Note 16 INCOME TAXES

The components of income before income taxes and earnings in equity interests are as follows (in thousands):


	Years Ended December 31,
	2011		2012		2013
United States	$	533,262	$	5,056,643	$	538,824
Foreign		294,254		157,564		94,459

Income before income taxes and earnings in equity interests	$	827,516	$	5,214,207	$	633,283

The provision for income taxes is composed of the following (in thousands):


	Years Ended December 31,
	2011			2012			2013
Current:
United States federal	$	141,922		$	2,278,759		$	138,032
State		(11,037	)		361,788			49,872
Foreign		40,490			68,816			49,790

Total current provision for income taxes		171,375			2,709,363			237,694

Deferred:
United States federal		77,012			(741,628	)		(63,166	)
State		(4,437	)		(29,470	)		(22,498	)
Foreign		(2,183	)		1,778			1,362

Total deferred provision (benefit) for income taxes		70,392			(769,320	)		(84,302	)

Provision for income taxes	$	241,767		$	1,940,043		$	153,392

The provision for income taxes differs from the amount computed by applying the federal statutory income tax rate to income before income taxes and earnings in equity interests as follows (in thousands):


	Years Ended December 31,
	2011			2012			2013
Income tax at the U.S. federal statutory rate of 35 percent	$	289,630		$	1,824,973		$	221,648
State income taxes, net of federal benefit		4,627			237,637			23,000
Stock-based compensation expense		20,021			19,946			16,015
Research tax credits		(10,499	)		—			(18,036	)
Effect of non-U.S. operations		(49,781	)		(138,078	)		(47,968	)
Settlement with tax authorities		(14,685	)		(4,711	)		(46,943	)
Remeasurement of prior year tax positions		—			—			(24,246	)
Acquisition related non-deductible expenses		—			1,894			9,296
Goodwill impairment charge		—			—			22,244
Other		2,454			(1,618	)		(1,618	)

Provision for income taxes	$	241,767		$	1,940,043		$	153,392

Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of deferred income tax assets and liabilities are as follows (in thousands):


	December 31,
	2012			2013
Deferred income tax assets:
Net operating loss and tax credit carryforwards	$	219,054		$	148,060
Stock-based compensation expense		81,910			66,583
Non-deductible reserves and expenses		265,751			431,374
Depreciation expense		21,386			22,937
Unrealized investment gains		3,584			2,878
Intangible assets		5,861			7,764

Gross deferred income tax assets		597,546			679,596
Valuation allowance		(51,503	)		(36,690	)

Deferred income tax assets	$	546,043		$	642,906

Deferred income tax liabilities:
Purchased intangible assets		(29,960	)		(156,435	)
Depreciation expense		(118,808	)		(86,641	)
Investments in equity interests		(13,120	)		(323,368	)
Restructuring liabilities		(6,547	)		(7,235	)

Deferred income tax liabilities	$	(168,435	)	$	(573,679	)

Net deferred income tax assets	$	377,608		$	69,227

As of December 31, 2013, the Company’s federal and state net operating loss carryforwards for income tax purposes were approximately $299 million and $31 million, respectively. The federal and state net operating loss carryforwards are subject to various limitations under Section 382 of the Internal Revenue Code and applicable state tax law. If not utilized, the federal and state net operating loss carryforwards will begin to expire in 2021.

The federal research and development credit expired on December 31, 2011. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law retroactively extending the credit for amounts paid or incurred after December 31, 2011 and before January 1, 2014. As such, the provision for income taxes for the year ended December 31, 2013 reflects the benefit of both the 2012 and 2013 federal research and development tax credit. The Company’s state research tax credit carryforward for income tax purposes is approximately $177 million and it can be carried forward indefinitely. Tax credit carryforwards that result from the exercise of employee stock options are not recorded on the Company’s consolidated balance sheets and are accounted for as a credit to additional paid-in capital if and when realized through a reduction in income taxes payable.

The Company has a valuation allowance of approximately $37 million as of December 31, 2013 against certain deferred income tax assets that are not more likely than not to be realized in future periods. In evaluating the Company’s ability to realize its deferred income tax assets, the Company considers all available positive and negative evidence, including operating results, ongoing tax planning, and forecasts of future taxable income on a jurisdiction by jurisdiction basis. The valuation allowance as of December 31, 2013 relates to foreign net operating loss carryforwards that will reduce the provision for income taxes if and when recognized.

