INCOME TAXES

The components of International Paper’s earnings from continuing operations before income taxes and equity earnings by taxing jurisdiction were as follows:



In millions	2012		2011		2010
Earnings (loss)
U.S.	$	478	$	874	$	198
Non-U.S.	546		584		624
Earnings (loss) from continuing operations before income taxes and equity earnings	$	1,024	$	1,458	$	822

The provision (benefit) for income taxes (excluding noncontrolling interests) by taxing jurisdiction was as follows:



In millions	2012			2011			2010
Current tax provision (benefit)
U.S. federal	$	14		$	(78	)	$	(249	)
U.S. state and local	11			(19		)	(19		)
Non-U.S.	102			91			67
	$	127		$	(6	)	$	(201	)
Deferred tax provision (benefit)
U.S. federal	$	226		$	207		$	301
U.S. state and local	6			46			45
Non-U.S.	(28		)	64			76
	$	204		$	317		$	422
Income tax provision	$	331		$	311		$	221

The Company’s deferred income tax provision (benefit) includes a $25 million provision, an $8 million benefit and a $0 million provision for 2012, 2011 and 2010, respectively, for the effect of changes in non-U.S. and U.S. state tax rates.

International Paper made income tax payments, net of refunds, of $95 million, $44 million and $(135) million in 2012, 2011 and 2010, respectively.

A reconciliation of income tax expense using the statutory U.S. income tax rate compared with the actual income tax provision follows:



In millions	2012			2011			2010
Earnings (loss) from continuing operations before income taxes and equity earnings	$	1,024		$	1,458		$	822
Statutory U.S. income tax rate	35		%	35		%	35		%
Tax expense (benefit) using statutory U.S. income tax rate	358			510			288
State and local income taxes	11			16			15
Tax rate and permanent differences on non-U.S. earnings	(116		)	(34		)	(69		)
Net U.S. tax on non-U.S. dividends	48			23			16
Tax benefit on manufacturing activities	(15		)	(8		)	3
Non-deductible business expenses	7			6			8
Non-deductible goodwill	34			—			—
Sales of non-strategic businesses	—			(195		)	—
Retirement plan dividends	(5		)	(5		)	(2		)
Cellulosic bio-fuel credits	—			—			(40		)
Tax credits	—			(7		)	(25		)
Medicare subsidy	5			—			29
Other, net	4			5			(2		)
Income tax provision	$	331		$	311		$	221
Effective income tax rate	32		%	21		%	27		%

The tax effects of significant temporary differences, representing deferred income tax assets and liabilities at December 31, 2012 and 2011, were as follows:



In millions	2012			2011
Deferred income tax assets:
Postretirement benefit accruals	$	229		$	242
Pension obligations	1,620			954
Alternative minimum and other tax credits	741			478
Net operating loss carryforwards	579			536
Compensation reserves	242			189
Other	302			232
Gross deferred income tax assets	3,713			2,631
Less: valuation allowance	(400		)	(424		)
Net deferred income tax asset	$	3,313		$	2,207
Deferred income tax liabilities:
Intangibles	$	(263	)	$	(59	)
Plants, properties and equipment	(3,126		)	(2,383		)
Forestlands and related installment sales	(2,511		)	(1,833		)
Gross deferred income tax liabilities	$	(5,900	)	$	(4,275	)
Net deferred income tax liability	$	(2,587	)	$	(2,068	)

Deferred income tax assets and liabilities are recorded in the accompanying consolidated balance sheet under the captions Deferred income tax assets, Deferred charges and other assets, Other accrued liabilities, and Deferred income taxes. The acquisition of Temple-Inland in 2012 resulted in additional deferred tax assets of $600 million and deferred income tax liabilities of $1.8 billion. In addition, there is an increase in deferred income tax assets principally relating to the tax impact of changes in qualified pension liabilities. Certain tax attributes reflected on our tax returns as filed differ significantly from those reflected in the deferred income tax accounts due to uncertain tax benefits.

The valuation allowance for deferred income tax assets as of December 31, 2012 was $400 million. The net change in the total valuation allowance for the year ended December 31, 2012 was a decrease of $24 million. The decrease is primarily attributable to the release of a valuation allowance previously imposed on state income tax attributes which the Company now foresees utilizing.

