Note 15. Income Taxes

Income before income taxes included income from domestic operations of $3,579 million, $4,948 million, and $4,693 million for 2009, 2010, and 2011, and income from foreign operations of $4,802 million, $5,848 million, and $7,633 million for 2009, 2010, and 2011. Substantially all of the income from foreign operations was earned by an Irish subsidiary.

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


	Year Ended December 31,
	2009			2010			2011
Current:
Federal	$	1,531		$	1,657		$	1,724
State		450			458			274
Foreign		148			167			248

Total		2,129			2,282			2,246

Deferred:
Federal		(273	)		(25	)		452
State		13			47			(109	)
Foreign		(8	)		(13	)		(0	)

Total		(268	)		9			343

Provision for income taxes	$	1,861		$	2,291		$	2,589

The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows (in millions):


	Year ended December 31,
	2009			2010			2011
Expected provision at federal statutory tax rate (35%)	$	2,933		$	3,779		$	4,314
State taxes, net of federal benefit		302			322			122
Stock-based compensation expense		63			79			105
Change in valuation allowance		(41	)		(34	)		27
Foreign rate differential		(1,339	)		(1,769	)		(2,001	)
Federal research credit		(56	)		(84	)		(140	)
Tax exempt interest		(15	)		(12	)		(10	)
Non-deductible legal settlement		0			0			175
Other permanent differences		14			10			(3	)

Provision for income taxes	$	1,861		$	2,291		$	2,589

We have not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, 2011 because we intend to permanently reinvest such earnings outside the U.S. If these foreign earnings were to be repatriated in the future, the related U.S. tax liability may be reduced by any foreign income taxes previously paid on these earnings. As of December 31, 2011, the cumulative amount of earnings upon which U.S. income taxes have not been provided is approximately $24.8 billion. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable.

Deferred Tax Assets

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. Significant components of our deferred tax assets and liabilities are as follows (in millions):


	As of December 31,
	2010			2011
Deferred tax assets:
Stock-based compensation expense	$	299		$	288
State taxes		207			138
Capital loss from impairment of equity investments		292			285
Settlement with the Authors Guild and AAP		39			35
Depreciation and amortization		20			0
Vacation accruals		35			52
Deferred rent		34			43
Accruals and reserves not currently deductible		244			268
Acquired net operating losses		132			156
State tax credit		0			55
Other		0			11

Total deferred tax assets		1,302			1,331
Valuation allowance		(292	)		(333	)

Total deferred tax assets net of valuation allowance		1,010			998
Deferred tax liabilities:
Depreciation and amortization		0			(479	)
Identified intangibles		(308	)		(398	)
Unrealized gains on investments and other		(56	)		(90	)
Other prepaids		(95	)		(70	)
Other		(27	)		(33	)

Total deferred tax liabilities		(486	)		(1,070	)

Net deferred tax assets (liabilities)	$	524		$	(72	)

As of December 31, 2011, our federal and state net operating loss carryforwards for income tax purposes were approximately $420 million and $310 million. If not utilized, the federal net operating loss carryforwards will begin to expire in 2018 and the state net operating loss carryforwards will begin to expire in 2014. The net operating loss carryforwards are subject to various annual limitations under Section 382 of the Internal Revenue Code.

As of December 31, 2011, our California research and development credit carryforwards for income tax purposes were approximately $55 million that can be carried over indefinitely. We believe it is more likely than not that a portion of the state tax credit will not be realized. Therefore, we have recorded a valuation allowance on the state tax credit carryforward in the amount of $48 million. We will 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.

As of December 31, 2011, our federal and state capital loss carryforwards for income tax purposes were approximately $165 million and $422 million. We also have deferred tax assets for impairment losses that, if recognized, will be capital in nature. We believe that it is more likely than not that our deferred tax assets for capital losses and impairment losses will not be realized. Therefore, we have recorded a valuation allowance on both our federal and state deferred tax assets for these items in the amount of $285 million. We will 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, 2009 to December 31, 2011 (in millions):


Balance as of January 1, 2009	$	721
Increases related to prior year tax positions		222
Decreases related to prior year tax positions		(1	)
Increases related to current year tax positions		246

Balance as of December 31, 2009		1,188
Increases related to prior year tax positions		37
Decreases related to prior year tax positions		(197	)
Decreases related to settlement with tax authorities		(47	)
Decreases as a result of a lapse of applicable statute of limitation		(97	)
Increases related to current year tax positions		256

Balance as of December 31, 2010		1,140
Increases related to prior year tax positions		77
Decreases related to prior year tax positions		(9	)
Increases related to current year tax positions		361
Decreases related to settlement with tax authorities		(5	)

Balance as of December 31, 2011	$	1,564

Our total unrecognized tax benefits that, if recognized, would affect our effective tax rate were $814 million, $951 million, and $1,350 million as of December 31, 2009, 2010, and 2011.

As of December 31, 2010 and 2011, we had accrued $97 million and $129 million for payment of interest and penalties. Interest and penalties included in our provision for income taxes were not material in all the periods presented.

We and our subsidiaries are routinely examined by various taxing authorities. Although we file U.S. federal, U.S. state, and foreign tax returns, our two major tax jurisdictions are the U.S. and Ireland. During the three months ended December 31, 2007, the IRS completed its examination of our 2003 and 2004 tax years. We have filed an appeal with the IRS for certain issues related to this audit and no resolution of the issues has been achieved at this time, but we believe we have adequately provided for these items and any adverse results would have an immaterial impact on our unrecognized tax benefit balance within the next 12 months. The IRS is currently in examination of our 2007, 2008, and 2009 tax years. We do not expect the examination to be completed within the next 12 months. Therefore, we do not anticipate any significant impact to our unrecognized tax benefit balance in 2012, related to our 2007, 2008, and 2009 tax years.

Our 2010 and 2011 tax years remain subject to examination by the IRS for U.S. federal tax purposes, and our 2003 through 2011 tax years remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are various other ongoing audits in various other jurisdictions that are not material to our financial statements.