Note 13 Income Taxes

Earnings Before Income Tax Expense

years ended December 31 (in millions)	2015			2014			2013

Domestic	$	(1,038	)	$	(3,245	)	$	(581	)
Foreign		7,683			5,614			5,913

Total earnings before income tax expense	$	6,645		$	2,369		$	5,332

The domestic loss before income taxes in 2014 was driven by transaction and financing-related costs associated with the terminated proposed combination with Shire. Refer to Note 5 for further information.

Income Tax Expense

years ended December 31 (in millions)	2015		2014			2013

Current
Domestic	$	1,036	$	634		$	226
Foreign		313		341			354

Total current taxes	$	1,349	$	975		$	580


Deferred
Domestic	$	141	$	(301	)	$	678
Foreign		11		(79	)		(54	)

Total deferred taxes	$	152	$	(380	)	$	624


Total income tax expense	$	1,501	$	595		$	1,204

Effective Tax Rate Reconciliation

years ended December 31	2015			2014			2013

Statutory tax rate		35.0	%		35.0	%		35.0	%
State taxes, net of federal benefit		0.1			—			0.3
Effect of foreign operations		(9.4	)		(11.3	)		(11.5	)
U.S. tax credits		(4.5	)		(8.9	)		(2.7	)
Branded prescription drug fee		0.7			3.7			0.4
Valuation allowances		(1.6	)		3.6			0.1
All other, net		2.3			3.0			1.0

Effective tax rate		22.6	%		25.1	%		22.6	%

The effective tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including acquisitions and collaborations. The effective tax rates in 2015, 2014 and 2013 differed from the statutory tax rate principally due to the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax exemptions and incentives in Puerto Rico and other foreign tax jurisdictions, and business development activities together with the cost of repatriation decisions. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The research and development credits for 2015 and 2014 were due to legislation enacted in the fourth quarter of each year that retroactively extended the credit. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax beginning in 2011 on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2015 included a tax benefit of $103 million from a reduction of state valuation allowances.

The effective tax rate in 2014 included additional expenses of $129 million related to the Branded Prescription Drug Fee, which is non-deductible, and state valuation allowances of $129 million. On July 28, 2014, the Internal Revenue Service issued final rules and regulations for the Branded Prescription Drug Fee, an annual non-tax-deductible fee payable to the federal government under the Affordable Care Act based on an allocation of a company's market share for branded prescription drugs sold to certain government programs in the prior year. The final rules accelerated the expense recognition criteria for the fee obligation from the year in which the fee is paid, to the year in which the market share used to allocate the fee is determined. This change required AbbVie and other industry participants to recognize an additional year of expense in 2014.

The effective income tax rate in 2015, 2014 and 2013 reflects income tax expenses relating to current earnings outside the United States that are not deemed indefinitely reinvested.

Deferred Tax Assets and Liabilities

as of December 31 (in millions)	2015			2014

Deferred tax assets
Compensation and employee benefits	$	584		$	627
Accruals and reserves		368			376
Chargebacks and rebates		472			297
Deferred revenue		372			382
Depreciation		45			53
Net operating losses and other credit carryforwards		282			125
Other		316			292

Total deferred tax assets		2,439			2,152
Valuation allowances		(70	)		(172	)

Total net deferred tax assets		2,369			1,980

Deferred tax liabilities
Excess of book basis over tax basis of intangible assets		(4,459	)		(331	)
Excess of book basis over tax basis in investments		(2,958	)		(326	)

Total deferred tax liabilities		(7,417	)		(657	)

Net deferred tax (liabilities) assets	$	(5,048	)	$	1,323

The increases in the deferred tax liabilities are primarily due to the acquisition of Pharmacyclics in which AbbVie recorded the excess of book basis over tax basis of intangible assets and investments.

Gross federal net operating loss and tax credit carryforwards as of December 31, 2015 were $293 million and $147 million, respectively, and are available for use through 2035. Gross state net operating loss and tax credit carryforwards as of December 31, 2015 were $1.3 billion and $152 million, respectively. The state tax carryforwards expire between 2017 and 2035. As of December 31, 2015, foreign net operating loss carryforwards were $232 million. Foreign net operating loss carryforwards of $177 million expire between 2018 and 2023, and the remaining do not have an expiration period.

As of December 31, 2015 and 2014, the company had valuation allowances of $70 million and $172 million, respectively, principally related to state net operating losses and credit carryforwards that are not expected to be realized.

Deferred income taxes have not been provided on approximately $25 billion of the undistributed earnings of foreign subsidiaries as these earnings have been indefinitely reinvested for continued use in foreign operations. Due to the complexities in tax laws and assumptions that would have to be made, it is not practicable to estimate the amount of income taxes that would be due if these earnings were distributed.

Unrecognized Tax Benefits

years ended December 31 (in millions)	2015			2014			2013

Balance as of January 1	$	421		$	247		$	1,140
Increase due to current year tax positions		187			115			195
Increase due to prior year tax positions		369			67			—
Decrease due to prior year tax positions		(15	)		(6	)		—
Lapse of statutes of limitations		(8	)		(2	)		—
Separation-related adjustments		—			—			(1,088	)

Balance as of December 31	$	954		$	421		$	247

AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation.

The table above reflects the 2013 reduction of $1.1 billion relating to tax periods prior to the separation for which Abbott is the primary obligor. However, under U.S. Treasury Regulations, each member of a consolidated group is severally liable for the U.S. federal income tax liability of each other member of the consolidated group. Accordingly, with respect to periods in which AbbVie was included in Abbott's consolidated group, AbbVie could be liable to the U.S. government for any U.S. federal income tax liability incurred by the consolidated group, to the extent not discharged by any other member. However, if any such liability were imposed, AbbVie would be entitled to be indemnified by Abbott pursuant to the tax sharing agreement.

If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $901 million and $389 million in 2015 and 2014, respectively. Of the unrecognized tax benefits recorded in the table above as of December 31, 2015, AbbVie would be indemnified for approximately $107 million. The "Increase due to prior year tax positions" in the table above includes amounts relating to federal, state, and international items as well as prior positions acquired through business development activities during the year. Uncertain tax positions are generally included as a long-term liability on the consolidated balance sheets.

AbbVie recognizes interest and penalties related to income tax matters in income tax expense. In 2015, 2014, and 2013, AbbVie recognized gross income tax expense of $13 million, $10 million, and $3 million, respectively, for interest and penalties related to income tax matters. At December 31, 2015, 2014, and 2013, AbbVie had $83 million, $25 million, and $15 million accrued for the payment of gross interest and penalties.

The company is routinely audited by the tax authorities in significant jurisdictions, and a number of audits are currently underway. It is reasonably possible during the next twelve months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state, and foreign examinations, and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next twelve months up to $15 million. All significant federal, state, local, and international matters have been concluded for years through 2005. The company believes adequate provision has been made for all income tax uncertainties.