Income Taxes

The following table summarizes the income tax benefit (provision) attributable to the income (loss) before income taxes for each of the three years ended December 31, 2014, 2013 and 2012:



	2014			2013			2012
(dollars in millions)
Current:
United States federal	$	—		$	9		$	—
State	(1		)	(1		)	(2		)
Foreign	(40		)	(37		)	(36		)
	(41		)	(29		)	(38		)
Deferred, net of changes in valuation allowances:
United States federal	6			(3		)	(3		)
State	15			—			—
Foreign	96			(6		)	(7		)
Income tax benefit (provision)	$	76		$	(38	)	$	(48	)

The United States and Foreign components of income (loss) before income taxes for each of the three years ended December 31, 2014, 2013 and 2012 are as follows (some of the income (loss) is subject to taxation in multiple jurisdictions):



	2014		2013			2012
(dollars in millions)
United States	$	207	$	(122	)	$	(434	)
Foreign	31		51			60
	$	238	$	(71	)	$	(374	)

A reconciliation of the actual income tax benefit (provision) and the tax computed by applying the U.S. federal rate (35%) to the income (loss) before income taxes for each of the three years ended December 31, 2014, 2013 and 2012 is shown in the following table:



	2014			2013			2012
	(dollars in millions)
Computed tax (provision) benefit at statutory rate	$	(83	)	$	25		$	131
Effect of earnings in jurisdictions outside of US	13			12			25
Change in valuation allowance	197			(27		)	(145		)
Permanent items	(44		)	(44		)	(48		)
Indefinite-lived assets	2			(3		)	(3		)
Uncertain tax positions	3			9			(3		)
Changes in tax rates	(7		)	(7		)	(4		)
Other, net	(5		)	(3		)	(1		)
Income tax benefit (provision)	$	76		$	(38	)	$	(48	)

The components of the net deferred tax assets (liabilities) as of December 31, 2014 and 2013 are as follows:



	2014			2013
	(dollars in millions)
Deferred Tax Assets:
Accrued payroll and related benefits	$	113		$	132
Deferred revenue	322			336
Unutilized tax net operating loss carry forwards	5,218			4,791
Fixed assets and intangible assets	90			102
Intercompany loss	128			139
Other	174			144
Total Deferred Tax Assets	6,045			5,644
Deferred Tax Liabilities:
Fixed assets and intangible assets	(1,371		)	(790		)
Deferred revenue	(73		)	(76		)
Other	(59		)	(33		)
Foreign branch income	(130		)	(163		)
Total Deferred Tax Liabilities	(1,633		)	(1,062		)
Net Deferred Tax Assets before valuation allowance	4,412			4,582
Valuation Allowance	(4,437		)	(4,698		)
Net Deferred Tax Liability after Valuation Allowance	$	(25	)	$	(116	)
Balance sheet classification of deferred taxes:
Net current deferred income tax asset	$	8		$	9
Net current deferred income tax liability	—			(2		)
Net non-current deferred income tax asset	292			211
Net non-current deferred income tax liability	(325		)	(334		)
Net Deferred Tax Liability after Valuation Allowance	$	(25	)	$	(116	)

On October 31, 2014, the Company completed its acquisition of tw telecom. The Merger qualified as a tax-free reorganization within the meaning of Section 368(a) of the Internal Revenue Code, and therefore the Company assumed the carryover tax basis of the acquired assets and liabilities of tw telecom. As a result, the Company recorded a net deferred tax liability of $15 million as the acquired deferred tax assets, net of valuation allowance, were offset by the deferred tax liabilities created by the additional financial reporting basis of the identifiable intangible assets. Simultaneously, the Company released $15 million of valuation allowance against its deferred tax assets as the acquired deferred tax liabilities serve as a source of taxable income to support such release. The final identification of tw telecom’s deferred taxes and the final determination of the purchase price allocation may be significantly different from the preliminary amounts reflected herein.

As of December 31, 2014, the Company had net operating loss carry forwards of approximately $10.3 billion (net of IRC Section 382 limitation) for U.S. federal income tax purposes, including $1 billion from the tw telecom acquisition. Although the tw telecom acquisition triggered an ownership change under Section 382 of the Internal Revenue Code, the Company has determined that its loss carryforwards should not be mathematically limited based on its value at the time of the ownership change and the expiration dates of its net operating losses.

The Company’s loss carry forwards expire in future years through 2034 and are subject to examination by the tax authorities until three years after the carry forwards are utilized. The U.S. federal tax loss carry forwards expire as follows (dollars in millions):



Expiring December 31,	Amount
2022	$	186
2023	380
2024	1,456
2025	1,299
2026	1,244
2027	1,615
2028	482
2029	694
2030	664
2031	827
2032	730
2033	289
2034	438
	$	10,304

Under the rules prescribed by Internal Revenue Code Section 382 and applicable regulations, if certain transactions occur with respect to an entity's capital stock that result in a cumulative ownership shift of more than 50 percentage points by 5% stockholders over a three-year testing period, annual limitations are imposed with respect to the entity's ability to utilize its net operating loss carry forwards and certain current deductions against any taxable income the entity achieves in future periods. Level 3 extended the term of its Stockholder Rights Plan, which was adopted to protect its U.S. federal net operating loss carry forwards from these limitations. This plan was designed to deter trading that would result in a change of control (as defined in Section 382) without the limitations imposed by Section 382, and therefore protect the Company's ability to use its historical U.S. federal net operating loss carry forwards in the future.

