7. INCOME TAXES

In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted. The 2017 Tax Act includes a number of changes to existing U.S. tax laws that impact the company, most notably a reduction of the U.S. corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017. The 2017 Tax Act also provides for a one-time transition tax on certain foreign earnings and the acceleration of depreciation for certain assets placed into service after September 27, 2017 as well as prospective changes beginning in 2018, including repeal of the domestic manufacturing deduction, acceleration of tax revenue recognition, capitalization of research and development expenditures, additional limitations on executive compensation and limitations on the deductibility of interest.

The company recognized the income tax effects of the 2017 Tax Act in its 2017 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the 2017 Tax Act was signed into law. As such, the company’s financial results reflect the income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is complete and provisional amounts for those specific income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined. The company did not identify items for which the income tax effects of the 2017 Tax Act have not been completed and a reasonable estimate could not be determined as of December 31, 2017.

The following table presents the impact of the 2017 Tax Act as an increase (decrease) reflected in the noted line items in the Consolidated Statements of Earnings and Comprehensive Income and Consolidated Statements of Financial Position:



	Year Ended December 31, 2017
($ in millions)	Reduction of U.S. Corporate Income Tax Rate			Transition Tax on Foreign Earnings			Acceleration of Depreciation			Other			Total
Income tax expense	$	280		$	13		$	5		$	2		$	300
Effective tax rate	9.1		%	0.4		%	0.2		%	0.1		%	9.8		%

	As of December 31, 2017
($ in millions)	Reduction of U.S. Corporate Income Tax Rate			Transition Tax on Foreign Earnings			Acceleration of Depreciation			Other			Total
Deferred tax assets	$	(280	)	$	(13	)	$	(80	)	$	—		$	(373	)
Other current liabilities	—			—			(75		)	2			(73		)

The changes to existing U.S. tax laws as a result of the 2017 Tax Act, which we believe have the most significant impact on the company’s federal income taxes are as follows:

Reduction of the U.S. Corporate Income Tax Rate

The company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 35 percent to 21 percent, resulting in a $280 million increase in income tax expense for the year ended December 31, 2017 and a corresponding $280 million decrease in net deferred tax assets as of December 31, 2017.

Transition Tax on Foreign Earnings

The company recognized a provisional income tax expense of $13 million for the year ended December 31, 2017 related to the one-time transition tax on certain foreign earnings. This resulted in a corresponding decrease in deferred tax assets due to the utilization of foreign tax credit carryforwards. The determination of the transition tax requires further analysis regarding the amount and composition of the company’s historical foreign earnings, which is expected to be completed in the second half of 2018.

Acceleration of Depreciation

The company recognized a provisional reduction to net deferred tax assets of $80 million attributable to the accelerated depreciation for certain assets placed into service after September 27, 2017 and a provisional income tax expense of $5 million for the corresponding impact on its 2017 domestic manufacturing deduction. These provisional adjustments resulted in a decrease in income tax payable of $75 million. The income tax effects for these positions require further analysis due to the volume of data required to complete the calculations; the company expects to complete those analyses in the second half of 2018.

Effective January 1, 2018, the 2017 Tax Act requires the acceleration of revenue for tax purposes for certain types of revenue. This change impacts several accounting methods previously used by the company and is expected to result in an acceleration of taxability of such revenue beginning in 2018 as compared with prior U.S. tax laws.

Income Tax Expense

Federal and foreign income tax expense consisted of the following:



	Year Ended December 31
$ in millions	2017			2016			2015
Federal income tax expense:
Current	$	449		$	661		$	310
Deferred	581			49			472
Total federal income tax expense	1,030			710			782
Foreign income tax expense:
Current	8			14			21
Deferred	(4		)	(1		)	(3		)
Total foreign income tax expense	4			13			18
Total federal and foreign income tax expense	$	1,034		$	723		$	800

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

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



	Year Ended December 31
$ in millions	2017					2016					2015
Income tax expense at statutory rate	$	1,067		35.0	%	$	1,023		35.0	%	$	976		35.0	%
Stock compensation - excess tax benefits	(48		)	(1.6	)	(85		)	(2.9	)	—			—
Research credit	(130		)	(4.2	)	(61		)	(2.1	)	(119		)	(4.3	)
Manufacturing deduction	(97		)	(3.2	)	(58		)	(2.0	)	(31		)	(1.1	)
Settlements with taxing authorities	(42		)	(1.4	)	(40		)	(1.4	)	—			—
Repatriation of non-U.S. earnings	—			—		(33		)	(1.1	)	—			—
Impacts related to the 2017 Tax Act	300			9.8		—			—		—			—
Other, net	(16		)	(0.5	)	(23		)	(0.8	)	(26		)	(0.9	)
Total federal and foreign income taxes	$	1,034		33.9	%	$	723		24.7	%	$	800		28.7	%

