Note 13: Income Taxes

Following is the composition of income tax expense:

	2011	2010	2009
Current
Federal	$ 671.4	$ 376.2	$ 45.7
Foreign	759.5	513.9	772.2
State	(22.9)	23.3	49.2
Total current tax expense	1,408.0	913.4	867.1
Deferred
Federal	(398.5)	624.4	82.5
Foreign	(34.7)	(55.2)	79.8
State	27.0	(26.9)	(0.4)
Total deferred tax expense (benefit)	(406.2)	542.3	161.9
Income taxes	$1,001.8	$1,455.7	$1,029.0

Significant components of our deferred tax assets and liabilities as of December 31 are as follows:

	2011	2010
Deferred tax assets
Compensation and benefits	$1,286.5	$ 890.4
Tax credit carryforwards and carrybacks	695.3	503.1
Asset purchases	428.5	275.1
Tax loss carryforwards and carrybacks	406.1	414.0
Intercompany profit in inventories	277.2	316.7
Debt	214.9	114.6
Sale of intangibles	207.1	112.8
Product return reserves	146.2	84.0
Contingencies	94.5	106.6
Other	301.3	363.4
Total gross deferred tax assets	4,057.6	3,180.7
Valuation allowances	(611.9)	(473.1)

Total deferred tax assets	3,445.7	2,707.6

Deferred tax liabilities
Unremitted earnings	(940.2)	(741.8)
Intangibles	(839.9)	(954.9)
Inventories	(489.2)	(525.6)
Property and equipment	(451.0)	(505.2)
Financial instruments	(196.9)	(160.9)
Other	(8.5)	(19.1)
Total deferred tax liabilities	(2,925.7)	(2,907.5)

Deferred tax assets (liabilities) - net	$ 520.0	$ (199.9)

At December 31, 2011 and 2010, no individually significant items were classified as "Other" deferred tax assets or liabilities.

The deferred tax asset and related valuation allowance amounts for U.S. and state net operating losses and tax credits shown above have been reduced for differences between financial reporting and tax return filings. At December 31, 2011, based on filed tax returns we had net operating losses and other carryforwards for international and U.S. income tax purposes of $780.8 million: $335.5 million will expire within 5 years; $404.8 million will expire between 5 and 20 years; and $40.5 million of the carryforwards will never expire. The remaining balance of the deferred tax asset for tax loss carryforwards and carrybacks is related to net operating losses for state income tax purposes that are substantially reserved.

Based on filed tax returns, we also have tax credit carryforwards and carrybacks of $1.01 billion available to reduce future income taxes; $514.4 million will be carried back; $53.0 million of the tax credit carryforwards will expire between 10 and 20 years; and $1.3 million of the tax credit carryforwards will never expire. The remaining portion of the tax credit carryforwards is related to federal tax credits of $93.8 million and state tax credits of $349.4 million, both of which are fully reserved.

Domestic and Puerto Rican companies contributed approximately 24 percent, 45 percent, and 39 percent for the years ended December 31, 2011, 2010, and 2009, respectively, to consolidated income before income taxes. We have a subsidiary operating in Puerto Rico under a tax incentive grant. The current tax incentive grant will not expire prior to 2017.

At December 31, 2011, we had an aggregate of $20.60 billion of unremitted earnings of foreign subsidiaries that have been or are intended to be permanently reinvested for continued use in foreign operations and that, if distributed, would result in additional income tax expense at approximately the U.S. statutory rate.

Cash payments of income taxes totaled $943.0 million, $861.0 million, and $1.14 billion, for the years ended December 31, 2011, 2010, and 2009, respectively.

Following is a reconciliation of the income tax expense applying the U.S. federal statutory rate to income before income taxes to reported income tax expense:

	2011	2010	2009
Income tax at the U.S. federal statutory tax rate	$1,872.3	$2,283.8	$1,875.2
Add (deduct)
International operations, including Puerto Rico	(796.7)	(823.3)	(741.1)
U.S. health care reform	62.9	85.1	0.0
General business credits	(80.8)	(83.2)	(79.4)
IRS audit conclusion	(85.3)	0.0	(54.4)
Other	29.4	(6.7)	28.7
Income taxes	$1,001.8	$1,455.7	$1,029.0

In October 2010, Puerto Rico enacted excise tax legislation that affected our operations beginning with the year ended December 31, 2011. The excise tax is imposed on the purchase of goods and services from a related manufacturer in Puerto Rico, and is therefore included in costs of sales in our consolidated statement of operations rather than income taxes. The Internal Revenue Service (IRS) has stated it would not challenge a taxpayer's position that this excise tax is creditable for U.S. income tax purposes, pending the resolution of numerous legal and factual issues. As a result, the 2011 benefit on international operations reported in the effective tax rate reconciliation above includes the benefit from the foreign tax credit related to the excise tax.

The U.S. health care legislation (both the primary "Patient Protection and Affordable Care Act" and the "Health Care and Education Reconciliation Act") eliminated the tax-free nature of the subsidy we receive for sponsoring retiree drug coverage that is "actuarially equivalent" to Medicare Part D. This provision is effective January 1, 2013. While this change has a future impact on our net tax deductions related to retiree health benefits, we were required to record a one-time charge to adjust our deferred tax asset for this change in the law in the quarter of enactment. Accordingly, we recorded a non-cash charge of $85.1 million in the first quarter of 2010. In addition, U.S. health care reform mandated an annual industry fee effective January 1, 2011, which is not deductible for tax purposes.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows:

	2011	2010	2009
Beginning balance at January 1	$1,619.6	$1,351.2	$1,223.2
Additions based on tax positions related to the current year	89.4	186.2	179.1
Additions for tax positions of prior years	390.0	117.0	170.4
Reductions for tax positions of prior years	(492.3)	(30.2)	(128.9)
Lapses of statutes of limitation	(2.6)	(7.0)	(3.3)
Settlements	(326.3)	(0.1)	(95.0)
Changes related to the impact of foreign currency translation	(3.0)	2.5	5.7
Balance at December 31	$1,274.8	$1,619.6	$1,351.2

The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate was $812.3 million and $1.07 billion at December 31, 2011 and 2010, respectively.

We file income tax returns in the U.S. federal jurisdiction and various state, local, and non-U.S. jurisdictions. We are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations in major taxing jurisdictions for years before 2007.

During 2011, we settled the U.S. examinations of tax years 2005-2007, along with certain matters related to tax years 2008-2009. The examination of the remainder of 2008-2009 commenced in the fourth quarter of 2011. Considering this current examination cycle, as well as the settlement of 2005-2007 and certain matters related to 2008-2009, our consolidated results of operations benefited from a reduction in tax expense of $85.3 million in 2011. We made cash payments totaling approximately $300 million for tax years 2005-2007. Because the examination of the remainder of 2008-2009 is still in the early stages, the resolution of all issues in this audit period will likely extend beyond the next 12 months.

During 2009, we settled an IRS administrative appeals matter from the 2001-2004 IRS audit. Considering the status of the 2005-2007 IRS examination at that time and the settlement of the IRS administrative appeals matter from the 2001-2004 audit, our income tax expense was reduced by $54.4 million, and a cash payment of approximately $50 million was paid, after utilization of applicable tax credit carryovers.

We recognize both accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ended December 31, 2011, 2010, and 2009, we recognized income tax expense (benefit) of $(47.3) million, $38.3 million, and $(1.9) million, respectively, related to interest and penalties. At December 31, 2011 and 2010, our accruals for the payment of interest and penalties totaled $145.1 million and $221.0 million, respectively. Substantially all of the expense (benefit) and accruals relate to interest.