Income Taxes

9 Months Ended

Dec. 31, 2011

Income Taxes

Income Taxes

(12) Income Taxes

        We were included in the consolidated federal income tax returns and the combined state income tax returns of QCII until CenturyLink's April 1, 2011 acquisition of QCII and the consolidated federal income tax returns and certain combined state income tax returns of CenturyLink subsequent to the acquisition. Both CenturyLink and QCII treat our consolidated results as if we were a separate taxpayer. The policy requires us to pay our tax liabilities in cash based upon our separate return taxable income. Because we are included in the consolidated federal income tax returns and the combined state income tax returns of QCII, any tax audits involving QCII will also involve us. The IRS examines all of QCII's federal income tax returns because QCII is included in the coordinated industry case program.

        As of December 31, 2010, the QCII federal income tax returns for tax years 2006-2007 and prior were examined by the IRS. We received $11 million in the third quarter of 2010 as our share of the settlements and we recorded a $4 million asset transfer with QSC to recognize the difference between the settlements recorded and the actual cash payment. In 2010, QCII filed amended federal income tax returns for 2006-2007 to make protective claims with respect to items reserved in QCII's audit settlements and to correct items not addressed in prior audits. Those amended federal income tax returns are subject to adjustment in an IRS audit.

        In 2009, QCII filed amended federal income tax returns for 2002-2005 to make protective claims with respect to items reserved in our audit settlements and to correct items not addressed in prior audits. Those amended federal income tax returns are subject to adjustment in an IRS audit. Additionally, our federal income tax returns filed for tax years after 2008 are still subject to adjustment in an IRS audit.

        QCII also files combined income tax returns in many states, and these combined returns remain open for adjustments to its federal income tax returns. In addition, certain combined state income tax returns filed since 1996 are still open for state specific adjustments.

        A reconciliation of the unrecognized tax benefits:

	Unrecognized Tax Benefits
	Successor		Predecessor
	2011		2010
	(Dollars in millions)
Balance at January 1	$	—		13
Additions for current year tax positions		—		—
Additions for prior year tax positions		—		—
Reductions for prior year tax positions		—		—
Settlements		—		(13	)
Reductions related to expirations of statute of limitations		—		—
Balance at December 31	$	—		—

        Effective on April 1, 2011 in conjunction with CenturyLink's indirect acquisition of us, we changed our accounting policy to recognize interest expense and penalties related to income taxes as income tax expense. Prior to April 1, 2011, interest expense and penalties related to income taxes were included in the other income (expense) line of our consolidated statements of operations. For the successor nine months ended December 31, 2011 and the predecessor three months ended March 31, 2011, we recognized immaterial amounts for interest related to uncertain tax positions. For the predecessor years ended December 31, 2010 and 2009, we recognized $1 million and $9 million of interest benefit related to uncertain tax positions, respectively. As of the successor date of December 31, 2011 and the predecessor date of December 31, 2010, we had recorded liabilities for interest related to uncertain tax positions in the amounts of $5 million and $6 million, respectively. We made no accrual for penalties related to income tax positions. The interest benefit and accrued interest liability recognized as of the successor date of December 31, 2011 is related to the carryover effects of settled positions.

Income Tax Expense

        The components of the income tax expense from continuing operations are as follows:

	Successor		Predecessor
	Nine Months Ended December 31, 2011		Three Months Ended March 31, 2011		Year Ended December 31, 2010		Year Ended December 31, 2009
	(Dollars in millions)
Income tax expense:
Current tax provision:
Federal	$	173		104		470		740
State and local		26		11		80		121
Total current tax provision		199		115		550		861
Deferred tax expense (benefit):
Federal		128		61		208		(109	)
State and local		22		15		33		(28	)
Total deferred tax expense (benefit)		150		76		241		(137	)
Income tax expense	$	349		191		791		724

        The effective income tax rate for continuing operations differs from the statutory tax rate as follows:

	Successor			Predecessor
	Nine Months Ended December 31, 2011			Three Months Ended March 31, 2011			Year Ended December 31, 2010			Year Ended December 31, 2009
	(in percent)
Effective income tax rate:
Federal statutory income tax rate		35.0	%		35.0	%		35.0	%		35.0	%
State income taxes—net of federal effect		3.5			3.4			3.9			3.1
Medicare subsidiary		—			—			2.7			—
Excess compensation		—			—			1.0			—
Other		0.6			0.6			(0.4	)		(0.4	)
Effective income tax rate		39.1	%		39.0	%		42.2	%		37.7	%

Deferred Tax Assets and Liabilities

        The components of the deferred tax assets and liabilities are as follows:

	Successor			Predecessor
	December 31, 2011			December 31, 2010
	(Dollars in millions)
Deferred tax assets and liabilities:
Deferred tax liabilities:
Property, plant and equipment	$	(1,315	)		(2,031	)
Intangibles assets		(2,306	)
Receivable from an affiliate due to pension plan participation		(364	)		(340	)
Other		(147	)		(94	)
Total deferred tax liabilities		(4,132	)		(2,465	)
Deferred tax assets:
Payable to affiliate due to post-retirement benefit plan participation		941			1,031
Debt premiums		166
Other		333			266
Total deferred tax assets		1,440			1,297
Net deferred tax liabilities	$	(2,692	)		(1,168	)

        We have performed an evaluation of the recoverability of our deferred tax assets. It is our opinion that it is more likely than not that the deferred tax assets will be realized and should not be reduced by a valuation allowance.

Other Income Tax Information

        We paid $211 million, $677 million, and $968 million, including $103 million as our share of QCII's 2002-2005 tax years settlement with the IRS, to QSC related to income taxes in the successor year ended 2011 and the predecessor years ended 2010 and 2009, respectively. As of the successor date of December 31, 2011 we had an approximate $19 million receivable from QSC relating to income taxes reflected in accounts receivable-affiliates. As of the predecessor date of December 31, 2010 we had approximately $8 million in amounts relating to taxes payable to QSC reflected in accounts payable-affiliates on our consolidated balance sheets.

        Income tax expense for the predecessor year ended December 31, 2010 compared to 2009 increased by $55 million as a result of the March 2010 enactments of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. Among other things, these laws will disallow federal income tax deductions for retiree prescription drug benefits to the extent we receive reimbursements for those benefits under the Medicare Part D program. Although this tax increase does not take effect until 2013, under accounting principles generally accepted in the U.S. we recognize the full accounting impact in the period in which the laws are enacted.

        In the predecessor year ended December 31, 2010, we increased our state tax rate based on a review of our state apportionment factors and the current tax rate of the states where we conduct business. This change resulted in a $2 million state deferred tax expense, net of federal effect.

        In the predecessor year ended December 31, 2009, we reduced our state tax rate based on a review of our state apportionment factors and the current tax rate of the states where we conduct business. This change resulted in a $4 million state deferred tax benefit, net of federal effect.

        We had unamortized investment tax credits of $2 million, $61 million and $68 million as of the successor date of December 31, 2011, and the predecessor dates of December 31, 2010 and 2009, respectively, which are included in other long-term liabilities on our consolidated balance sheets. These investment credits are amortized over the lives of the related assets. Amortization of investment tax credits was immaterial in 2011. Amortization of investment tax credits of $8 million is included in the provision for income taxes for the predecessor years ended December 31, 2010 and 2009.