Note 9—Income Taxes

Income before income taxes is comprised of the following:


	2012		2011		2010
Domestic (including Puerto Rico)	$	1,809	$	1,526	$	1,426
Foreign		958		857		628

Total	$	2,767	$	2,383	$	2,054

The provisions for income taxes for 2012, 2011, and 2010 are as follows:


	2012			2011			2010
Federal:
Current	$	591		$	409		$	445
Deferred		12			74			1

Total federal		603			483			446

State:
Current		100			78			79
Deferred		2			14			5

Total state		102			92			84

Foreign:
Current		312			270			200
Deferred		(17	)		(4	)		1

Total foreign		295			266			201

Total provision for income taxes	$	1,000		$	841		$	731

Tax benefits associated with the exercise of employee stock options and other employee stock programs were allocated to equity attributable to Costco in the amount of $65, $59, and $15, in 2012, 2011, and 2010, respectively.

The reconciliation between the statutory tax rate and the effective rate for 2012, 2011, and 2010 is as follows:


	2012					2011					2010
Federal taxes at statutory rate	$	969		35.0	%	$	834		35.0	%	$	718		35.0	%
State taxes, net		59		2.1			55		2.4			56		2.7
Foreign taxes, net		(61	)	(2.2	)		(66	)	(2.8	)		(38	)	(1.9	)
Other		33		1.2			18		0.7			(5	)	(0.2	)

Total	$	1,000		36.1	%	$	841		35.3	%	$	731		35.6	%

The Company’s provision for income taxes for 2012 was adversely impacted by nonrecurring net tax expense of $25 relating primarily to the following items: the adverse impact of an audit of Costco Mexico by the Mexican tax authority; the tax effects of the cash dividend declared by Costco Mexico (included in Other in the table above); and the tax effects of nondeductible expenses for the Company’s contribution to an initiative reforming alcohol beverage laws in Washington State.

The components of the deferred tax assets and liabilities are as follows:


	2012		2011
Equity compensation	$	79	$	89
Deferred income/membership fees		148		134
Accrued liabilities and reserves		461		429
Other		55		32

Total deferred tax assets		743		684

Property and equipment		522		494
Merchandise inventories		182		164

Total deferred tax liabilities		704		658

Net deferred tax assets	$	39	$	26

The deferred tax accounts at the end of 2012 and 2011 include current deferred income tax assets of $393 and $360 respectively, included in deferred income taxes and other current assets; non-current deferred income tax assets of $58 and $53, respectively, included in other assets; and non-current deferred income tax liabilities of $412 and $387, respectively, included in deferred income taxes and other liabilities.

The Company has not provided for U.S. deferred taxes on cumulative undistributed earnings of $3,162 and $2,646 at the end of 2012 and 2011, respectively, of certain non-U.S. consolidated subsidiaries as such earnings are deemed by the Company to be indefinitely reinvested. Because of the availability of U.S. foreign tax credits and complexity of the computation, it is not practicable to determine the U.S. federal income tax liability that would be associated with such earnings if such earnings were not deemed to be indefinitely reinvested. The Company believes that its U.S. current assets position is sufficient to meet its U.S. liquidity requirements and has no current plans to repatriate for use in the U.S. the cash and cash equivalents and short-term investments held by these subsidiaries.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2012 and 2011 is as follows:


	2012			2011
Gross unrecognized tax benefit at beginning of year	$	106		$	83
Gross increases—current year tax positions		15			21
Gross increases—tax positions in prior years		3			10
Gross decreases—tax positions in prior years		(3	)		(6	)
Settlements		(3	)		(1	)
Lapse of statute of limitations		(2	)		(1	)

Gross unrecognized tax benefit at end of year	$	116		$	106

Included in the balance at the end of 2012, are $70 of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.

The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $36 and $34 at the end of 2012 and 2011, respectively.

Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Interest and penalties were not material in 2012 and 2011, respectively. Accrued interest and penalties were $16 and $12 at the end of 2012 and 2011, respectively.

The Company is currently under audit by several taxing jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits we have recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next twelve months.

The Company files income tax returns in the United States, various state and local jurisdictions, in Canada and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2007. The Company is currently subject to examination in Canada for fiscal years 2008 to present and in California for fiscal years 2004 to present. No other examinations are believed to be material.