Income Taxes

The income tax expense applicable to income before income taxes consists of the following:



	Year Ended
	January 26, 2014			January 27, 2013		January 29, 2012
	(In thousands)
Current income taxes:
Federal	$	7,896		$	7,506	$	7,099
State	1,234			1,016		789
Foreign	18,513			16,766		7,630
Total current	27,643			25,288		15,518
Deferred taxes:
Federal	17,070			28,143		25,111
State	—			—		—
Foreign	(1,640		)	3,717		(6,055		)
Total deferred	15,430			31,860		19,056
Charge in lieu of taxes attributable to employer stock option plans	27,191			42,355		47,732
Income tax expense	$	70,264		$	99,503	$	82,306

Income before income taxes consists of the following:



	Year Ended
	January 26, 2014		January 27, 2013		January 29, 2012
	(In thousands)
Domestic	$	79,136	$	99,422	$	120,768
Foreign	431,118		562,617		542,628
Income before income tax	$	510,254	$	662,039	$	663,396

The income tax expense (benefit) differs from the amount computed by applying the federal statutory income tax rate of 35% to income (loss) before income taxes as follows:



	Year Ended
	January 26, 2014			January 27, 2013			January 29, 2012
	(In thousands)
Tax expense computed at federal statutory rate	$	178,589		$	231,714		$	232,189
State income taxes, net of federal tax effect	1,608			1,048			2,302
Foreign tax rate differential	(93,831		)	(123,626		)	(142,071		)
U.S. federal R&D tax credit	(30,155		)	(29,294		)	(24,270		)
Stock-based compensation	8,900			11,876			10,983
Tax expense related to intercompany transaction	9,785			9,785			1,533
Other	(4,632		)	(2,000		)	1,640
Income tax expense	$	70,264		$	99,503		$	82,306

The tax effect of temporary differences that gives rise to significant portions of the deferred tax assets and liabilities are presented below:



	January 26, 2014			January 27, 2013
	(In thousands)
Deferred tax assets:
Net operating loss carryforwards	$	81,629		$	84,156
Accruals and reserves, not currently deductible for tax purposes	131,932			121,644
Property, equipment and intangible assets	48,358			54,636
Research and other tax credit carryforwards	306,975			271,933
Stock-based compensation	33,135			34,187
Convertible debt	14,885			—
Gross deferred tax assets	616,914			566,556
Less: valuation allowance	(244,487		)	(224,774		)
Total deferred tax assets	$	372,427		$	341,782
Deferred tax liabilities:
Acquired intangibles	$	(33,244	)	$	(43,878	)
Unremitted earnings of foreign subsidiaries	(425,401		)	(383,591		)
Gross deferred tax liabilities	$	(458,645	)	$	(427,469	)
Net deferred tax liability	$	(86,218	)	$	(85,687	)

We recognized income tax expense of $70.3 million, $99.5 million, and $82.3 million during fiscal years 2014, 2013 and 2012, respectively. Income tax expense as a percentage of income before taxes, or our annual effective tax rate, was 13.8% in fiscal year 2014, 15.0% in fiscal year 2013 and 12.4% in fiscal year 2012.

Our effective tax rate on income or loss before tax for the fiscal years was lower than the United States federal statutory rate of 35% due to income or loss earned in jurisdictions, including British Virgin Islands, Hong Kong, China, Taiwan and United Kingdom, where the tax rate is lower than the United States federal statutory tax rate of 35%, favorable recognition in these fiscal years of the U.S. federal R&D tax credit and release of tax reserves as a result of the expiration of statutes of limitations in certain non-U.S. jurisdictions for which we had not previously recognized related tax benefits. As of January 26, 2014 and January 27, 2013 we had a valuation allowance of $244.5 million and $224.8 million, respectively, related to state and certain foreign deferred tax assets that management determined not likely to be realized due, in part, to projections of future taxable income. To the extent realization of the deferred tax assets becomes more-likely-than-not, we would recognize such deferred tax asset as an income tax benefit during the period.

Our deferred tax assets do not include the excess tax benefit related to stock-based compensation that are a component of our federal and state net operating loss and research tax credit carryforwards in the amount of $427.9 million as of January 26, 2014. Consistent with prior years, the excess tax benefit reflected in our net operating loss and research tax credit carryforwards will be accounted for as a credit to stockholders' equity, if and when realized. In determining if and when excess tax benefits have been realized, we have elected to utilize the with-and-without approach with respect to such excess tax benefits. We have also elected to ignore the indirect tax effects of stock-based compensation deductions for financial and accounting reporting purposes, and specifically to recognize the full effect of the research tax credit in income from operations.