The U.S. Department of the Treasury issued final regulations on the deduction and capitalization of expenditures related to tangible property for income tax purposes. These regulations apply to the Company’s tax year beginning on January 1, 2014. Based on its assessment as of December 31, 2013, these regulations will not have a material impact on the Company’s financial position, results of operations, or cash flows.

In 2012, the Company made a one-time distribution of foreign earnings resulting in an overall net benefit of $117 million. During 2013, the Company recorded an additional net benefit of $36 million related to this distribution. As of December 31, 2013, the Company does not anticipate a repatriation of its undistributed foreign earnings of approximately $2.6 billion. Those earnings are principally related to Yahoo Japan. If these earnings were to be repatriated in the future, the Company may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits). It is not practicable to determine the income tax liability that might be incurred if these earnings were to be repatriated.

The total amount of gross unrecognized tax benefits was $695 million as of December 31, 2013, of which up to $466 million would affect the Company’s effective tax rate if realized. A reconciliation of the beginning and ending amount of unrecognized tax benefits in 2012 and 2013 is as follows (in thousands):


	2012			2013
Unrecognized tax benefits balance at January 1	$	532,862		$	727,367
Gross increase for tax positions of prior years		9,441			69,188
Gross decrease for tax positions of prior years		(32,513	)		(40,298	)
Gross increase for tax positions of current year		231,525			34,556
Settlements		(10,520	)		(94,640	)
Lapse of statute of limitations		(3,428	)		(888	)

Unrecognized tax benefits balance at December 31	$	727,367		$	695,285

The remaining balances are recorded on the Company’s consolidated balance sheets as follows (in thousands):


	December 31,
	2012			2013
Total unrecognized tax benefits balance	$	727,367		$	695,285
Amounts netted against related deferred tax assets		(83,635	)		(89,048	)

Unrecognized tax benefits recorded on consolidated balance sheets	$	643,732		$	606,237

Amounts classified as accrued expenses and other current liabilities	$	30,484		$	—
Amounts classified as deferred and other long-term tax liabilities, net		613,248			606,237

Unrecognized tax benefits recorded on consolidated balance sheets	$	643,732		$	606,237

The Company recognizes interest and/or penalties related to uncertain tax positions in income tax expense. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision in the period that such determination is made. During 2011, 2012 and 2013, interest and penalties recorded in the consolidated statements of income were a credit of $2 million and a charge of $37 million and $21 million (net of interest received of $4 million), respectively. The amounts of accrued interest and penalties recorded on the consolidated balance sheets as of December 31, 2012 and 2013 were approximately $51 million and $76 million, respectively.

In 2013, the Company settled the IRS income tax examination for the 2005 and 2006 returns resulting in a benefit of approximately $54 million. In addition, the Company recorded a reduction of tax reserves of approximately $24 million based on proposed adjustments to its intercompany transfer pricing methodology for the 2007 and 2008 returns. As of December 31, 2013, the Company’s federal 2009 and 2010 income tax returns are currently under the IRS examination. The Company’s 2005 through 2008 tax returns are also under various stages of audit by the California Franchise Tax Board. While the California Franchise Tax Board has not reached any conclusions on the 2007 and 2008 returns, the Company has protested the proposed California Franchise Tax Board’s adjustments to the 2005 and 2006 returns. The Company is also in various stages of examination and appeal in connection with its taxes in foreign jurisdictions, which generally span tax years 2005 through 2012.

It is difficult to predict when the examinations will be settled or their final outcomes. The Company believes that it has adequately provided for any reasonably foreseeable adjustment and that any settlement will not have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

The Company may have additional tax liabilities in China related to the sale to Alibaba Group of 523 million Alibaba Group Shares that took place during the year ended December 31, 2012. Any taxes assessed and paid in China are expected to be ultimately offset and recovered in the U.S.

During the year ended December 31, 2012, tax authorities from the Brazilian State of Sao Paulo assessed certain indirect taxes against the Company’s Brazilian subsidiary, Yahoo! do Brasil Internet Ltda., related to online advertising services. The assessment totaling approximately $85 million is for calendar years 2008 and 2009. The Company currently believes the assessment is without merit. The Company believes the risk of loss is remote and has not recorded an accrual for the assessment.