A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2012, 2011 and 2010 is as follows:



In millions	2012			2011			2010
Balance at January 1	$	(857	)	$	(199	)	$	(308	)
(Additions) reductions based on tax positions related to current year	12			(2		)	(12		)
Additions for tax positions of prior years	(140		)	(719		)	(50		)
Reductions for tax positions of prior years	6			29			97
Settlements	2			2			—
Expiration of statutes of limitations	7			25			70
Currency translation adjustment	(2		)	7			4
Balance at December 31	$	(972	)	$	(857	)	$	(199	)

Included in the balance at December 31, 2012, 2011 and 2010 are $14 million, $9 million and $13 million, respectively, for tax positions for which the ultimate benefits are highly certain, but for which there is uncertainty about the timing of such benefits. However, except for the possible effect of any penalties, any disallowance that would change the timing of these benefits would not affect the annual effective tax rate, but would accelerate the payment of cash to the taxing authority to an earlier period.

The Company accrues interest on unrecognized tax benefits as a component of interest expense. Penalties, if incurred, are recognized as a component of income tax expense. The Company had approximately $104 million and $88 million accrued for the payment of estimated interest and penalties associated with unrecognized tax benefits at December 31, 2012 and 2011, respectively.

The major jurisdictions where the Company files income tax returns are the United States, Brazil, France, Poland and Russia. Generally, tax years 2002 through 2011 remain open and subject to examination by the relevant tax authorities. The Company is typically engaged in various tax examinations at any given time, both in the United States and overseas. Currently, the Company is engaged in discussions with the U.S. Internal Revenue Service regarding the examination of tax years 2006 through 2009. As a result of these discussions, other pending tax audit settlements, and the expiration of statutes of limitation, the Company currently estimates that the amount of unrecognized tax benefits could be reduced by up to $860 million during the next twelve months. During 2012, unrecognized tax benefits increased by $115 million primarily driven by the acquisition of Temple-Inland. While the Company believes that it is adequately accrued for possible audit adjustments, the final resolution of these examinations cannot be determined at this time and could result in final settlements that differ from current estimates.

Included in the Company’s 2012, 2011 and 2010 income tax provision (benefit) are $(85) million, $(266) million and $(143) million, respectively, related to special items. The components of the net provisions related to special items were as follows:



In millions	2012			2011			2010
Special items and other charges:
Restructuring and other charges	$	(104	)	$	(293	)	$	(149	)
Tax-related adjustments:
Internal restructurings	14			24			—
India deal costs	—			9			—
IP UK valuation allowance release	—			(13		)	—
Settlement of tax audits and legislative changes	—			5			—
Incentive plan deferred income tax write-off	—			—			14
Medicare D deferred income tax write-off	5			—			32
Cellulosic bio-fuel credits	—			—			(40		)
Other tax adjustments	—			2			—
Income tax provision (benefit) related to special items	$	(85	)	$	(266	)	$	(143	)

Excluding the impact of special items, the 2012, 2011 and 2010 income tax provisions were $410 million, $577 million and $364 million, respectively, or 29%, 32% and 30%, respectively, of pre-tax earnings before equity earnings.

The following details the scheduled expiration dates of the Company’s net operating loss and income tax credit carryforwards:



In millions	2013 Through 2022		2023 Through 2032		Indefinite		Total
U.S. federal and non-U.S. NOLs	$	19	$	151	$	359	$	529
State taxing jurisdiction NOLs	167		133		—		300
U.S. federal, non- U.S. and state tax credit carryforwards	188		74		669		931
State capital loss carryforwards	24		—		—		24
Total	$	398	$	358	$	1,028	$	1,784

Deferred income taxes are not provided for temporary differences of approximately $4.7 billion, $4.5 billion and $4.3 billion as of December 31, 2012, 2011 and 2010, respectively, representing earnings of non-U.S. subsidiaries intended to be permanently reinvested. Computation of the potential deferred tax liability associated with these undistributed earnings and other basis differences is not practicable.

The American Taxpayer Relief Act of 2012 (the “Act”) was signed into law on January 2, 2013. The Act retroactively restored several expired business tax provisions, including the research and experimentation credit and the Subpart F controlled foreign corporation look-through exception. Because a change in tax law is accounted for in the period of enactment, the retroactive effect of the Act on the Company's U.S. federal taxes for 2012 of a benefit of approximately $32 million will be recognized in the first quarter of 2013. In addition, we expect the Act's extension of these provisions through the end of 2013 will favorably impact our estimated annual effective tax rate for 2013 by approximately one percentage point.