In 2017, the U.S. enacted the Tax Cuts and Jobs Act (2017 Tax Act), which significantly revised U.S. tax law. Guidance related to the 2017 Tax Act, including Notices, Proposed Regulations, and Final Regulations, has been issued, and we expect additional guidance will be issued in 2020. This additional guidance could materially impact our assumptions and estimates used to record our U.S. federal and state income tax expense resulting from the 2017 Tax Act.

We are included in Lilly's U.S. tax examinations by the Internal Revenue Service through the full separation date of March 11, 2019. Pursuant to the tax matters agreement we executed with Lilly in connection with the IPO, the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. Certain matters of Lilly’s U.S. examination of tax years 2013 - 2015 effectively settled during the second quarter of 2019 and the resulting adjustments will not require any cash tax payments by Elanco. During the fourth quarter of 2019, certain matters for tax year 2015 were effectively settled upon conclusion of the IRS' examination and the resulting adjustments will not require any cash tax payments by Elanco. In the fourth quarter of 2019, the IRS began its examination of tax years 2016 - 2018.

Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution.


	2019		2018		2017
Current:
Federal	$	(5.5)	$	45.1	$	—
Foreign	13.4		45.5		91.6
State	2.3		(2.3)		(0.1)
Total current tax expense	10.2		88.3		91.5
Deferred:
Federal	14.5		(56.8)		42.6
Foreign	(7.5)		(5.6)		(16.6)
State	(6.9)		1.7		(6.3)
2017 Tax Act	—		—		(33.1)
Total deferred tax expense (benefit)	0.1		(60.7)		(13.4)
Income taxes	$	10.3	$	27.6	$	78.1


	2019		2018
Deferred tax assets:
Compensation and benefits	$	25.3	$	32.2
Accruals and reserves	13.7		26.9
Tax credit carryovers	12.8		6.2
Tax loss carryovers	69.5		17.4
Inventories	20.1		18.3
Restructuring and other reserves	24.6		6.0
Operating lease liabilities	20.5		—
Other	2.3		20.1
Total gross deferred tax assets	188.8		127.1
Valuation allowances	(32.7)		(21.4)
Total deferred tax assets	156.1		105.7
Deferred tax liabilities:
Right-of-use assets	(20.5)		—
Intangibles	(134.5)		(130.8)
Property and equipment	(56.4)		(50.8)
Other	(0.6)		(2.7)
Total deferred tax liabilities	(212.0)		(184.3)
Deferred tax liabilities - net	$	(55.9)	$	(78.6)

The deferred tax assets and related valuation allowance amounts for U.S. federal and state net operating losses and tax credits shown above have been reduced for differences between financial reporting and tax return filings.

At December 31, 2019, we have tax credit carryovers of $14.0 million available to reduce future income taxes. The amount is comprised of foreign, U.S. federal and state credits. The foreign credits total $5.1 million and if unused, will begin to expire in 2030. The U.S. federal credits total $3.2 million and if unused, will begin to expire in 2030. The state credits total $5.7 million and if unused, will begin to expire in 2020. The U.S. federal and state credits are subject to a full valuation allowance.

At December 31, 2019, we had net operating loss carryovers and other carryovers for foreign, U.S. federal and state income tax purposes of $348.4 million: $285.5 million will expire between 2020 and 2039; and $62.9 million of the carryovers have an indefinite carryforward period. Net operating losses and other carryovers for foreign and state income tax purposes are subject to a partial valuation allowance.


	2019		2018
January 1	$	(21.4)	$	(127.7)
Adjustment related to Separation	—		110.4
January 1	(21.4)		(17.3)
Increase ⁽¹⁾	(23.2)		(5.8)
Release	11.9		1.7
December 31	$	(32.7)	$	(21.4)

⁽¹⁾ The increase in the valuation allowance during 2019 is primarily attributable to the acquisition of Aratana Therapeutics, Inc. and Prevtec Microbia Inc. (see Note 6: Acquisitions).

Prior to the IPO, we prepared the income tax amounts and balances based upon a separate return methodology, as if we were separate taxpayers from Lilly. As a result, certain tax credits and net operating loss carryovers are not available for use in future periods as they were used in Lilly consolidated or combined tax return filings. Accordingly, as a result of the Separation, the tax credit and net operating loss carryovers and related valuation allowance have been adjusted to reflect the balance after Separation. These adjustments had no impact on income tax expense in the consolidated and combined financial statements. The separation entries related to the valuation allowance were offset by $133.7 million, prior to tax effect, of separation entries related to the removal of the net operating losses.

The 2017 Tax Act introduced international tax provisions that significantly change the U.S. taxation of foreign earnings. At December 31, 2019, no U.S. taxes or foreign withholding taxes have been accrued with respect to the $496.7 million in unremitted earnings of our foreign subsidiaries as they are considered indefinitely reinvested for continued use in our foreign operations. It is not practicable to determine the unrecognized deferred tax liability related to these earnings.


	2019		2018		2017
Income tax at the U.S. federal statutory tax rate	$	16.4	$	24.0	$	(81.4)
Add (deduct):
Taxation of international operations	20.7		20.5		59.8
State taxes	2.9		4.4		5.4
Income tax credits	(9.8)		(17.3)		(1.8)
Non-deductible employee compensation	4.2		(1.9)		—
IPO and separation costs	—		2.3		—
Other permanent adjustments	(4.2)		(1.0)		0.8
Change in uncertain tax positions	(14.7)		(1.7)		6.2
Change in valuation allowance	(5.2)		(1.7)		122.2
2017 Tax Act	—		—		(33.1)

Income taxes	$	10.3	$	27.6	$	78.1


	2019		2018		2017
Beginning balance at January 1	$	14.7	$	29.6	$	25.7
Adjustments related to Separation	(2.2)		(17.6)		—
Adjusted beginning balance at January 1	12.5		12.0		25.7
Additions based on tax positions related to the current year	1.3		2.2		7.9
Changes for tax positions of prior years	(1.2)		4.0		—
Settlements	(4.3)		(3.0)		(4.0)
Changes related to the impact of foreign currency translation	(0.1)		(0.5)		—
Ending balance at December 31	$	8.2	$	14.7	$	29.6

The total amount of unrecognized tax benefits that, if recognized, would affect tax expense was $8.2 million and $12.8 million at December 31, 2019 and 2018, respectively. There were $1.9 million of 2018 unrecognized tax benefits which related to temporary differences which did not impact the effective tax rate. Adjustments related to the Separation represent unrecognized tax benefits assumed by Lilly in the Separation and have no impact on income tax expense in the consolidated and combined financial statements.

We file income tax returns in the U.S. federal jurisdiction and various state, local and non-U.S. jurisdictions. Prior to full separation, certain of these income tax returns were filed on a consolidated or combined basis with Lilly.

We recognize both accrued interest and penalties related to unrecognized tax benefits in income tax expense (benefit). We recognized income tax expense (benefit) related to interest and penalties as follows: