Income Taxes

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



	Year Ended
	January 28, 2018			January 29, 2017			January 31, 2016
	(In millions)
Current income taxes:
Federal	$	464		$	7		$	(43	)
State	1			1			1
Foreign	43			34			25
Total current	508			42			(17		)
Deferred taxes:
Federal	(376		)	199			134
State	—			—			—
Foreign	17			(2		)	—
Total deferred	(359		)	197			134
Charge in lieu of taxes attributable to employer stock option plans	—			—			12
Income tax expense	$	149		$	239		$	129

Income before income tax consists of the following:



	Year Ended
	January 28, 2018		January 29, 2017		January 31, 2016
	(In millions)
Domestic (1)	$	1,600	$	600	$	129
Foreign	1,596		1,305		614
Income before income tax	$	3,196	$	1,905	$	743


(1)	The increase in domestic income is primarily due to jurisdictional allocation of stock-based compensation charges.

The income tax expense differs from the amount computed by applying the blended U.S. federal statutory rate of 33.9% for fiscal year 2018 and U.S. federal statutory rate of 35% for fiscal years 2017 and 2016 to income before income taxes as follows:



	Year Ended
	January 28, 2018			January 29, 2017			January 31, 2016
	(In millions)
Tax expense computed at federal statutory rate	$	1,084		$	667		$	260
Expense (benefit) resulting from:
State income taxes, net of federal tax effect	10			4			1
Foreign tax rate differential	(545		)	(315		)	(95		)
Stock-based compensation (1)	(181		)	(70		)	13
Tax Cuts and Jobs Act of 2017 (2)	(133		)	—			—
U.S. federal R&D tax credit	(87		)	(52		)	(38		)
Tax expense related to intercompany transaction	—			10			10
Restructuring and expiration of statute of limitations	—			—			(21		)
Other	1			(5		)	(1		)
Income tax expense	$	149		$	239		$	129


(1)	We adopted an accounting standard related to stock-based compensation effective February 1, 2016, which required the excess tax benefit to be reflected in our provision for income taxes rather than in additional paid-in-capital. The total related excess tax benefit recognized for fiscal year 2018 and 2017 was $197 million and $82 million, respectively.


(2)	We recognized a provisional tax benefit of $133 million, which was included as a component of income tax expense.

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



	January 28, 2018			January 29, 2017
	(In millions)
Deferred tax assets:
Net operating loss carryforwards	$	67		$	199
Accruals and reserves, not currently deductible for tax purposes	24			40
Property, equipment and intangible assets	32			50
Research and other tax credit carryforwards	579			728
Stock-based compensation	24			34
Convertible debt	—			6
Gross deferred tax assets	726			1,057
Less valuation allowance	(469		)	(353		)
Total deferred tax assets	257			704
Deferred tax liabilities:
Acquired intangibles	(4		)	(11		)
Unremitted earnings of foreign subsidiaries	(26		)	(827		)
Gross deferred tax liabilities	(30		)	(838		)
Net deferred tax asset (liability)	$	227		$	(134	)

We recognized income tax expense of $149 million, $239 million, and $129 million for fiscal years 2018, 2017, and 2016, respectively. Our annual effective tax rate was 4.7%, 12.5%, and 17.3% for fiscal years 2018, 2017, and 2016, respectively.

In December 2017, the TCJA was enacted into law. The TCJA significantly changes U.S. tax law, including a reduction of the U.S. federal corporate income tax rate from 35% to 21%, a requirement for companies to pay a one-time transition tax on the earnings of certain foreign subsidiaries that were previously tax deferred and the creation of new taxes on certain foreign-source earnings. As a fiscal year-end taxpayer, certain provisions of the TCJA began to impact us in the fourth quarter of fiscal year 2018, while other provisions will impact us beginning in fiscal year 2019.

The corporate tax reduction is effective as of January 1, 2018. Since we operate on a fiscal year rather than a calendar year, we are subject to transitional tax rules. As a result, our fiscal year 2018 federal statutory rate is a blended rate of 33.9%. The change in the statutory tax rate from 35% to 33.9% for fiscal year 2018 did not have a significant impact on the effective tax rate.

U.S. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. However, the SEC also issued guidance that allows companies to record provisional amounts during a measurement period not to exceed one year. Accordingly, as of January 28, 2018, we recognized a provisional tax benefit of $133 million as a component of income tax expense, which is our reasonable estimate of the effects of the tax law changes on existing deferred tax balances and the calculation of the one-time transition tax.

