
16.	INCOME TAXES

Income (loss) from continuing operations before income tax expense (benefit) from U.S. and international operations was as follows (in millions):



	Year Ended December 31,
	2011		2010		2009
U.S. operations	$	3,190	$	1,436	$	(371	)
International operations	132		62		55
Income (loss) from continuing operations before income tax expense (benefit)	$	3,322	$	1,498	$	(316	)

The following is a reconciliation of income tax expense (benefit) related to continuing operations to income taxes computed by applying the U.S. statutory federal income tax rate (35 percent for all years presented) to income (loss) from continuing operations before income tax expense (benefit) (in millions):



	Year Ended December 31,
	2011			2010			2009
Federal income tax expense (benefit) at the U.S. statutory rate	$	1,163		$	524		$	(111	)
U.S. state income tax expense (benefit), net of U.S. federal income tax effect	29			(21		)	(2		)
U.S. manufacturing deduction	(28		)	5			7
International operations	46			27			75
Permanent differences	8			8			(7		)
Change in tax law	—			16			—
Other, net	8			16			(5		)
Income tax expense (benefit)	$	1,226		$	575		$	(43	)

The Aruba Refinery’s profits through June 1, 2010 were non-taxable in Aruba due to a tax holiday granted by the GOA. The tax holiday, which expired on June 1, 2010, had an immaterial effect on our results of operations for the years ended December 31, 2010 and 2009.

The income tax benefit related to discontinued operations for the years ended December 31, 2011, 2010, and 2009 was $4 million, $370 million, and $1.1 billion, respectively.

Components of income tax expense (benefit) related to continuing operations were as follows (in millions):



	Year Ended December 31,
	2011			2010			2009
Current:
U.S. federal	$	562		$	(75	)	$	(309	)
U.S. state	13			(13		)	(16		)
International	186			22			142
Total current	761			(66		)	(183		)

Deferred:
U.S. federal	527			634			181
U.S. state	32			(19		)	12
International	(94		)	26			(53		)
Total deferred	465			641			140
Income tax expense (benefit)	$	1,226		$	575		$	(43	)

The tax effects of significant temporary differences representing deferred income tax assets and liabilities were as follows (in millions):



	December 31,
	2011			2010
Deferred income tax assets:
Tax credit carryforwards	$	158		$	99
Net operating losses (NOL)	300			265
Compensation and employee benefit liabilities	324			286
Environmental liabilities	78			85
Inventories	273			170
Property, plant and equipment	14			—
Other	160			184
Total deferred income tax assets	1,307			1,089
Less: Valuation allowance	(295		)	(270		)
Net deferred income tax assets	1,012			819

Deferred income tax liabilities:
Turnarounds	(310		)	(256		)
Property, plant and equipment	(5,292		)	(4,835		)
Inventories	(274		)	(260		)
Other	(119		)	(65		)
Total deferred income tax liabilities	(5,995		)	(5,416		)
Net deferred income tax liabilities	$	(4,983	)	$	(4,597	)

We had the following income tax credit and loss carryforwards as of December 31, 2011 (in millions):



	Amount		Expiration
U.S. state income tax credits	$	63	2013 through 2027
U.S. state income tax credits	42		Unlimited
U.S. foreign tax credits	30		2012
U.S. state NOL (gross amount)	5,431		2012 through 2031
International NOL	249		Unlimited
U.S. alternative minimum tax credit	59		Unlimited

We have recorded a valuation allowance as of December 31, 2011 and 2010 due to uncertainties related to our ability to utilize some of our deferred income tax assets, primarily consisting of certain U.S. state NOLs and income tax credits, international NOLs, and U.S. foreign tax credits, before they expire. The valuation allowance is based on our estimates of taxable income in the various jurisdictions in which we operate and the period over which deferred income tax assets will be recoverable. The realization of net deferred income tax assets recorded as of December 31, 2011 is primarily dependent upon our ability to generate future taxable income in certain U.S. states and international jurisdictions and foreign source income in the U.S.

Subsequently recognized tax benefits related to the valuation allowance for deferred income tax assets as of December 31, 2011 will be allocated as follows (in millions):



Income tax benefit	$	286
Additional paid-in capital	9
Total	$	295

Deferred income taxes have not been provided on the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases of our international subsidiaries based on the determination that such differences are essentially permanent in duration in that the earnings of these subsidiaries are expected to be indefinitely reinvested in the international operations. As of December 31, 2011, the cumulative undistributed earnings of these subsidiaries were approximately $4.9 billion. If those earnings were not considered indefinitely reinvested, deferred income taxes would have been recorded after consideration of U.S. foreign tax credits. In addition, as a result of our Pembroke Acquisition, certain U.S. tax elections may be available to us. The decision by us to forego these elections could significantly increase our taxable earnings and profits. It is not practicable to estimate the amount of additional tax that might be payable on those earnings, if distributed.

The following is a reconciliation of the change in unrecognized tax benefits, excluding the effect of related penalties and interest and the U.S. federal tax effect of U.S. state unrecognized tax benefits (in millions):



	Year Ended December 31,
	2011			2010			2009
Balance as of beginning of year	$	330		$	484		$	238
Additions based on tax positions related to the current year	14			4			158
Additions for tax positions related to prior years	55			49			106
Reductions for tax positions related to prior years	(66		)	(203		)	(6		)
Reductions for tax positions related to the lapse of applicable statute of limitations	(3		)	(4		)	(1		)
Settlements	(4		)	—			(11		)
Balance as of end of year	$	326		$	330		$	484

As of December 31, 2011, 2010, and 2009, there were $135 million, $153 million, and $155 million respectively, of unrecognized tax benefits that if recognized would affect our annual effective tax rate. We do not expect our unrecognized tax benefits to change significantly over the next 12 months.

During the years ended December 31, 2011, 2010, and 2009, we recognized approximately $1 million, $19 million, and $22 million in interest and penalties, which is reflected within income tax expense (benefit). We had accrued approximately $110 million and $109 million for the payment of interest and penalties as of December 31, 2011 and 2010, respectively.

Our tax years for 2002 through 2009 and Premcor Inc.’s separate tax years for 2004 and 2005 are currently under examination by the IRS. Premcor Inc. was merged into Valero effective September 1, 2005. The IRS proposed adjustments to our taxable income for certain open years, including adjustments related to depreciation methods and how we accounted for line fill, which is the volume of hydrocarbon materials present within our Units and pipelines necessary to maintain pressure and provide uninterrupted flow. We are protesting the proposed adjustments and do not expect that the ultimate disposition of these adjustments will result in a material change to our financial position or results of operations. Thus, we believe that adequate provisions for income taxes have been reflected in the financial statements.