Income Taxes

12 Months Ended

Dec. 31, 2011

INCOME TAXES [Abstract]

10. INCOME TAXES

10. INCOME TAXES

The company’s effective tax rate on earnings from continuing operations for the year ended December 31, 2011 was 32.3 percent, as compared with 19.5 percent and 30.7 percent for the years ended December 31, 2010 and 2009, respectively. The company’s effective tax rate reflects deductions for domestic manufacturing and research tax credits, and a deduction for employee stock ownership plan dividends in all years, as well as the impact of settlements with the Internal Revenue Service (IRS) in 2010 and 2009.

During 2010, the company received final approval from the IRS and the U.S. Congressional Joint Committee on Taxation (Joint Committee) of the IRS’ examination of the company’s tax returns for the years 2004 through 2006. As a result of the settlement, the company recognized a net tax benefit of approximately $298 million (of which $66 million was in cash), which was recorded as a reduction to the company’s provision for income taxes.

During 2009, the company reached a final settlement with the IRS regarding its audit of the company’s tax returns for 2001 through 2003 and recognized $75 million of net benefit upon settlement, including $20 million of interest.

Federal and foreign income tax expense consisted of the following:

	Year Ended December 31
$ in millions	2011			2010			2009
Income Taxes on Continuing Operations
Currently payable
Federal income taxes		$	592		$	394		$	390
Foreign income taxes			18			11			34
Total federal and foreign income taxes currently payable			610			405			424
Change in deferred federal and foreign income taxes			387			57			212
Total federal and foreign income taxes		$	997		$	462		$	636

The geographic source of earnings from continuing operations before income taxes is as follows:

	Year Ended December 31
$ in millions	2011			2010			2009
Domestic		$	2,998		$	2,319		$	1,944
Foreign			85			47			126
Earnings from continuing operations before income taxes		$	3,083		$	2,366		$	2,070

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	2011				2010				2009
Income tax expense on continuing operations at statutory rate		$	1,079			$	828			$	725
Manufacturing deduction			(32	)			(33	)			(18	)
Research tax credit			(17	)			(12	)			(15	)
Settlement of IRS appeals cases, net of additional uncertain tax position accruals							(298	)			(77	)
ESOP dividends			(13	)			(14	)			(13	)
Other, net			(20	)			(9	)			34
Total federal and foreign income taxes		$	997			$	462			$	636

Uncertain Tax Positions – As of December 31, 2011, the amount recorded for uncertain tax positions was a liability of $135 million, which includes accrued interest and penalties of $17 million. This liability is included in other long-term liabilities in the consolidated statements of financial position. If the income tax benefits from these tax positions are ultimately realized, $95 million of federal benefits would affect the company’s effective tax rate. The remaining $40 million relates to state taxes and would be realized through operating income.

In 2010, in connection with the settlement agreement with IRS for years 2004 through 2006, the company reduced its liability for uncertain tax positions by $311 million, including previously accrued interest, which was recorded as a reduction to the company’s effective tax rate.

In 2009, in connection with the settlement agreement with IRS for years 2001 through 2003, the company reduced its liability for uncertain tax positions by $60 million, which was recorded as a reduction to the company’s effective tax rate.

The change in unrecognized tax benefits during 2011, 2010 and 2009, excluding interest, is as follows:

	December 31
$ in millions	2011				2010				2009
Unrecognized tax benefits at beginning of the year		$	126			$	429			$	416
Additions based on tax positions related to the current year			11				19				12
Additions for tax positions of prior years			31				4				61
Reductions for tax positions of prior years			(22	)
Settlements			(28	)			(326	)			(60	)
Net change in unrecognized tax benefits			(8	)			(303	)			13
Unrecognized tax benefits at end of the year		$	118			$	126			$	429

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 company does not expect the unrecognized tax benefits to significantly change in the next 12 months. The IRS is currently conducting an examination of the company’s tax returns for the years 2007 through 2009.

During the years ended December 31, 2011, 2010 and 2009, the company recorded approximately $(5) million, $88 million, and $6 million of net interest income/(expense), 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 noncurrent 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	2011				2010
Deferred Tax Assets
Retirement benefits		$	1,819			$	1,337
Provisions for accrued liabilities			649				686
Stock-based compensation			130				91
Other			78				10
Gross deferred tax assets			2,676				2,124
Less valuation allowance			(50	)
Net deferred tax assets			2,626				2,124
Deferred Tax Liabilities
Goodwill amortization			716				692
Depreciation and amortization			277				143
Contract accounting differences			218				255
Purchased intangibles			19				14
Gross deferred tax liabilities			1,230				1,104
Total net deferred tax assets		$	1,396			$	1,020

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, 2011, the company has available unused net operating losses that may be applied against future taxable income in Japan of $16 million that will expire in 2015 through 2018, $23 million in Norway, and $153 million in the United Kingdom that may be used indefinitely. A valuation allowance of $50 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 in foreign jurisdictions.

Net deferred tax assets as presented in the consolidated statements of financial position are as follows:

	December 31
$ in millions	2011			2010
Net current deferred tax assets		$	496		$	392
Net non-current deferred tax assets			900			628
Total net deferred tax assets		$	1,396		$	1,020

At December 31, 2011, the company completed a comprehensive review of its deferred income tax balances and determined that certain net deferred income tax assets were overstated and required correction. The company was able to determine that the overstatement relates to periods prior to January 1, 2007. Management has evaluated the impact of the overstatement and concluded that the effect of the correction is not material to the company’s consolidated statements of financial position, results of operations or cash flows for any period presented. In order to correct the overstatement, the company has reduced the opening retained earnings balance as of January 1, 2007 by $121 million, which reduces opening retained earnings for the year ended December 31, 2009, from the originally reported amount of $5.6 billion to $5.5 billion.

Foreign Income – As of December 31, 2011, the company had approximately $761 million of 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.