2017 – The effective tax rate for 2017 was 33.9 percent, as compared with 24.7 percent in 2016. The higher rate is principally due to $300 million of tax expense recorded in connection with the 2017 Tax Act, largely due to the write-down of net deferred tax assets, partially offset by a $69 million increase in research credits and a $39 million benefit recognized for additional manufacturing deductions principally related to prior years. The effective tax rates for the years ended December 31, 2017 and 2016 each include separate approximately $40 million benefits recognized in connection with the resolution of Internal Revenue Service (IRS) examinations of the company’s prior year tax returns.

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, a $40 million benefit recognized in connection with resolution of the 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. These benefits were 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.

Income tax payments, net of refunds received, were $517 million, $691 million and $118 million for the years ended December 31, 2017, 2016 and 2015, respectively.

Uncertain Tax Positions

We file income tax returns in the U.S. federal jurisdiction and in various state and foreign jurisdictions. Our 2014-2015 federal tax returns are currently under IRS examination and our 2007-2011 federal tax returns are subject to examination due to the filing of refund claims for these years. The company believes it is reasonably possible that within the next twelve months we may resolve certain matters related to the years under examination, which may result in reductions of our unrecognized tax benefits up to $115 million and income tax expense up to $30 million.

Tax returns for open tax years related to state and foreign jurisdictions remain subject to examination, but the amounts currently subject to examination are not considered material.

The change in unrecognized tax benefits during 2017, 2016 and 2015, excluding interest, is as follows:



	December 31
$ in millions	2017			2016			2015
Unrecognized tax benefits at beginning of the year	$	135		$	223		$	210
Additions based on tax positions related to the current year	102			35			52
Additions for tax positions of prior years	110			2			17
Reductions for tax positions of prior years	(44		)	(40		)	(10		)
Settlements with taxing authorities	(20		)	(84		)	—
Other, net	—			(1		)	(46		)
Net change in unrecognized tax benefits	148			(88		)	13
Unrecognized tax benefits at end of the year	$	283		$	135		$	223

These liabilities, along with $11 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, $149 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. As described above, deferred tax assets and liabilities are measured based on the enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. As such, during December 2017, the company remeasured its deferred tax assets and liabilities as a result of passage of the 2017 Tax Act. The primary impact of this remeasurement was a reduction in deferred tax assets and liabilities in connection with the reduction of the U.S. corporate income tax rate from 35 percent to 21 percent.

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	2017			2016
Deferred Tax Assets
Retiree benefits	$	1,477		$	2,814
Accrued employee compensation	263			349
Provisions for accrued liabilities	193			295
Inventory	191			287
Stock-based compensation	46			72
Other	39			72
Gross deferred tax assets	2,209			3,889
Less valuation allowance	(26		)	(31		)
Net deferred tax assets	2,183			3,858
Deferred Tax Liabilities
Goodwill	511			798
Property, plant and equipment, net	256			321
Contract accounting differences	898			1,200
Other	43			77
Deferred tax liabilities	1,708			2,396
Total net deferred tax assets	$	475		$	1,462

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, 2017, the company has available foreign tax credits and unused net operating losses of $5 million and $142 million, respectively, that may be applied against future taxable income. The net operating losses are primarily attributable to the United Kingdom and may be carried forward indefinitely. A valuation allowance of $26 million, predominantly related to net operating losses, has been recorded due to the uncertainty regarding the realization of the asset.

Undistributed Foreign Earnings

As of December 31, 2017, the company has accumulated undistributed earnings generated by our foreign subsidiaries of approximately $168 million, of which $153 million was subject to the one-time transition tax on foreign earnings required by the 2017 Tax Act or has otherwise been previously taxed. We intend to indefinitely reinvest these earnings, as well as future earnings from our foreign subsidiaries, to fund our international operations and foreign credit facility. In addition, we expect future U.S. cash generation will be sufficient to meet future U.S. cash needs.