Note 14. Income Taxes

Income from continuing operations before income taxes included income from domestic operations of $4,948 million, $4,693 million, and $5,311 million for 2010, 2011, and 2012, and income from foreign operations of $5,848 million, $7,633 million, and $8,075 million for 2010, 2011, and 2012. Substantially all of the income from foreign operations was earned by an Irish subsidiary.

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


	Year Ended December 31,
	2010			2011			2012
Current:
Federal	$	1,657		$	1,724		$	2,342
State		458			274			171
Foreign		167			248			358

Total		2,282			2,246			2,871

Deferred:
Federal		(25	)		452			(328	)
State		47			(109	)		(19	)
Foreign		(13	)		(0	)		74

Total		9			343			(273	)

Provision for income taxes	$	2,291		$	2,589		$	2,598

The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows (in millions):


	Year ended December 31,
	2010			2011			2012
Expected provision at federal statutory tax rate (35%)	$	3,779		$	4,314		$	4,685
State taxes, net of federal benefit		322			122			99
Stock-based compensation expense		79			105			52
Change in valuation allowance		(34	)		27			1,921
Foreign rate differential		(1,769	)		(2,001	)		(2,200	)
Federal research credit		(84	)		(140	)		0
Tax exempt interest		(12	)		(10	)		(7	)
Non-deductible legal settlement		0			175			0
Basis difference in investment in Home business		0			0			(1,960	)
Other permanent differences		10			(3	)		8

Provision for income taxes	$	2,291		$	2,589		$	2,598

We have not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, 2012 because we intend to permanently reinvest such earnings outside the U.S. If these foreign earnings were to be repatriated in the future, the related U.S. tax liability may be reduced by any foreign income taxes previously paid on these earnings. As of December 31, 2012, the cumulative amount of earnings upon which U.S. income taxes have not been provided is approximately $33.3 billion. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable.

Deferred Tax Assets

Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows (in millions):


	As of December 31,
	2011			2012
Deferred tax assets:
Stock-based compensation expense	$	288		$	311
State taxes		138			184
Capital loss carryforward		285			236
Settlement with the Authors Guild and AAP		35			28
Vacation accruals		52			67
Deferred rent		43			50
Accruals and reserves not currently deductible		268			688
Acquired net operating losses		156			505
Tax credit		55			274
Basis difference in investment in Home business		0			2,043
Other		11			128

Total deferred tax assets		1,331			4,514
Valuation allowance		(333	)		(2,629	)

Total deferred tax assets net of valuation allowance		998			1,885
Deferred tax liabilities:
Depreciation and amortization		(479	)		(761	)
Identified intangibles		(398	)		(1,496	)
Unrealized gains on investments and other		(90	)		(105	)
Other prepaids		(70	)		(118	)
Other		(33	)		(133	)

Total deferred tax liabilities		(1,070	)		(2,613	)

Net deferred tax liabilities	$	(72	)	$	(728	)

As of December 31, 2012, our federal, state and foreign net operating loss carryforwards for income tax purposes were approximately $1,048 million, $333 million and $384 million. If not utilized, the federal net operating loss carryforwards will begin to expire in 2017 and the state net operating loss carryforwards will begin to expire in 2013. The foreign net operating loss can be carried forward indefinitely, however it is more likely than not that it will not be realized, therefore we have recorded a full valuation allowance. The net operating loss carryforwards are subject to various annual limitations under Section 382 of the Internal Revenue Code and similar limitations under the tax laws of the foreign jurisdictions.

As of December 31, 2012, our California research and development credit carryforwards for income tax purposes were approximately $146 million that can be carried over indefinitely. We believe it is more likely than not that a portion of the state tax credit will not be realized. Therefore, we have recorded a valuation allowance on the state tax credit carryforward in the amount of $130 million. We will reassess the valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

As of December 31, 2012, our federal and state capital loss carryforwards for income tax purposes were approximately $483 million and $612 million. We also have deferred tax assets for impairment losses that, if recognized, will be capital in nature. We believe that it is more likely than not that our deferred tax assets for capital losses and impairment losses will not be realized. Therefore, we have recorded a valuation allowance on both our federal and state deferred tax assets for these items in the amount of $205 million. We will reassess the valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

In December 2012, we entered into an agreement with Arris Group Inc. (Arris) for the disposition of the Motorola Home business. A deferred tax asset was established for the book to tax basis difference in our investment in the Motorola Home Business upon signing the agreement. When the disposition event actually occurs in the foreseeable future, some or all of the basis difference in the Home business will become a basis difference in Google’s investment in Arris. Since any future losses to be recognized upon sale of the Home business or Arris Shares will be capital losses and Google already has an excess capital loss carryforward, a full valuation allowance was recorded against this deferred tax asset. We will reassess the valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

Uncertain Tax Positions

The following table summarizes the activity related to our gross unrecognized tax benefits from January 1, 2010 to December 31, 2012 (in millions):


Balance as of January 1, 2010	$	1,188
Increases related to prior year tax positions		37
Decreases related to prior year tax positions		(197	)
Decreases related to settlement with tax authorities		(47	)
Decreases as a result of a lapse of applicable statute of limitation		(97	)
Increases related to current year tax positions		256

Balance as of December 31, 2010		1,140
Increases related to prior year tax positions		77
Decreases related to prior year tax positions		(9	)
Increases related to current year tax positions		361
Decreases related to settlement with tax authorities		(5	)

Balance as of December 31, 2011		1,564
Increases related to prior year tax positions		43
Decreases related to prior year tax positions		(40	)
Decreases related to settlement with tax authorities		(62	)
Increases related to acquisition		17
Increases related to current year tax positions		411

Balance as of December 31, 2012		1,933

Our total unrecognized tax benefits that, if recognized, would affect our effective tax rate were $951 million, $1,350 million, and $1,749 million as of December 31, 2010, 2011, and 2012.

As of December 31, 2011 and 2012, we had accrued $129 million and $139 million for payment of interest and penalties. Interest and penalties included in our provision for income taxes were not material in all the periods presented.

We and our subsidiaries are routinely examined by various taxing authorities. Although we file U.S. federal, U.S. state, and foreign tax returns, our two major tax jurisdictions are the U.S. and Ireland. During the three months ended December 31, 2007, the IRS completed its examination of our 2003 and 2004 tax years. We have filed an appeal with the IRS for certain issues related to this audit and settlements were reached in 2012 on all but one issue which we plan to litigate in court. As a result we released the related reserves in the three month ended December 31, 2012. The IRS is currently in examination of our 2007, 2008, and 2009 tax years. We expect the examination to be completed within the next 12 months, but we do not anticipate any significant impact to our unrecognized tax benefit balance as of December 31, 2012, related to our 2007, 2008, and 2009 tax years.

Our 2010, 2011 and 2012 tax years remain subject to examination by the IRS for U.S. federal tax purposes, and our 2006 through 2012 tax years remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are various other ongoing audits in various other jurisdictions that are not material to our financial statements.