6. INCOME TAXES

Federal and foreign income tax expense consisted of the following:



	Year Ended December 31
$ in millions	2016			2015			2014
Federal income tax expense:
Current	$	661		$	310		$	701
Deferred	49			472			155
Total federal income tax expense	710			782			856
Foreign income tax expense:
Current	14			21			10
Deferred	(1		)	(3		)	2
Total foreign income tax expense	13			18			12
Total federal and foreign income tax expense	$	723		$	800		$	868

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

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



	Year Ended December 31
$ in millions	2016			2015			2014
Income tax expense at statutory rate	$	1,023		$	976		$	1,028
Stock compensation - excess tax benefits	(85		)	—			—
Research credit	(61		)	(119		)	(43		)
Manufacturing deduction	(58		)	(31		)	(48		)
Settlements with taxing authorities	(40		)	—			(51		)
Repatriation of Non-U.S Earnings	(33		)	—			—
Other, net	(23		)	(26		)	(18		)
Total federal and foreign income taxes	$	723		$	800		$	868

2016 – The effective tax rate for 2016 was 24.7 percent, as compared with 28.7 percent in 2015. The lower rate is principally due to $85 million of excess tax benefits related to employee share-based payment transactions recognized in 2016 resulting from the adoption of ASU No. 2016-09, as described in Note 1, a $40 million benefit recognized in connection with resolution of the Internal Revenue Service (IRS) examination of the company’s 2007-2011 tax returns and a $33 million benefit recognized in connection with the repatriation of earnings from certain of our foreign subsidiaries, as described below. These benefits are partially offset by a $58 million decrease in research credits, which were principally a result of credits recorded in 2015 that were claimed on our prior year tax returns.

2015 – The effective tax rate for 2015 was 28.7 percent, as compared with 29.6 percent in 2014. This reduction was driven by a $76 million increase in research credits primarily resulting from credits claimed on our prior year tax returns, partially offset by a $51 million benefit recorded in 2014 for the partial resolution of the IRS examination of our 2007-2009 tax returns.

Income tax payments, net of refunds received, were $691 million, $118 million and $727 million for the years ended December 31, 2016, 2015 and 2014, respectively.

Uncertain Tax Positions

We file income tax returns in the U.S. federal jurisdiction and in various state and foreign jurisdictions. In the third quarter of 2016, the U.S. Congressional Joint Committee on Taxation approved a resolution of the IRS examination of the company’s 2007-2011 tax returns. As a result, the company recorded a reduction of our unrecognized tax benefits of approximately $115 million and a reduction of our income tax expense of $40 million.

Our 2012-2015 federal tax returns are currently under IRS examination. The company believes it is reasonably possible that within the next twelve months we may resolve certain tax matters related to the years under examination, which may result in further reductions of our unrecognized tax benefits up to $70 million and income tax expense up to $40 million.

Open tax years related to state and foreign jurisdictions remain subject to examination, but are not considered material.

The change in unrecognized tax benefits during 2016, 2015 and 2014, excluding interest, is as follows:



	December 31
$ in millions	2016			2015			2014
Unrecognized tax benefits at beginning of the year	$	223		$	210		$	241
Additions based on tax positions related to the current year	35			52			62
Additions for tax positions of prior years	2			17			9
Reductions for tax positions of prior years	(40		)	(10		)	(47		)
Settlements with taxing authorities	(84		)	—			(14		)
Other, net	(1		)	(46		)	(41		)
Net change in unrecognized tax benefits	(88		)	13			(31		)
Unrecognized tax benefits at end of the year	$	135		$	223		$	210

These liabilities, along with $7 million of accrued interest and penalties, are included in other current and non-current liabilities in the consolidated statements of financial position. If the income tax benefits from these tax positions are ultimately realized, $112 million of federal and foreign tax benefits would reduce the company’s effective tax rate.

Net interest expense within the company's federal, foreign and state income tax provisions was not material for all years presented.

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. Net deferred tax assets and liabilities are classified as non-current in the consolidated statements of financial position.

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	2016			2015
Deferred Tax Assets
Retiree benefits	$	2,814		$	2,549
Accrued employee compensation	349			316
Provisions for accrued liabilities	295			347
Inventory	287			227
Stock-based compensation	72			76
Other	72			68
Gross deferred tax assets	3,889			3,583
Less valuation allowance	(31		)	(34		)
Net deferred tax assets	3,858			3,549
Deferred Tax Liabilities
Goodwill	798			788
Property, plant and equipment, net	321			297
Contract accounting differences	1,200			976
Other	77			79
Deferred tax liabilities	2,396			2,140
Total net deferred tax assets	$	1,462		$	1,409

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

At December 31, 2016, the company has available foreign tax credits and unused net operating losses of $18 million and $191 million, respectively, that may be applied against future taxable income. The net operating losses are primarily attributable to the United Kingdom and may be used indefinitely. A valuation allowance of $31 million, predominantly related to net operating losses, has been recorded due to the uncertainty regarding the realization of the asset.

Distributed and Undistributed Foreign Earnings

In the fourth quarter of 2016, certain of our foreign subsidiaries distributed earnings in the form of dividends to their respective immediate parent companies. Through this process, we repatriated $352 million of earnings generated by these foreign subsidiaries due, in part, to recent changes in foreign exchange rates, which improved the tax efficiency of such repatriation. The repatriation generated a net tax benefit of $33 million resulting from foreign tax credits in excess of U.S. income taxes due on these earnings.

As of December 31, 2016, the company has remaining undistributed earnings generated by our foreign subsidiaries of approximately $70 million. No deferred tax liability has been recorded on these earnings since we intend to indefinitely reinvest these earnings, as well as future earnings from our foreign subsidiaries, to fund our international operations. In addition, we expect future U.S. cash generation will be sufficient to meet future U.S. cash needs. Should the remaining undistributed earnings be distributed in the form of dividends or otherwise, the distributions would result in an immaterial amount of tax.