As of January 26, 2014, we had a federal net operating loss carryforward of $601.8 million, combined state net operating loss carryforwards of $716.0 million, and combined foreign net operating loss carryforwards of $366.9 million. The federal net operating loss carryforwards will expire beginning in fiscal year 2022 and the state net operating loss carryforwards will begin to expire in fiscal year 2015 in accordance with the rules of each particular state. The total foreign net operating loss carryforwards of $366.9 million, include $91.4 million attributable to Germany, $250.4 million attributable to UK, both of which may be carried forward indefinitely, $21.0 million attributable to Canada and the remainder to other foreign jurisdictions that begin to expire in fiscal year 2015. As of January 26, 2014, we had federal research tax credit carryforwards of $387.7 million that will begin to expire in fiscal year 2018. We have other federal tax credit carryforwards of $1.5 million that will begin to expire in fiscal year 2015. The research tax credit carryforwards attributable to states is in the amount of $369.2 million, of which $358.2 million is attributable to the State of California and may be carried over indefinitely, and $11.0 million is attributable to various other states and will expire beginning in fiscal year 2015 according to the rules of each particular state. We have other state tax credit carryforwards of $3.0 million that will expire in fiscal year 2026 and other foreign tax credit carryforwards of $15.7 million, of which $4.7 million may be refunded in fiscal year 2016, $4.8 million may be refunded in fiscal year 2017 and $6.2 million may be refunded in fiscal year 2018 if not utilized. Our tax attributes, net operating loss and tax credit carryforwards, remain subject to audit and may be adjusted for changes or modification in tax laws, other authoritative interpretations thereof, or other facts and circumstances. Utilization of federal, state, and foreign net operating losses and tax credit carryforwards may also be subject to limitations due to ownership changes and other limitations provided by the Internal Revenue Code and similar state and foreign tax provisions. If any such limitations apply, the federal, states, or foreign net operating loss and tax credit carryforwards, as applicable, may expire or be denied before utilization.

As of January 26, 2014, U.S. federal and state income taxes have not been provided on approximately $1.96 billion of undistributed earnings of non-United States subsidiaries as such earnings are considered to be indefinitely reinvested. We have not provided the amount of unrecognized deferred tax liabilities for temporary differences related to investments in our foreign subsidiaries as the determination of such amount is not practicable.

As of January 26, 2014, we had $237.7 million of gross unrecognized tax benefits, of which $215.4 million would affect our effective tax rate if recognized. However, included in the unrecognized tax benefits that would affect our effective tax rate if recognized of $215.4 million is $40.3 million and $0.2 million related to state and foreign income tax, respectively, that, if recognized, would be in the form of a carryforward deferred tax asset that would likely attract a full valuation allowance. The $215.4 million of unrecognized tax benefits as of January 26, 2014 consisted of $107.1 million recorded in non-current income taxes payable and $108.3 million reflected as a reduction to the related deferred tax assets.

A reconciliation of gross unrecognized tax benefits is as follows:



	January 26, 2014			January 27, 2013			January 29, 2012
	(In thousands)
Balance at beginning of period	$	220,543		$	138,262		$	121,034
Increases in tax positions for prior years	—			18,800			385
Decreases in tax positions for prior years	(714		)	(304		)	(293		)
Increases in tax positions for current year	22,787			67,764			22,181
Settlements	—			—			—
Lapse in statute of limitations	(4,878		)	(3,979		)	(5,045		)
Balance at end of period	$	237,738		$	220,543		$	138,262

We classify an unrecognized tax benefit as a current liability, or as a reduction of the amount of a net operating loss carry-forward or amount refundable, to the extent that we anticipate payment or receipt of cash for income taxes within one year. Likewise, the amount is classified as a long-term liability if we anticipate payment or receipt of cash for income taxes during a period beyond a year.

Our policy is to include interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of January 26, 2014, January 27, 2013, and January 29, 2012, we had accrued $12.9 million, $11.3 million, and $9.5 million, respectively, for the payment of interest and penalties related to unrecognized tax benefits, which is not included as a component of our unrecognized tax benefits. As of January 26, 2014, non-current income taxes payable of $120.0 million consisted of unrecognized tax benefits of $107.1 million, reduced by the associated federal deduction for state taxes, and the related interest and penalties of $12.9 million.

While we believe that we have adequately provided for all tax positions, amounts asserted by tax authorities could be greater or less than our accrued position. Accordingly, our provisions on federal, state and foreign tax-related matters to be recorded in the future may change as revised estimates are made or the underlying matters are settled or otherwise resolved. As of January 26, 2014, we do not believe that our estimates, as otherwise provided for, on such tax positions will significantly increase or decrease within the next twelve months.

We are subject to taxation by a number of taxing authorities both in the United States and throughout the world. As of January 26, 2014, the material tax jurisdictions that may be subject to examination include the United States, Taiwan, Canada, China, Germany, Hong Kong, France, Japan, and India for fiscal years 2003 through 2013. As of January 26, 2014, the material tax jurisdictions for which we are currently under examination include India and Germany for fiscal years 2003 through 2012.