
| | 14,354 |
|
Deferred: | | | | | |
Federal and state | (241 | ) | | (70 | ) | | 220 |
|
Foreign | (17 | ) | | (50 | ) | | (43 | ) |
Total | (258 | ) | | (120 | ) | | 177 |
|
Provision for income taxes | $ | 3,303 |
| | $ | 4,672 |
| | $ | 14,531 |
|
The U.S. Tax Cuts and Jobs Act (Tax Act) was enacted on December 22, 2017 and introduces significant changes to U.S. income tax law. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income tax and the base erosion tax, respectively. In addition, in 2017 we were subject to a one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax.
Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we have made reasonable estimates of the effects and recorded provisional amounts in our financial statements as of December 31, 2017. As we collect and prepare necessary data, and interpret the Tax Act and any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes and effective tax rate in the period in which the adjustments are made. The accounting for the tax effects of the Tax Act will be completed in 2018.
Provisional amounts for the following income tax effects of the Tax Act have been recorded as of December 31, 2017 and are subject to change during 2018.
One-time transition tax
The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion. We have recorded provisional amounts based on estimates of the effects of the Tax Act as the analysis requires significant data from our foreign subsidiaries that is not regularly collected or analyzed.
Deferred tax effects
The Tax Act reduces the U.S. statutory tax rate from 35% to 21% for years after 2017. Accordingly, we have remeasured our deferred taxes as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. We recognized a deferred tax benefit of $376 million to reflect the reduced U.S. tax rate and other effects of the Tax Act. Although the tax rate reduction is known, we have not collected the necessary data to complete our analysis of the effect of the Tax Act on the underlying deferred taxes and as such, the amounts recorded as of December 31, 2017 are provisional.
The net tax expense recognized in 2017 related to the Tax Act was $9.9 billion. As we complete our analysis of the Tax Act and incorporate additional guidance that may be issued by the U.S. Treasury Department, the IRS or other standard-setting bodies, we may identify additional effects not reflected as of December 31, 2017.
The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows:
|
| | | | | | | | |
| Year Ended December 31, |
| 2015 | | 2016 | | 2017 |
U.S. federal statutory tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
Foreign income taxed at different rates | (13.4 | )% | | (11.0 | )% | | (14.2 | )% |
Impact of the Tax Act |
|
| |
|
| |
|
|
One-time transition tax | 0.0 | % | | 0.0 | % | | 37.6 | % |
Deferred tax effects | 0.0 | % | | 0.0 | % | | (1.4 | )% |
Federal research credit | (2.1 | )% | | (2.0 | )% | | (1.8 | )% |
Stock-based compensation expense | 0.3 | % | | (3.4 | )% | | (4.5 | )% |
European Commission Fine | 0.0 | % | | 0.0 | % | | 3.5 | % |
Other adjustments | (3.0 | )% | | 0.7 | % | | (0.8 | )% |
Effective tax rate | 16.8 | % | | 19.3 | % | | 53.4 | % |
Our effective tax rate for each of the years presented was impacted by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. Substantially all of the income from foreign operations was earned by an Irish subsidiary. Beginning in 2018, earnings realized in foreign jurisdictions will be subject to U.S. tax in accordance with the Tax Act.
On July 27, 2015, the United States Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. The IRS served a Notice of Appeal on February 22, 2016 and the case is being heard by the Ninth Circuit Court of Appeals. At this time, the U.S. Treasury has not withdrawn the requirement to include stock-based compensation from its regulations. We have evaluated the opinion and continue to record a tax benefit related to reimbursement of cost share payments for the previously shared stock-based compensation costs. In accordance with the Tax Act, the Altera tax benefit was remeasured from 35% to 21%. We also remeasured the tax benefit expected to be realized upon settlement including the expected future new taxes enacted by the Tax Act due upon resolution of the matter. The tax liability recorded as of December 31, 2016 for the U.S. tax cost of the potential repatriation associated with the contingent foreign earnings was reversed due to the Tax Act introducing a territorial tax system and providing a 100% dividend received deduction on certain qualified dividends from foreign subsidiaries. We will continue to monitor developments related to the case and the potential impact on our consolidated financial statements.