The one-time transition tax is based on the post-1986 earnings and profits, or E&P, of our foreign subsidiaries. We had previously accrued deferred taxes on a portion of these same earnings. We recorded a provisional one-time transition tax liability of $971 million and released the previously accrued deferred tax liabilities of $1.15 billion, resulting in a net decrease to income tax expense of $176 million.

We have reasonably estimated, but not yet completed, the calculation of the total post-1986 E&P for our foreign subsidiaries. Our calculation of the transition tax may change with further analysis, additional guidance from the U.S. federal and state tax authorities and additional guidance for the associated income tax accounting.

As a result of the reduction of the corporate income tax rate to 21%, companies were required to remeasure their deferred tax assets and liabilities as of the date of enactment. As a result, we recorded a provisional income tax expense of $43 million on the write-down of our deferred tax balance.

The decrease in the effective tax rate in fiscal year 2018 as compared to fiscal years 2017 and 2016 was primarily due to the provisional impact of the tax law changes and the recognition of excess tax benefits related to stock-based compensation. The decrease in our effective tax rate in fiscal year 2017 as compared to fiscal year 2016 was primarily due to the recognition of excess tax benefits from our adoption of a new accounting standard in fiscal year 2017 related to the simplification of certain aspects of stock-based compensation accounting.

Our effective tax rate for fiscal year 2018 was lower than the blended U.S. federal statutory rate of 33.9% due primarily to income earned in jurisdictions, including British Virgin Islands, Hong Kong, China, Taiwan and United Kingdom, where the tax rate was lower than the U.S. federal statutory tax rates, favorable recognition of the U.S. federal research tax credit, the provisional impact of the recent tax law changes in 2018, and excess tax benefits related to stock-based compensation.

Our effective tax rate for fiscal years 2017 and 2016 was lower than U.S. federal statutory tax rate of 35% due primarily to income earned in jurisdictions, including British Virgin Islands, Hong Kong, China, Taiwan and United Kingdom, where the tax rate was lower than the U.S. federal statutory tax rates, favorable recognition in those fiscal years of the U.S. federal research tax credit, favorable discrete events primarily attributable to the tax benefit recognized upon the expiration of the applicable statutes of limitations, and adoption of an accounting standard related to stock-based compensation in fiscal year 2017.

As of January 28, 2018 and January 29, 2017, we had a valuation allowance of $469 million and $353 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.

As of January 28, 2018, we had federal, state and foreign net operating loss carryforwards of $74 million, $226 million and $281 million, respectively. The federal and state carryforwards will expire beginning in fiscal year 2023 and 2019, respectively. The foreign net operating loss carryforwards of $281 million may be carried forward indefinitely. As of January 28, 2018, we had federal research tax credit carryforwards of $361 million that will begin to expire in fiscal year 2032. We have state research tax credit carryforwards of $575 million, of which $554 million is attributable to the State of California and may be carried over indefinitely, and $21 million is attributable to various other states and will expire beginning in fiscal year 2019. 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 28, 2018, we had $447 million of gross unrecognized tax benefits, of which $413 million would affect our effective tax rate if recognized. However, approximately $58 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 $413 million of unrecognized tax benefits as of January 28, 2018 consisted of $175 million recorded in non-current income taxes payable and $238 million reflected as a reduction to the related deferred tax assets.

A reconciliation of gross unrecognized tax benefits is as follows:



	January 28, 2018			January 29, 2017			January 31, 2016
	(In millions)
Balance at beginning of period	$	224		$	230		$	254
Increases in tax positions for prior years	7			3			—
Decreases in tax positions for prior years	(1		)	—			(1		)
Increases in tax positions for current year	222			46			28
Settlements	—			(48		)	—
Lapse in statute of limitations	(5		)	(7		)	(51		)
Balance at end of period	$	447		$	224		$	230

The increase in the unrecognized tax benefit in fiscal year 2018 is primarily due to the one-time transition tax imposed on foreign earnings under the TCJA. We classify an unrecognized tax benefit as a current liability, or amount refundable, to the extent that we anticipate payment or receipt of cash for income taxes within one year. The amount is classified as a long-term liability, or 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 28, 2018, January 29, 2017, and January 31, 2016, we had accrued $15 million, $13 million, and $11 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 28, 2018, unrecognized tax benefits of $175 million and the related interest and penalties of $15 million are included in non-current income taxes payable.

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 28, 2018, 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 28, 2018, the significant tax jurisdictions that may be subject to examination include the United States, Hong Kong, Taiwan, China, United Kingdom, Germany, and India for fiscal years 2003 through 2017. As of January 28, 2018, the significant tax jurisdictions for which we are currently under examination include India, Taiwan, UK, and Germany for fiscal years 2003 through 2017.