Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes [Abstract]

Income Taxes

13. Income Taxes

Prior to the separation from Loews in 2008 (the “Separation”), Lorillard was included in the Loews consolidated federal income tax return, and federal income tax liabilities were included on the balance sheet of Loews. Under the terms of the pre-Separation Tax Allocation Agreement between Lorillard and Loews, Lorillard made payments to, or was reimbursed by Loews for the tax effects resulting from its inclusion in Loews’s consolidated federal income tax return. As of December 31, 2011, there were no tax obligations between Lorillard and Loews for periods prior to the Separation. Following the Separation, Lorillard and its eligible subsidiaries filed a stand-alone consolidated federal income tax return.

The Separation Agreement with Loews (the “Separation Agreement”) requires Lorillard (and any successor entity) to indemnify Loews for any losses resulting from the failure of the Separation to qualify as a tax-free transaction (except if the failure to qualify is solely due to Loews’s fault). This indemnification obligation applies regardless of whether Lorillard or a potential acquirer obtains a supplemental ruling or an opinion of counsel.

The Separation Agreement further provides for cooperation between Lorillard and Loews with respect to additional tax matters, including the exchange of information and the retention of records which may affect the income tax liability of the parties to the Separation Agreement.

For 2007 and 2008, Lorillard, as a subsidiary in the Loews consolidated federal income tax return, participated in the Compliance Assurance Process (“CAP”) which is a voluntary program for a limited number of large corporations. Under CAP, the IRS conducts a real-time audit and works contemporaneously with Lorillard to resolve any issues prior to the filing of the tax return. Lorillard’s participation in the CAP ended in 2010 when the IRS approved Loews’s 2008 consolidated federal income tax return as filed.

During 2008 and 2010, the IRS completed its examination of the 2007 and 2008 Loews consolidated federal income tax returns, respectively, resulting in no changes being made to Lorillard’s reported tax on the returns.

For years after the Separation, Lorillard and its subsidiaries file a consolidated federal income tax return. During 2011, the IRS completed its examination of the 2008 and 2009 consolidated federal income tax returns filed by Lorillard and its subsidiaries. There were no changes proposed.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

(In millions)	2011			2010			2009
Balance at January 1,	$	33		$	39		$	29
Additions for tax positions of prior years		6			1			9
Reductions for tax positions of prior years		(2	)		(15	)		(7	)
Additions based on tax positions related to the current year		9			9			20
Settlements		(1	)		—			(10	)
Lapse of statute of limitations		(3	)		(1	)		(2	)
Balance at December 31,	$	42		$	33		$	39

At December 31, 2011, 2010 and 2009, there were $28 million, $22 million and $18 million, respectively, of tax benefits that, if recognized, would affect the effective tax rate.

Lorillard recognizes interest accrued related to unrecognized tax benefits and tax refund claims in interest expense and recognizes penalties (if any) in income tax expense. During the years ended December 31, 2011, 2010 and 2009, Lorillard recognized an expense (benefit) of approximately $2 million, $3 million and ($1) million in interest and penalties. Lorillard had accrued interest and penalties related to unrecognized tax benefits of $15 million and $14 million at December 31, 2011 and 2010, respectively.

Due to the potential for resolution of certain tax examinations and the expiration of various statutes of limitation, it is reasonably possible that Lorillard’s gross unrecognized tax benefits balance may decrease by approximately $6 million in the next twelve months.

Lorillard and/or one or more of its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states and city jurisdictions and one foreign jurisdiction. Lorillard’s consolidated federal income tax returns for the periods following the Separation are subject to IRS examination. With few exceptions, Lorillard’s state, local or foreign tax returns are subject to examination by taxing authorities for years after 2006.

The provision (benefit) for income taxes consisted of the following:

	Year Ended December 31,
	2011			2010		2009
	(In millions)
Current
Federal	$	548		$	489	$	469
State		120			112		111
Deferred
Federal		(10	)		5		(6	)
State		(4	)		—		(3	)
Total	$	654		$	606	$	571

Deferred tax assets (liabilities) are as follows:

	December 31,
(In millions)	2011			2010
Deferred tax assets:
Employee benefits	$	154		$	98
Settlement costs		498			456
State and local income taxes		18			14
Litigation and legal		7			36
Other		8			10
Gross deferred tax assets		685			614
Deferred tax liabilities:
Depreciation		(57	)		(52	)
Inventory		(6	)		(21	)
Federal effect of state deferred taxes		(33	)		(32	)
Gross deferred tax liabilities		(96	)		(105	)
Net deferred tax assets	$	589		$	509

Total income tax expense for the years ended December 31, 2011, 2010 and 2009 was different than the amounts of $620 million, $572 million and $531 million, computed by applying the statutory U.S. federal income tax rate of 35% to income before taxes for each of the years.

A reconciliation between the statutory federal income tax rate and Lorillard’s effective income tax rate as a percentage of income is as follows:

	2011			2010			2009
Statutory rate		35.0	%		35.0	%		35.0	%
Increase (decrease) in rate resulting from:
State taxes		4.3			4.5			4.6
Domestic manufacturer’s deduction		(2.4	)		(2.5	)		(1.9	)
Other		0.1			0.1			(0.1	)
Effective rate		37.0	%		37.1	%		37.6	%