Income Taxes

12 Months Ended

Dec. 31, 2019

8. Income Taxes

Components of income tax expense were as follows for the years ended December 31:



Millions	2019		2018		2017
Current tax expense:
Federal	$	1,000	$	1,144	$	1,750
State		254		287		235
Foreign		8		5		2
Total current tax expense		1,262		1,436		1,987
Deferred and other tax expense:
Federal		417		344		(5,260)
State		128		5		183
Foreign		21		(10)		10
Total deferred and other tax expense/(benefit) [a]		566		339		(5,067)
Total income tax expense/(benefit)	$	1,828	$	1,775	$	(3,080)

[a]2017 includes a ($5,935) million adjustment to income tax expense resulting from the Tax Cuts and Jobs Act. Of this amount, ($5,965) million is a federal income tax benefit and $30 million is state income tax expense.

For the years ended December 31, reconciliations between statutory and effective tax rates are as follows:



Tax Rate Percentages	2019		2018		2017
Federal statutory tax rate	21.0	%	21.0	%	35.0	%
State statutory rates, net of federal benefits	3.7		3.9		3.1
Adjustment for Tax Cuts and Jobs Act	-		-		(77.8)
Excess tax benefits from equity compensation plans	(0.7)		(0.4)		(0.6)
Other deferred tax adjustments	(0.1)		(0.6)		0.4
Other	(0.3)		(1.0)		(0.5)
Effective tax rate	23.6	%	22.9	%	(40.4)	%

Deferred tax assets and liabilities are recorded for the expected future tax consequences of events that are reported in different periods for financial reporting and income tax purposes. The majority of our deferred tax assets relate to deductions that already have been claimed for financial reporting purposes but not for tax purposes. The majority of our deferred tax liabilities relate to differences between the tax bases and financial reporting amounts of our land and depreciable property, due to accelerated tax depreciation (including bonus depreciation), revaluation of assets in purchase accounting transactions, and differences in capitalization methods.

On December 22, 2017, The Tax Cuts and Jobs Act (the Tax Act) was enacted. The Tax Act made significant changes to federal tax law, including a reduction in the federal income tax rate from 35% to 21% effective January 1, 2018, 100% bonus depreciation for certain capital expenditures, stricter limits on deductions for interest and certain executive compensation, and a one-time transition tax on previously deferred earnings of certain foreign subsidiaries. As a result of our initial analysis of the Tax Act and existing implementation guidance, we remeasured our deferred tax assets and liabilities and computed our transition tax liability net of offsetting foreign tax credits. This resulted in a $5.9 billion reduction in our income tax expense in the fourth quarter of 2017. We also recorded a $212 million reduction to our operating expense related to income tax adjustments at equity-method affiliates in the fourth quarter of 2017.

In the second quarter of 2019, Arkansas enacted legislation to reduce their corporate income tax rate for future years resulting in a $21 million reduction of our deferred tax expense.

In the second quarter of 2018, Iowa and Missouri enacted legislation to reduce their corporate tax rates for future years resulting in a $31 million reduction of our deferred tax expense.

In the third quarter of 2017, Illinois enacted legislation to increase their corporate tax rate for future years resulting in a $33 million increase of our deferred tax expense.

Deferred income tax (liabilities)/assets were comprised of the following at December 31:



Millions	2019		2018
Deferred income tax liabilities:
Property	$	(12,184)	$	(11,590)
Other		(341)		(213)
Total deferred income tax liabilities		(12,525)		(11,803)
Deferred income tax assets:
Accrued wages		45		46
Accrued casualty costs		146		148
Stock compensation		37		44
Retiree benefits		171		138
Other		134		125
Total deferred income tax assets		533		501
Net deferred income tax liability	$	(11,992)	$	(11,302)

When appropriate, we record a valuation allowance against deferred tax assets to reflect that these tax assets may not be realized. In determining whether a valuation allowance is appropriate, we consider whether it is more likely than not that all or some portion of our deferred tax assets will not be realized based on management’s judgments using available evidence for purposes of estimating whether future taxable income will be sufficient to realize a deferred tax asset. In 2019 and 2018, there were no valuation allowances.

Tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement. Unrecognized tax benefits are tax benefits claimed in our tax returns that do not meet these recognition and measurement standards.

A reconciliation of changes in unrecognized tax benefits liabilities/(assets) from the beginning to the end of the reporting period is as follows:



Millions	2019		2018		2017
Unrecognized tax benefits at January 1	$	174	$	179	$	125
Increases for positions taken in current year		20		30		38
Increases for positions taken in prior years		44		9		51
Decreases for positions taken in prior years		(96)		(30)		(56)
Refunds from/(payments to) and settlements with taxing authorities		(11)		21		64
Increases/(decreases) for interest and penalties		(5)		4		-
Lapse of statutes of limitations		(62)		(39)		(43)
Unrecognized tax benefits at December 31	$	64	$	174	$	179

We recognize interest and penalties as part of income tax expense. Total accrued liabilities for interest and penalties were $3 million and $8 million at December 31, 2019, and 2018, respectively. Total interest and penalties recognized as part of income tax expense (benefit) were ($4) million for 2019, ($1) million for 2018, and ($3) million for 2017.

In the second quarter of 2019, UPC signed final Revenue Agent Reports (RARs) from the Internal Revenue Service (IRS) for the limited scope audits of UPC’s 2016 and 2017 tax returns. As a result of the signed RARs, UPC paid the IRS $11 million in the third quarter, consisting of $10 million of tax and $1 million of interest. The statute of limitations has run for all years prior to 2016.

In 2017, UPC amended its 2013 income tax return, primarily to claim deductions resulting from the resolution of prior year IRS examinations. The IRS and Joint Committee on Taxation have completed their review of the 2013 return, and in the second quarter of 2018 we received a refund of $19 million.

In 2016, UPC amended its 2011 and 2012 income tax returns to claim deductions resulting from the resolution of IRS examinations for years prior to 2011. The IRS and Joint Committee on Taxation reviewed

these amended returns. In the third quarter of 2017, we received a refund of $62 million, consisting of $60 million of tax and $2 million of interest.

Several state tax authorities are examining our state income tax returns for years 2015 through 2017.

We do not expect our unrecognized tax benefits to change significantly in the next 12 months.

The portion of our unrecognized tax benefits that relates to permanent changes in tax and interest would reduce our effective tax rate, if recognized. The remaining unrecognized tax benefits relate to tax positions for which only the timing of the benefit is uncertain. Recognition of the tax benefits with uncertain timing would reduce our effective tax rate only through a reduction of accrued interest and penalties. The unrecognized tax benefits that would reduce our effective tax rate are as follows:



Millions	2019		2018		2017
Unrecognized tax benefits that would reduce the effective tax rate	$	39	$	63	$	83
Unrecognized tax benefits that would not reduce the effective tax rate		25		111		96
Total unrecognized tax benefits	$	64	$	174	$	179