Income Taxes

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



	Year Ended
	January 25, 2015			January 26, 2014			January 27, 2013
	(In thousands)
Current income taxes:
Federal	$	7,995		$	7,896		$	7,506
State	818			1,234			1,016
Foreign	17,356			18,513			16,766
Total current	26,169			27,643			25,288
Deferred taxes:
Federal	83,827			17,070			28,143
State	—			—			—
Foreign	(1,258		)	(1,640		)	3,717
Total deferred	82,569			15,430			31,860
Charge in lieu of taxes attributable to employer stock option plans	15,511			27,191			42,355
Income tax expense	$	124,249		$	70,264		$	99,503

Income before income tax consists of the following:



	Year Ended
	January 25, 2015		January 26, 2014		January 27, 2013
	(In thousands)
Domestic	$	173,865	$	79,136	$	99,422
Foreign	580,971		431,118		562,617
Income before income tax	$	754,836	$	510,254	$	662,039

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



	Year Ended
	January 25, 2015			January 26, 2014			January 27, 2013
	(In thousands)
Tax expense computed at federal statutory rate	$	264,192		$	178,589		$	231,714
State income taxes, net of federal tax effect	681			1,608			1,048
Foreign tax rate differential	(119,786		)	(93,831		)	(123,626		)
U.S. federal R&D tax credit	(34,319		)	(30,155		)	(29,294		)
Stock-based compensation	4,332			8,900			11,876
Tax expense related to intercompany transaction	9,785			9,785			9,785
Other	(636		)	(4,632		)	(2,000		)
Income tax expense	$	124,249		$	70,264		$	99,503

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



	January 25, 2015			January 26, 2014
	(In thousands)
Deferred tax assets:
Net operating loss carryforwards	$	72,322		$	81,629
Accruals and reserves, not currently deductible for tax purposes	109,123			131,932
Property, equipment and intangible assets	45,593			48,358
Research and other tax credit carryforwards	350,655			306,975
Stock-based compensation	29,850			33,135
Convertible debt	12,327			14,885
Gross deferred tax assets	619,870			616,914
Less valuation allowance	(260,985		)	(244,487		)
Total deferred tax assets	358,885			372,427
Deferred tax liabilities:
Acquired intangibles	(24,463		)	(33,244		)
Unremitted earnings of foreign subsidiaries	(500,031		)	(425,401		)
Gross deferred tax liabilities	(524,494		)	(458,645		)
Net deferred tax liability	$	(165,609	)	$	(86,218	)

We recognized income tax expense of $124.2 million, $70.3 million and $99.5 million during fiscal years 2015, 2014 and 2013, respectively. Income tax expense as a percentage of income before taxes, or our annual effective tax rate, was 16.5% in fiscal year 2015, 13.8% in fiscal year 2014 and 15.0% in fiscal year 2013. The difference in the effective tax rates amongst the three years was primarily due to an increase in the amount of earnings subject to United States tax in fiscal year 2015 and a higher percentage of research tax credit benefit in fiscal year 2014.

Our effective tax rate on income before tax for the fiscal years was lower than the United States federal statutory rate of 35% due to income earned in jurisdictions, including British Virgin Islands, Hong Kong, China, Taiwan and United Kingdom, where the tax rate is lower, favorable recognition of the U.S. federal research 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 25, 2015 and January 26, 2014 we had a valuation allowance of $261.0 million and $244.5 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 $411.9 million as of January 25, 2015. 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 shareholders' equity, if and when realized.

As of January 25, 2015, we had federal, state and foreign net operating loss carryforwards of $521.5 million, $667.2 million and $332.6 million, respectively. The federal and state carryforwards will expire beginning in fiscal year 2022 and 2016, respectively. The foreign net operating loss carryforwards of $316.7 million may be carried forward indefinitely and the remainder of $15.9 million will begin to expire in fiscal year 2016. As of January 25, 2015, we had federal research tax credit carryforwards of $429.6 million that will begin to expire in fiscal year 2018. We have state research tax credit carryforwards of $411.7 million, of which $395.9 million is attributable to the State of California and may be carried over indefinitely, and $15.8 million is attributable to various other states and will expire beginning in fiscal year 2016. We have other state tax credit carryforwards of $3.0 million that will expire in fiscal year 2026 and foreign tax credit carryforwards of $18.4 million, which may be refunded in fiscal years 2016 through 2019 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 25, 2015, U.S. federal and state income taxes have not been provided on approximately $2.27 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 25, 2015, we had $253.7 million of gross unrecognized tax benefits, of which $228.7 million would affect our effective tax rate if recognized. However, approximately $45.3 million of the unrecognized tax benefits were related to state income tax positions taken, that, if recognized, would be in the form of a carryforward deferred tax asset that would likely attract a full valuation allowance. The $228.7 million of unrecognized tax benefits as of January 25, 2015 consisted of $106.6 million recorded in non-current income taxes payable and $122.1 million reflected as a reduction to the related deferred tax assets.

A reconciliation of gross unrecognized tax benefits is as follows:



	January 25, 2015			January 26, 2014			January 27, 2013
	(In thousands)
Balance at beginning of period	$	237,738		$	220,543		$	138,262
Increases in tax positions for prior years	—			—			18,800
Decreases in tax positions for prior years	(871		)	(714		)	(304		)
Increases in tax positions for current year	22,865			22,787			67,764
Lapse in statute of limitations	(5,997		)	(4,878		)	(3,979		)
Balance at end of period	$	253,735		$	237,738		$	220,543

We classify an unrecognized tax benefit as a current liability, or as a reduction of the deferred tax assets 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, reduction of long-term deferred tax assets or amount refundable, 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 25, 2015, January 26, 2014, and January 27, 2013, we had accrued $14.4 million, $12.9 million and $11.3 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 25, 2015, non-current income taxes payable of $121.0 million consisted of unrecognized tax benefits of $106.6 million and the related interest and penalties of $14.4 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 25, 2015, 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 25, 2015, 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 2014. As of January 25, 2015, the material tax jurisdictions for which we are currently under examination include the state of California for fiscal years 2011 through 2012, and India, France and Germany for fiscal years 2003 through 2014.