Deferred Income Taxes
Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We recorded a provisional adjustment to our U.S. deferred income taxes as of December 31, 2017 to reflect the reduction in the U.S. statutory tax rate from 35% to 21% resulting from the Tax Act. Significant components of our deferred tax assets and liabilities are as follows (in millions):
|
| | | | | | | |
| As of December 31, |
| 2016 | | 2017 |
Deferred tax assets: | | | |
Stock-based compensation expense | $ | 574 |
| | $ | 251 |
|
Accrued employee benefits | 939 |
| | 285 |
|
Accruals and reserves not currently deductible | 500 |
| | 717 |
|
Tax credits | 631 |
| | 1,187 |
|
Basis difference in investment of Arris | 1,327 |
| | 849 |
|
Prepaid cost sharing | 4,409 |
| | 498 |
|
Net Operating Losses | 305 |
| | 320 |
|
Other | 621 |
| | 379 |
|
Total deferred tax assets | 9,306 |
| | 4,486 |
|
Valuation allowance | (2,076 | ) | | (2,531 | ) |
Total deferred tax assets net of valuation allowance | 7,230 |
| | 1,955 |
|
Deferred tax liabilities: | | | |
Depreciation and amortization | (877 | ) | | (551 | ) |
Identified intangibles | (844 | ) | | (419 | ) |
Renewable energy investments | (788 | ) | | (531 | ) |
Foreign earnings | (4,409 | ) | | (68 | ) |
Other | (155 | ) | | (136 | ) |
Total deferred tax liabilities | (7,073 | ) | | (1,705 | ) |
Net deferred tax assets | $ | 157 |
| | $ | 250 |
|
As of December 31, 2017, our federal and state net operating loss carryforwards for income tax purposes were approximately $931 million and $785 million, respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2021 and the state net operating loss carryforwards will begin to expire in 2018. It is more likely than not that certain federal net operating loss carryforwards and our state net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. Our foreign net operating loss carryforwards for income tax purposes were $327 million that will begin to expire in 2021.
As of December 31, 2017, our California research and development credit carryforwards for income tax purposes were approximately $1.8 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized.
As of December 31, 2017, we maintained a valuation allowance with respect to certain of our deferred tax assets relating primarily to investment losses that are capital in nature, California deferred tax assets, certain federal net operating losses, and certain foreign net operating losses that we believe are not likely to be realized. We established a deferred tax asset for the book-to-tax basis difference in our investments in Arris shares received from the sale of the Motorola Home business to Arris in 2013. Since any future losses to be recognized upon the sale of Arris shares will be capital losses, a valuation allowance has been recorded against this deferred tax asset to the extent such deferred tax asset is not likely to be covered by capital gains generated as of December 31, 2017. We reassess the valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.
Uncertain Tax Positions
The following table summarizes the activity related to our gross unrecognized tax benefits from January 1, 2015 to December 31, 2017 (in millions):
|
| | | | | | | | | | | |
| 2015 | | 2016 | | 2017 |
Beginning gross unrecognized tax benefits | $ | 3,294 |
| | $ | 4,167 |
| | $ | 5,393 |
|
Increases related to prior year tax positions | 224 |
| | 899 |
| | 685 |
|
Decreases related to prior year tax positions | (176 | ) | | (157 | ) | | (257 | ) |
Decreases related to settlement with tax authorities | (27 | ) | | (196 | ) | | (1,875 | ) |
Increases related to current year tax positions | 852 |
| | 680 |
| | 750 |
|
Ending gross unrecognized tax benefits | $ | 4,167 |
| | $ | 5,393 |
| | $ | 4,696 |
|
The total amount of gross unrecognized tax benefits was $4.2 billion, $5.4 billion, and $4.7 billion as of December 31, 2015, 2016, and 2017, respectively, of which, $3.6 billion, $4.3 billion, and $3.0 billion if recognized, would affect our effective tax rate. The decrease in gross unrecognized tax benefits in 2017 was primarily as a result of the resolution of a multi-year U.S. audit.
As of December 31, 2016 and 2017, we had accrued $493 million and $362 million in interest and penalties in provision for income taxes, respectively.
We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions, our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS completed its examination through our 2012 tax years; all issues have been concluded except for one which is currently under review in the U.S. Tax Court. The IRS is currently examining our 2013 through 2015 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented.
Our 2016 tax year remains subject to examination by the IRS for U.S. federal tax purposes, and our 2011 through 2016 tax years remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements.
We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the impact, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions.
We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, closure of audits is not certain, it is reasonably possible that certain U.S. federal and non-U.S. tax audits may be concluded within the next 12 months, which could significantly increase or decrease the balance of our gross unrecognized tax benefits.
We estimate that our unrecognized tax benefits as of December 31, 2017 could possibly decrease by approximately $500 million in the next 12 months. Positions that may be resolved include various U.S. and non-U.S. matters.