Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes [Abstract]

Income Taxes

15. INCOME TAXES

The components of earnings before taxes consist of the following (in millions):

For the Years Ended December 31,	2011		2010		2009
United States operations	$	485.7	$	382.4	$	489.7
Foreign operations		493.2		477.8		508.5
Total	$	978.9	$	860.2	$	998.2

The provision for income taxes consists of (in millions):

Current:
Federal	$	148.4		$	235.3		$	204.9
State		14.3			19.5			23.3
Foreign		75.9			81.0			72.3
		238.6			335.8			300.5
Deferred:
Federal		(2.6	)		(54.9	)		(17.4	)
State		(0.9	)		(2.0	)		(3.1	)
Foreign		(16.2	)		(15.6	)		0.8
		(19.7	)		(72.5	)		(19.7	)
Provision for income taxes	$	218.9		$	263.3		$	280.8

Income taxes paid during 2011, 2010 and 2009 were $236.4 million, $330.6 million and $268.5 million, respectively.

A reconciliation of the U.S. statutory income tax rate to our effective tax rate is as follows:

For the Years Ended December 31,	2011			2010			2009
U.S. statutory income tax rate		35.0	%		35.0	%		35.0	%
State taxes, net of federal deduction		0.7			1.3			1.4
Tax impact of foreign operations, including foreign tax credits		(11.0	)		(10.6	)		(9.9	)
Tax benefit relating to U.S. manufacturer’s deduction and export sales		(1.6	)		(2.6	)		(1.5	)
R&D credit		(0.5	)		(0.8	)		(0.3	)
Goodwill impairment		–			8.3			2.6
Other		(0.2	)		–			0.8
Effective income tax rate		22.4	%		30.6	%		28.1	%

Our operations in Puerto Rico, Switzerland and the State of Indiana benefit from various tax incentive grants. Unless these grants are extended, they will expire between fiscal years 2016 and 2026.

ZIMMER HOLDINGS, INC. 2011 FORM 10-K ANNUAL REPORT

Notes to Consolidated Financial Statements (Continued)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are recorded to reduce deferred income tax assets when it is more likely than not that an income tax benefit will not be realized.

The components of deferred taxes consisted of the following (in millions):

As of December, 31	2011			2010
Deferred tax assets:
Inventory	$	218.5		$	234.3
Net operating loss carryover		23.5			22.0
Tax credit carryover		16.9			32.5
Capital loss carryover		4.0			–
Accrued liabilities		116.1			91.3
Share-based compensation		98.3			85.4
Unremitted earnings of foreign subsidiaries		103.9			104.2
Other		73.1			59.2
Total deferred tax assets		654.3			628.9
Less: Valuation allowances		(40.3	)		(39.9	)
Total deferred tax assets after valuation		614.0			589.0
Deferred tax liabilities:
Fixed assets	$	(111.6	)	$	(101.7	)
Intangible assets		(148.9	)		(151.9	)
Accrued liabilities		(1.0	)		(0.7	)
Other		–			(1.0	)
Total deferred tax liabilities		(261.5	)		(255.3	)
Total net deferred tax assets	$	352.5		$	333.7

The net operating loss carryovers are available to reduce future federal, state and foreign taxable earnings. At December 31, 2011, these net operating loss carryovers generally expire within a period of 1 to 20 years. Valuation allowances for net operating loss carryovers have been established in the amount of $14.6 million for both December 31, 2011 and 2010. The tax credit carryovers are available to offset future federal, state and foreign tax liabilities. At December 31, 2011, these tax credit carryovers generally expire within a period of 1 to 10 years. We have established valuation allowances for certain tax credit carryovers in the amount of $15.3 million and $17.5 million at December 31, 2011 and 2010, respectively. The capital loss carryover is also available to reduce future federal taxable earnings. However, the entire $4.0 million capital loss carryover is subject to a valuation allowance and expires in 5 years. The remaining valuation allowances of $6.4 million and $7.8 million at December 31, 2011 and 2010, respectively, relate primarily to potential capital losses.

At December 31, 2011, we had an aggregate of approximately $2,551 million of unremitted earnings of foreign subsidiaries that have been, or are intended to be, indefinitely reinvested for continued use in foreign operations. If the total undistributed earnings of foreign subsidiaries were remitted, a significant amount of the additional tax would be offset by the allowable foreign tax credits. It is not practical for us to determine the additional tax of remitting these earnings.

The following is a tabular reconciliation of the total amounts of unrecognized tax benefits (in millions):

For the Years Ended December 31,	2011			2010			2009
Balance at January 1	$	168.0		$	150.4		$	129.5
Increases related to prior periods		11.4			23.1			32.9
Decreases related to prior periods		(49.0	)		(6.1	)		(26.7	)
Increases related to current period		34.4			23.7			17.4
Decreases related to settlements with taxing authorities		(4.8	)		(14.1	)		(1.1	)
Decreases related to lapse of statute of limitations		(1.6	)		(9.0	)		(1.6	)
Balance at December 31	$	158.4		$	168.0		$	150.4

Included in the balance of unrecognized tax benefits at December 31, 2011 are $132.7 million of tax benefits that, if recognized, would affect the effective tax rate.

We recognize accrued interest and penalties related to unrecognized tax benefits as income tax expense. We decreased interest and penalties by $12.1 million during 2011, and as of December 31, 2011, had recognized a liability for interest and penalties of $10.7 million. During 2010, we decreased interest and penalties by $5.8 million, and as of December 31, 2010, had recognized a liability for interest and penalties of $22.8 million. During 2009, we accrued interest and penalties of $5.7 million, and as of December 31, 2009, had recognized a liability for interest and penalties of $28.6 million.

We operate on a global basis and are subject to numerous and complex tax laws and regulations. Our income tax filings are regularly under audit in multiple federal, state and foreign jurisdictions. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed. During 2011, we resolved tax matters with the IRS and multiple foreign and state tax authorities resulting in a reduction in both the net amount of tax liability for unrecognized tax benefits and income tax expense. The net amount of tax liability for unrecognized tax benefits may change within the next twelve months due to changes in audit status, expiration of statutes of limitations and other events which could impact our determination of unrecognized tax benefits. Currently, we cannot reasonably estimate the amount by which our unrecognized tax benefits will change.

During the third quarter of 2009, we settled various tax matters with the IRS for all years prior to 2005. During the second quarter of 2011, the IRS concluded their examination of our U.S. federal returns for years 2005 through 2007 and issued income tax assessments reallocating profits between certain of our U.S. and foreign subsidiaries. We believe that we have followed applicable U.S. tax laws and are vigorously defending our income tax positions. The ultimate resolution of this matter is uncertain and could have a material impact on our income tax expense, results of operations, and cash flows for future periods. Our U.S. federal returns for years 2008 and 2009 are currently under IRS examination.

State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes generally remains subject to examination by various states for a period of up to one year after formal notification to the states. We have various state income tax returns in the process of examination, administrative appeals or litigation.

Our tax returns are currently under examination in various foreign jurisdictions. Foreign jurisdictions have statutes of limitations generally ranging from 3 to 5 years. Years still open to examination by foreign tax authorities in major jurisdictions include: Australia (2007 onward), Canada (2005 onward), France (2009 onward), Germany (2006 onward), Ireland (2008 onward), Italy (2006 onward), Japan (2010 onward), Korea (2006 onward), Puerto Rico (2005 onward), Switzerland (2010 onward), and the United Kingdom (2010 onward).