Note 5 – Income Taxes

The provision for income taxes for the three years ended September 24, 2011, consisted of the following (in millions):


	2011			2010			2009
Federal:
Current	$	3,884		$	2,150		$	1,922
Deferred		2,998			1,676			1,077

		6,882			3,826			2,999

State:
Current		762			655			524
Deferred		37			(115	)		(2	)

		799			540			522

Foreign:
Current		769			282			345
Deferred		(167	)		(121	)		(35	)

		602			161			310

Provision for income taxes	$	8,283		$	4,527		$	3,831

The foreign provision for income taxes is based on foreign pretax earnings of $24.0 billion, $13.0 billion and $6.6 billion in 2011, 2010 and 2009, respectively. The Company’s consolidated financial statements provide for any related tax liability on amounts that may be repatriated, aside from undistributed earnings of certain of the Company’s foreign subsidiaries that are intended to be indefinitely reinvested in operations outside the U.S. As of September 24, 2011, U.S. income taxes have not been provided on a cumulative total of $23.4 billion of such earnings. The amount of unrecognized deferred tax liability related to these temporary differences is estimated to be approximately $8.0 billion.

As of September 24, 2011 and September 25, 2010, $54.3 billion and $30.8 billion, respectively, of the Company’s cash, cash equivalents and marketable securities were held by foreign subsidiaries and are generally based in U.S. dollar-denominated holdings. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S.

Deferred tax assets and liabilities reflect the effects of tax losses, credits, and the future income tax effects of temporary differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates that apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

As of September 24, 2011 and September 25, 2010, the significant components of the Company’s deferred tax assets and liabilities were (in millions):


	2011			2010
Deferred tax assets:
Accrued liabilities and other reserves	$	1,610		$	1,369
Basis of capital assets and investments		390			179
Share-based compensation		355			308
Other		795			707

Total deferred tax assets		3,150			2,563
Less valuation allowance		0			0

Deferred tax assets, net of valuation allowance		3,150			2,563

Deferred tax liabilities:
Unremitted earning of foreign subsidiaries		8,896			4,979
Other		272			150

Total deferred tax liabilities		9,168			5,129

Net deferred tax liabilities	$	(6,018	)	$	(2,566	)

A reconciliation of the provision for income taxes, with the amount computed by applying the statutory federal income tax rate (35% in 2011, 2010 and 2009) to income before provision for income taxes for the three years ended September 24, 2011, is as follows (in millions):


	2011			2010			2009
Computed expected tax	$	11,973		$	6,489		$	4,223
State taxes, net of federal effect		552			351			339
Indefinitely invested earnings of foreign subsidiaries		(3,898	)		(2,125	)		(647	)
Research and development credit, net		(167	)		(23	)		(84	)
Domestic production activities deduction		(168	)		(48	)		(36	)
Other		(9	)		(117	)		36

Provision for income taxes	$	8,283		$	4,527		$	3,831

Effective tax rate		24.2%			24.4%			31.8%

The Company’s income taxes payable have been reduced by the tax benefits from employee stock plan awards. For stock options, the Company receives an income tax benefit calculated as the difference between the fair market value of the stock issued at the time of the exercise and the option price, tax effected. For RSUs, the Company receives an income tax benefit upon the award’s vesting equal to the tax effect of the underlying stock’s fair market value. The Company had net excess tax benefits from equity awards of $1.1 billion, $742 million and $246 million in 2011, 2010 and 2009, respectively, which were reflected as increases to common stock.

Uncertain Tax Positions

Tax positions are evaluated in a two-step process. The Company first determines whether it is more likely than not that a tax position will be sustained upon examination. If a tax position meets the more-likely-than-not recognition threshold it is then measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Company classifies gross interest and penalties and unrecognized tax benefits that are not expected to result in payment or receipt of cash within one year as non-current liabilities in the Consolidated Balance Sheets.

As of September 24, 2011, the total amount of gross unrecognized tax benefits was $1.4 billion, of which $563 million, if recognized, would affect the Company’s effective tax rate. As of September 25, 2010, the total amount of gross unrecognized tax benefits was $943 million, of which $404 million, if recognized, would affect the Company’s effective tax rate.

The aggregate changes in the balance of gross unrecognized tax benefits, which excludes interest and penalties, for the three years ended September 24, 2011, is as follows (in millions):


	2011			2010			2009
Beginning Balance	$	943			971		$	506
Increases related to tax positions taken during a prior year		49			61			341
Decreases related to tax positions taken during a prior year		(39	)		(224	)		(24	)
Increases related to tax positions taken during the current year		425			240			151
Decreases related to settlements with taxing authorities		0			(102	)		0
Decreases related to expiration of statute of limitations		(3	)		(3	)		(3	)

Ending Balance	$	1,375		$	943		$	971

The Company includes interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of September 24, 2011 and September 25, 2010, the total amount of gross interest and penalties accrued was $261 million and $247 million, respectively, which is classified as non-current liabilities in the Consolidated Balance Sheets. In connection with tax matters, the Company recognized interest expense in 2011 and 2009 of $14 million and $64 million, respectively, and in 2010 the Company recognized an interest benefit of $43 million.

The Company is subject to taxation and files income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. For U.S. federal income tax purposes, all years prior to 2004 are closed. The Internal Revenue Service (the “IRS”) has completed its field audit of the Company’s federal income tax returns for the years 2004 through 2006 and proposed certain adjustments. The Company has contested certain of these adjustments through the IRS Appeals Office. The IRS is currently examining the years 2007 through 2009. In addition, the Company is also subject to audits by state, local and foreign tax authorities. In major states and major foreign jurisdictions, the years subsequent to 1988 and 2001, respectively, generally remain open and could be subject to examination by the taxing authorities.

Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income tax in the period such resolution occurs. Although timing of the resolution and/or closure of audits is not certain, the Company does not believe it is reasonably possible that its unrecognized tax benefits would materially change in the next 12 months.