INCOME TAXES

Deferred Income Taxes

Deferred income taxes reflect the impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and such amounts for tax purposes. The Company has a net deferred tax liability, primarily due to differences in depreciation rates for federal income tax purposes and for financial reporting purposes.

Deferred tax (assets) and liabilities comprise the following (in millions):



	2017			2016
Excess of tax over book depreciation	$	964		$	1,282
Intangibles—net	14			39
Other—net	43			26
Gross deferred tax liabilities	1,021			1,347

Mileage Plan™	(208		)	(310		)
Inventory obsolescence	(16		)	(23		)
Deferred gains	(5		)	(8		)
Employee benefits	(154		)	(196		)
Acquired net operating losses	(127		)	(289		)
Other—net	(57		)	(62		)
Gross deferred tax assets	(567		)	(888		)
Valuation allowance	—			4
Net deferred tax (assets) liabilities	$	454		$	463

On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The Tax Cuts and Jobs Act changed many aspects of the U.S. corporate income taxation, including but not limited to, a reduction in the corporate income tax rate from 35% to 21% and accelerated depreciation that will allow for full expensing of qualified property. ASC 740 requires a company to record the effects of a tax law change in the period of enactment.

The Company evaluated the impact of the Tax Cuts and Jobs Act and other law changes and recorded a discrete adjustment in our 2017 income tax expense of $280 million. The Company will continue to evaluate the impact of the new law and future guidance as issued.

At December 31, 2017, the Company had federal NOLs of approximately $525 million that expire beginning in 2029 and continuing through 2036, and state NOLs of approximately $254 million that expire beginning in 2028 and continuing through 2035.

Virgin America experienced multiple “ownership changes” as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), the most recent being its acquisition by the Company. Section 382 of the Code imposes an annual limitation on the utilization of pre-ownership change NOLs. Any unused annual limitation may, subject to certain limits, be carried over to later years. The combined Company’s ability to use the NOLs will also depend on the amount of taxable income generated in future periods.

Valuation allowances are provided to reduce the related deferred income tax assets to an amount which will, more likely than not, be realized. As a result of the Company’s assessment of the realization of deferred income tax assets, the Company concluded that it is more likely than not that all of its federal and state deferred income tax assets will be realized and thus no valuation allowance is necessary. The change from 2016 to 2017 was due to the reversal of the valuation allowance related to state NOL carryforwards. The Company reassesses the need for a valuation allowance each reporting period.

Components of Income Tax Expense

The components of income tax expense were as follows (in millions):



	2017			2016		2015
Current income tax expense:
Federal	$	127		$	392	$	397
State	35			48		30
Total current income tax expense	162			440		427

Deferred income tax expense (benefit):
Federal	(30		)	77		60
State	41			14		(23		)
Total deferred income tax expense (benefit)	11			91		37
Income tax expense	$	173		$	531	$	464

Income Tax Rate Reconciliation

Income tax expense reconciles to the amount computed by applying the U.S. federal rate of 35% to income before income tax and the 2018 US federal rate of 21% for deferred taxes as follows (in millions):



	2017			2016			2015
Income before income tax	$	1,207		$	1,345		$	1,312

Expected tax expense	422			471			459
Nondeductible expenses	5			20			4
State income taxes	29			28			19
State income sourcing	9			13			(15		)
Tax law changes	(280		)	—			—
Other—net	(12		)	(1		)	(3		)
Actual tax expense	$	173		$	531		$	464

Effective tax rate	14.3		%	39.5		%	35.4		%

As a result of tax changes signed into law during 2017, the Company recorded a deferred tax benefit of $280 million as a result of the reduction in future corporate income tax rate and other state law changes.

The Company incurred $39 million of acquisition-related costs that are not deductible under U.S. federal tax law in 2016. These expenses are included in Special items—merger-related costs and other on the Company’s consolidated statement of operations and are reflected as a permanent unfavorable adjustment for the year ended December 31, 2016, in the table above.

In the fourth quarter of 2015, the Company filed amended state tax returns for the years 2010 through 2013 to change the Company’s position on income sourcing in various states. These positions were also taken on 2014 and subsequent filings, unless guidance or rules changed. In 2017, adjustments were made to the Company's position on income sourcing in various states due to updated guidance from state taxing authorities. The impact of this guidance is reflected as an increase in income tax expense of approximately $9 million for the year ended December 31, 2017.

Uncertain Tax Positions

The Company has identified its federal tax return and its state tax returns in Alaska, Oregon and California as “major” tax jurisdictions. A summary of the Company's jurisdictions and the periods that are subject to examination are as follows:



Jurisdiction	Period
Federal	2007 to 2016^(a)(b)
Alaska	2012 to 2016
California	2006 to 2016^(a)
Oregon	2003 to 2016^(a)

^(a)

The 2007-2012 Federal and California Virgin America tax returns are subject to examination only to the extent of net operating loss carryforwards from those years that were utilized in 2012 and later years. The 2003, 2004, 2008-2010 and 2011 Oregon tax returns are subject to examination only to the extent of net operating loss carryforwards from those years that were utilized in 2010 and later years.


^(b)	Income tax years 2012 and 2013 are currently under exam by the Internal Revenue Service.

Changes in the liability for gross unrecognized tax benefits during 2017, 2016 and 2015 are as follows (in millions):



	2017			2016		2015
Balance at January 1,	$	40		$	32	$	3
Additions related to prior years	16			—		29
Releases related to prior years	(2		)	—		—
Additions related to current year activity	2			—		—
Additions from acquisitions	—			8		—
Releases due to settlements	(11		)	—		—
Releases due to lapse of statute of limitations	(2		)	—		—
Balance at December 31,	$	43		$	40	$	32

As of December 31, 2017, the Company had $43 million of accrued tax contingencies, of which $36 million, if fully recognized, would decrease the effective tax rate. As of December 31, 2017, 2016 and 2015, the Company has accrued interest and penalties, net of federal income tax benefit, of $5 million, $3 million, and zero. In 2017, 2016, and 2015, the Company recognized an expense of $2 million, $3 million, and zero for interest and penalties, net of federal income tax benefit. At December 31, 2017, the Company has unrecognized tax benefits recorded as a liability and some reducing deferred tax assets. The Company added $3 million of reserves for uncertain tax positions in 2017, primarily due to changes in income sourcing for state income taxes. These uncertain tax positions could change as a result of the Company's ongoing audits, settlement of issues, new audits and status of other taxpayer court cases. The Company cannot predict the timing of these actions. Due to the positions being taken in various jurisdictions, the amounts currently accrued are the Company's best estimate as of December 31, 2017.