INCOME TAXES

The company’s effective tax rate on earnings from continuing operations for the year ended December 31, 2012, was 33.3 percent, as compared with 32.3 percent and 19.5 percent for the years ended December 31, 2011 and 2010, respectively. The company's higher effective tax rate for 2012, as compared to 2011, reflects the absence of research tax credits, which expired at the end of 2011. The company's higher effective tax rate for 2011, as compared to 2010, was primarily due to recognized net tax benefits of $298 million in 2010 to reflect the final approval from the IRS and the U.S. Congressional Joint Committee on Taxation of the IRS’ examination of our tax returns for the years 2004 through 2006.

Federal and foreign income tax expense consisted of the following:



	Year Ended December 31
$ in millions	2012		2011		2010
Income Taxes on Continuing Operations
Currently payable
Federal income taxes		$912		$592		$394
Foreign income taxes	15		18		11
Total federal and foreign income taxes currently payable	927		610		405
Change in deferred federal and foreign income taxes	60		387		57
Total federal and foreign income taxes		$987		$997		$462

Earnings from foreign continuing operations before income taxes is not material for all periods presented.

Income tax expense differs from the amount computed by multiplying the statutory federal income tax rate times the earnings from continuing operations before income taxes due to the following:



	Year Ended December 31
$ in millions	2012			2011			2010
Income tax expense on continuing operations at statutory rate		$1,038			$1,079			$ 828
Manufacturing deduction	(42		)	(32		)	(33		)
Research tax credit	—			(17		)	(12		)
Tax settlements and adjustments to uncertain tax position accruals	—			—			(298		)
Other, net	(9		)	(33		)	(23		)
Total federal and foreign income taxes		$ 987			$ 997			$ 462

Uncertain Tax Positions

The company files income tax returns in the U.S. federal jurisdiction, and in various state and foreign jurisdictions. The IRS is currently conducting an examination of the company's tax returns for the years 2007 through 2011. Open tax years related to state and foreign jurisdictions remain subject to examination, but are not considered material.

Although the company believes that it has adequately provided for all of its tax positions, amounts asserted by taxing authorities in future years could be greater than the company’s accrued positions. Accordingly, additional provisions on income tax related matters could be recorded in the future due to revised estimates, settlement or other resolution of the underlying tax matters.

The change in unrecognized tax benefits during 2012, 2011, and 2010, excluding interest, is as follows:



	December 31
$ in millions	2012			2011			2010
Unrecognized tax benefits at beginning of the year		$118			$126			$429
Additions based on tax positions related to the current year	12			11			19
Additions for tax positions of prior years	28			31			4
Reductions for tax positions of prior years	(1		)	(22		)	—
Settlements	(1		)	(28		)	(326		)
Net change in unrecognized tax benefits	38			(8		)	(303		)
Unrecognized tax benefits at end of the year		$156			$118			$126

These liabilities, along with $19 million of accrued interest and penalties, are included in other non-current liabilities in the consolidated statements of financial position. If the income tax benefits from these tax positions are ultimately realized, $128 million of federal and foreign benefits would affect the company’s effective tax rate.

During the years ended December 31, 2012, 2011, and 2010, the company recorded approximately ($1) million, ($5) million, and $88 million of net interest (expense)/income, respectively, within its federal, foreign and state income tax provisions.

Deferred Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and tax purposes. Such amounts are classified in the consolidated statements of financial position as current or non-current assets or liabilities based upon the classification of the related assets and liabilities.

The tax effects of significant temporary differences and carryforwards that gave rise to year-end deferred federal, state and foreign tax balances, as presented in the consolidated statements of financial position, are as follows:



	December 31
$ in millions	2012			2011
Deferred Tax Assets
Retirement benefits		$2,710			$1,819
Provisions for accrued liabilities	675			649
Stock-based compensation	146			130
Other	151			147
Gross deferred tax assets	3,682			2,745
Less valuation allowance	(52		)	(50		)
Net deferred tax assets	3,630			2,695
Deferred Tax Liabilities
Goodwill	804			716
Property, plant, and equipment, net	376			277
Contract accounting differences	199			218
Other	135			88
Gross deferred tax liabilities	1,514			1,299
Total net deferred tax assets		$2,116			$1,396

Realization of the deferred tax asset is primarily dependent on generating sufficient taxable income in future periods. The company believes it is more-likely-than-not that all deferred tax assets will be realized, net of any valuation allowances currently established.

At December 31, 2012, the company has available unused net operating losses of $185 million that may be applied against future taxable income, primarily in the United Kingdom that may be used indefinitely. A valuation allowance of $52 million has been recorded against the tax assets due to the uncertainty of the realization of these net operating losses and other deferred tax assets principally in foreign jurisdictions.

Undistributed Foreign Earnings

As of December 31, 2012, the company has accumulated undistributed earnings generated by its foreign subsidiaries. No deferred tax liability has been recorded on these earnings since the company intends to permanently reinvest these earnings. Should these earnings be distributed in the form of dividends or otherwise, the distributions would be subject to U.S. federal income tax at the statutory rate of 35 percent, less foreign tax credits available to offset such distributions, if any. In addition, such distributions may be subject to withholding taxes in the various tax jurisdictions.