As of December 31, 2014, the Company had state net operating loss carry forwards of approximately $7.9 billion that are subject to limitations on their utilization and have various expiration periods through 2034. The Company had approximately $6.1 billion of foreign jurisdiction net operating loss carry forwards that are subject to limitations on their utilization. The majority of these foreign jurisdiction tax loss carry forwards have no expiration period.

The Company recognizes deferred tax assets and liabilities for its domestic and non-U.S. operations, for operating loss and other credit carry forwards and the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. To date, the Company has provided a valuation allowance to reduce the deferred tax assets of most of its businesses in North America and certain other jurisdictions to the amount that is more likely than not to be realized as it believes the objective evidence of its historical pretax net losses in those jurisdictions outweighs the positive evidence of its forecasted future results. However, in 2014, the Company released approximately $100 million of deferred tax valuation allowance primarily related to its business in the UK due to consolidation of legal entities whereby one UK entity with a full valuation allowance was merged with an entity that had no valuation allowance against its deferred tax assets. As a result, management projects future profitability of that business. Although the Company believes its estimates are reasonable, the ultimate determination of the appropriate amount of valuation allowance involves significant judgment.

The Company monitors its cumulative loss position and other evidence each quarter to determine the appropriateness of its valuation allowance. If the Company continues to generate income before taxes in future periods, the conclusion about the appropriateness of the valuation allowance could change in a future period, and the Company could record a substantial benefit in its consolidated statement of operations when that occurs.

The valuation allowance for deferred tax assets was approximately $4.4 billion as of December 31, 2014 and $4.7 billion as of December 31, 2013. The change in valuation allowance is primarily due to the income before taxes in the United States and a valuation allowance release in the United Kingdom. In making the determination to release the valuation allowance, the Company analyzed, among other things, the tax-paying entity’s recent history of earnings, its cumulative earnings for the last 12 quarters, and forecasts of future earnings.

The Company provides for U.S. income taxes on the undistributed earnings and the other outside basis temporary differences of foreign corporations unless they are considered indefinitely reinvested outside the United States. The amount of temporary differences related to undistributed earnings and other outside basis temporary differences of investments in foreign subsidiaries upon which U.S. income taxes have not been provided was immaterial.

The Company's liability for uncertain income tax positions totaled $17 million at December 31, 2014 and $13 million at December 31, 2013. If the remaining balance of unrecognized tax benefits were realized in a future period, it would result in a tax benefit of $14 million ($13 million as of December 31, 2013) and a reduction in the effective tax rate. The Company does not expect that the liability for uncertain tax positions will materially increase or decrease during the twelve months ended December 31, 2015. A reconciliation of the beginning and ending balance of unrecognized income tax benefits follows (dollars in millions):



	Amount
Balance as of January 1, 2012	$	15
Gross increases - tax positions of prior years	4
Gross increases - tax positions during 2012	1
Gross decreases - lapse of statute of limitations	(1		)
Gross decreases - settlement with taxing authorities	(1		)
Balance as of December 31, 2012	18
Gross increases - tax positions of prior years	—
Gross increases - tax positions during 2013	1
Gross decreases - lapse of statute of limitations	(6		)
Gross decreases - settlement with taxing authorities	—
Balance as of December 31, 2013	13
Tax positions of prior years netted against deferred tax assets	5
Gross increases - tax positions of prior years	1
Gross increases - tax positions during 2014	—
Gross decreases - lapse of statute of limitations	(2		)
Gross decreases - settlement with taxing authorities	—
Balance as of December 31, 2014	$	17

The unrecognized tax benefits in the table above do not include accrued interest and penalties of $17 million, $18 million and $22 million as of December 31, 2014, 2013 and 2012, respectively. The Company's policy is to record interest and penalties related to uncertain tax positions in income tax expense. The Company recognized accrued interest and penalties related to uncertain tax positions in income tax expense in its Consolidated Statements of Operations of a benefit of approximately $1 million, a benefit of approximately $4 million and charges of approximately $3 million for the years ended December 31, 2014, 2013 and 2012, respectively.

The Company, or at least one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003. The Internal Revenue Service and state and local taxing authorities reserve the right to audit any period where net operating loss carry forwards are available.

Income Tax Expense/(Benefit) was ($76) million in 2014 compared to $38 million in 2013 and $48 million in 2012. Income tax (benefit) or expense in all periods is primarily related to taxes in foreign jurisdictions.

The Company incurs tax expense attributable to income in various subsidiaries that are required to file state or foreign income tax returns on a separate legal entity basis. The Company also recognizes accrued interest and penalties in income tax expense related to uncertain tax benefits. Our tax rate is volatile and may move up or down with changes in, among other things, the amount and source of income or loss, our ability to utilize foreign tax credits, changes in tax laws, and the movement of liabilities established for uncertain tax positions as statutes of limitations expire or positions are otherwise effectively settled.