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):



	2018			2017
Excess of tax over book depreciation	$	1,066		$	964
Intangibles—net	15			14
Other—net	43			88
Deferred tax liabilities	1,124			1,066

Mileage Plan™	(315		)	(337		)
Inventory obsolescence	(15		)	(16		)
Deferred gains	(5		)	(5		)
Employee benefits	(172		)	(154		)
Acquired net operating losses	(64		)	(127		)
Other—net	(43		)	(57		)
Deferred tax assets	(614		)	(696		)
Valuation allowance	2			—
Net deferred tax (assets) liabilities	$	512		$	370

In 2018, the Company adopted the full retrospective method under ASC 606 "Revenue Contracts with Customers." The tax deferred assets and liabilities from 2017 were adjusted to reflect the retrospective adjustments of ASC 606. The retrospective adjustments increased other-net deferred tax liabilities $45 million and increased deferred tax assets $129 million, for a net deferred tax change of $84 million.

At December 31, 2018, the Company had federal NOLs of approximately $243 million that expire beginning in 2032 and continuing through 2036, and state NOLs of approximately $189 million that expire beginning in 2029 and continuing through 2036.

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. The Company has determined it is more likely than not that a portion of the capital loss carryforward will not be realized and, therefore, has provided a valuation allowance of $2 million for that portion. 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):



	2018			2017			2016
Current income tax expense:
Federal	$	(5	)	$	127		$	392
State	9			35			48
Total current income tax expense	4			162			440

Deferred income tax expense (benefit):
Federal	125			(3		)	67
State	19			40			12
Total deferred income tax expense (benefit)	144			37			79
Income tax expense	$	148		$	199		$	519

Income Tax Rate Reconciliation

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



	2018			2017			2016
Income before income tax	$	585		$	1,159		$	1,316

Expected tax expense	123			406			461
Nondeductible expenses	9			5			20
State income taxes	21			28			27
State income sourcing	—			9			12
Tax law changes	(7		)	(237		)	—
Other—net	2			(12		)	(1		)
Actual tax expense	$	148		$	199		$	519

Effective tax rate	25.3		%	17.2		%	39.4		%

As a result of the ASC 606 full retrospective adoption, 2017 tax expense increased by $26 million and 2016 tax expense decreased by $12 million.

As a result of tax changes signed into law during 2017, the Company recorded a deferred tax benefit of $237 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 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 2017
Alaska	2012 to 2017
California	2007 to 2017
Oregon	2003 to 2017

Certain tax years are open to the extent of net operating loss carryforwards.

Changes in the liability for gross unrecognized tax benefits during 2018, 2017 and 2016 are as follows (in millions):



	2018			2017			2016
Balance at January 1,	$	43		$	40		$	32
Additions related to prior years	1			16			—
Releases related to prior years	(4		)	(2		)	—
Additions related to current year activity	2			2			—
Additions from acquisitions	—			—			8
Releases due to settlements	(1		)	(11		)	—
Releases due to lapse of statute of limitations	(1		)	(2		)	—
Balance at December 31,	$	40		$	43		$	40

As of December 31, 2018, the Company had $40 million of accrued tax contingencies, of which $33 million, if fully recognized, would decrease the effective tax rate. As of December 31, 2018, 2017 and 2016, the Company has accrued interest and penalties, net of federal income tax benefit, of $6 million, $5 million, and $3 million. In 2018, 2017, and 2016, the Company recognized an expense of $1 million, $2 million, and $3 million for interest and penalties, net of federal income tax benefit. At December 31, 2018, the Company has unrecognized tax benefits recorded as a liability. The Company reduced $3 million of reserves for uncertain tax positions in 2018, primarily due to settlements on state incomes taxes and statute lapses on reserved amounts. 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, 2018.