Income Taxes

9 Months Ended

Sep. 30, 2021

Income Tax Disclosure [Abstract]

Income Taxes

NOTE 6. INCOME TAXES

For the third quarter of 2021, we recorded income tax expense of $53 million on income before income taxes of $187 million. For the first nine months of 2021, we recorded income tax expense of $95 million on income before income taxes of $318 million. Income tax expense for the nine months ended September 30, 2021 includes a net discrete benefit of $30 million, primarily related to adjusting our deferred tax assets in England for a recently enacted increase in the tax rate, partially offset by net discrete charges for various items, including the settlement of a tax audit in Poland.

For the third quarter of 2020, we recorded an income tax benefit of $13 million on a loss before income taxes of $10 million. For the first nine months of 2020, we recorded income tax expense of $50 million on a loss before income taxes of $1,267 million. The income tax benefit for the three months ended September 30, 2020 includes net discrete benefits of $14 million, primarily to adjust our deferred tax assets in England for an enacted change in the tax rate during 2020. Income tax expense for the nine months ended September 30, 2020 includes net discrete charges of $278 million, including the establishment of a $295 million valuation allowance on deferred tax assets for foreign tax credits during the first quarter of 2020.

We record taxes based on overall estimated annual effective tax rates. The difference between our effective tax rate and the U.S. statutory rate of 21% for the three and nine months ended September 30, 2021 primarily relates to the tax on a favorable indirect tax ruling in Brazil during the second quarter, losses in foreign jurisdictions in which no tax benefits are recorded, and the discrete items noted above. The difference between our effective tax rate and the U.S. statutory rate of 21% for the three and nine months ended September 30, 2020 primarily relates to the discrete items noted above, a first quarter non-cash goodwill impairment charge of $182 million, and forecasted losses for the full year in foreign jurisdictions in which no tax benefits are recorded, which were accentuated during 2020 by business interruptions resulting from the COVID-19 pandemic.

We consider both positive and negative evidence when measuring the need for a valuation allowance. The weight given to the evidence is commensurate with the extent to which it may be objectively verified. Current and cumulative financial reporting results are a source of objectively verifiable evidence. We give operating results during the most recent three-year period a significant weight in our analysis. We typically only consider forecasts of future profitability when positive cumulative operating results exist in the most recent three-year period. We perform scheduling exercises to determine if sufficient taxable income of the appropriate character exists in the periods required in order to realize our deferred tax assets with limited lives (such as tax loss carryforwards and tax credits) prior to their expiration. We consider tax planning strategies available to accelerate taxable amounts if required to utilize expiring deferred tax assets. A valuation allowance is not required to the extent that, in our judgment, positive evidence exists with a magnitude and duration sufficient to result in a conclusion that it is more likely than not that our deferred tax assets will be realized.

At September 30, 2021 and December 31, 2020, we had approximately $800 million and $1.2 billion of U.S. federal, state and local net deferred tax assets, respectively, net of valuation allowances totaling $368 million primarily for foreign tax credits with limited lives. At September 30, 2021, approximately $500 million of these U.S. net deferred tax assets have unlimited lives and approximately $300 million have limited lives and expire between 2025 and 2041. The decrease in our U.S. net deferred tax assets from December 31, 2020 primarily reflects the establishment of deferred tax liabilities for the tax impacts of certain fair value and other purchase accounting adjustments related to the Cooper Tire acquisition. In the U.S., we have a cumulative loss for the three-year period ending September 30, 2021. However, as the three-year cumulative loss in the U.S. is driven by business disruptions created by the COVID-19 pandemic, primarily in 2020, we also considered other objectively verifiable information in assessing our ability to utilize our net deferred tax assets, including recent favorable recovery trends in the tire industry and our tire volume as well as expected continued improvement. In addition, the Cooper Tire acquisition is expected to generate incremental domestic earnings and provide opportunities for cost and other operating synergies to further improve our U.S. profitability. These favorable trends, together with tax planning strategies, may provide sufficient objectively verifiable information to reverse a portion or all of our U.S. valuation allowance for foreign tax credits within the next twelve months.

At September 30, 2021 and December 31, 2020, our U.S. net deferred tax assets included $160 million and $133 million, respectively, of foreign tax credits with limited lives, net of valuation allowances of $328 million, generated primarily from the receipt of foreign dividends. Our earnings and forecasts of future profitability, taking into consideration recent trends, along with three significant sources of foreign income provide us sufficient positive evidence that we will be able to utilize our remaining foreign tax credits that expire between 2025 and 2031. Our sources of foreign income are (1) 100% of our domestic profitability can be re-characterized as foreign source income under current U.S. tax law to the extent domestic losses have offset foreign source income in prior years, (2) annual net foreign source income, exclusive of dividends, primarily from royalties, and (3) tax planning strategies, including capitalizing research and development costs, accelerating income on cross border transactions, including sales of inventory or raw materials to our subsidiaries, and reducing U.S. interest expense by, for example, reducing intercompany loans through repatriating current year earnings of foreign subsidiaries, all of which would increase our domestic profitability.

We consider our current forecasts of future profitability in assessing our ability to realize our deferred tax assets, including our foreign tax credits. As noted above, these forecasts include the impact of recent trends, including various macroeconomic factors such as the impact of the COVID-19 pandemic, on our profitability, as well as the impact of tax planning strategies. Macroeconomic factors, including the impact of the COVID-19 pandemic, possess a high degree of volatility and can significantly impact our profitability. As such, there is a risk that future earnings will not be sufficient to fully utilize our U.S. net deferred tax assets, including our remaining foreign tax credits. However, we believe our forecasts of future profitability along with the three significant sources of foreign income described above provide us sufficient positive, objectively verifiable evidence to conclude that it is more likely than not that, at September 30, 2021, our U.S. net deferred tax assets, including our foreign tax credits, net of valuation allowances, will be fully utilized.

At September 30, 2021 and December 31, 2020, we had approximately $1.3 billion of foreign deferred tax assets and valuation allowances of $1.0 billion and $1.1 billion, respectively. Our losses in various foreign taxing jurisdictions in recent periods represented sufficient negative evidence to require us to maintain a full valuation allowance against certain of these net foreign deferred tax assets. Most notably, in Luxembourg, we maintain a valuation allowance of approximately $897 million on all of our net deferred tax assets. Each reporting period, we assess available positive and negative evidence and estimate if sufficient future taxable income will be generated to utilize these existing deferred tax assets. We do not believe that sufficient positive evidence required to release valuation allowances having a significant impact on our financial position or results of operations will exist within the next twelve months.

For the nine months ended September 30, 2021, changes to our unrecognized tax benefits did not, and for the full year of 2021 are not expected to, have a significant impact on our financial position or results of operations.

We are open to examination in the United States for 2020 and in Germany from 2018 onward. Cooper Tire, our newly acquired wholly owned subsidiary, is open to examination in the United States from 2017 onward. Generally, for our remaining tax jurisdictions, years from 2016 onward are still open to examination.