17. Income Taxes

Following are the domestic and international components of pre-tax income:


	2012		2011		2010
	(in millions)
Domestic	$	508	$	321	$	158
International		99		114		99
Total pre-tax income	$	607	$	435	$	257

The income tax provision consists of the following:


	2012		2011		2010
	(in millions)
Current:
Federal	$	152	$	93	$	(28	)
State and local		22		11		4
International		16		24		28
Total current tax provision		190		128		4
Deferred:
Federal		13		16		79
State and local		5		6		4
International		2		7		1
Total deferred tax provision		20		29		84
Total income tax provision	$	210	$	157	$	88

Provision has been made in the accompanying Consolidated Statements of Operations for additional income taxes applicable to dividends received or expected to be received from international subsidiaries. The amount of unremitted earnings of international subsidiaries for which no such tax is provided and which is considered to be permanently reinvested in the subsidiaries totaled $835 million and $771 million at February 2, 2013 and January 28, 2012, respectively. The determination of the amount of the deferred tax liability related to permanently reinvested earnings is not practicable.

A reconciliation of the significant differences between the federal statutory income tax rate and the effective income tax rate on pre-tax income is as follows:


	2012			2011			2010
Federal statutory income tax rate		35.0	%		35.0	%		35.0	%
State and local income taxes, net of federal tax benefit		3.2			3.1			2.3
International income taxed at varying rates		(0.4	)		(0.3	)		1.0
Foreign tax credits		(1.8	)		(1.3	)		(2.0	)
Decrease in valuation allowance		—			—			(0.4	)
Domestic/foreign tax settlements		(2.2	)		0.3			(2.3	)
Federal tax credits		(0.2	)		(0.6	)		(0.7	)
Other, net		1.0			(0.2	)		1.4
Effective income tax rate		34.6	%		36.0	%		34.3	%

Deferred income taxes are provided for the effects of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for income tax purposes. Items that give rise to significant portions of the Company’s deferred tax assets and deferred tax liabilities are as follows:


	2012			2011
	(in millions)
Deferred tax assets:
Tax loss/credit carryforwards and capital loss	$	13		$	18
Employee benefits		63			77
Property and equipment		160			166
Straight-line rent		28			27
Goodwill and other intangible assets		20			21
Other		36			32
Total deferred tax assets		320			341
Valuation allowance		(4	)		(5	)
Total deferred tax assets, net		316			336
Deferred tax liabilities:
Merchandise inventories		76			71
Other		15			8
Total deferred tax liabilities		91			79
Net deferred tax asset	$	225		$	257
Balance Sheet caption reported in:
Deferred taxes	$	257		$	284
Other current assets		4			2
Accrued and other current liabilities		(31	)		(24	)
Other liabilities		(5	)		(5	)
	$	225		$	257

The Company operates in multiple taxing jurisdictions and is subject to audit. Audits can involve complex issues that may require an extended period of time to resolve. A taxing authority may challenge positions that the Company has adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax positions for such transactions and records reserves for those differences.

The Company’s U.S. Federal income tax filings have been examined by the Internal Revenue Service through 2011. The Company is participating in the IRS’s Compliance Assurance Process (“CAP”) for 2012, which is expected to conclude during 2013. The Company has started the CAP for 2012. Due to the recent utilization of net operating loss carryforwards, the Company is subject to state and local tax examinations effectively including years from 1996 to the present. To date, no adjustments have been proposed in any audits that will have a material effect on the Company’s financial position or results of operations.

As of February 2, 2013, the Company has a valuation allowance of $4 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. The valuation allowance primarily relates to the deferred tax assets arising from a capital loss associated with the 2008 impairment of the Northern Group note receivable. A full valuation allowance is required for the capital loss because the Company does not anticipate realizing capital gains to utilize this loss. The valuation allowance for state tax loss and credit carryforwards decreased to a nominal amount in 2012 principally due to anticipated expirations of those attributes.

Based upon the level of historical taxable income and projections for future taxable income, which are based upon the Company’s strategic long-range plans, over the periods in which the temporary differences are anticipated to reverse, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowances at February 2, 2013. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.

At February 2, 2013, the Company has state operating loss carryforwards with a potential tax benefit of $5 million that expire between 2014 and 2032. The Company will have, when realized, a capital loss with a potential benefit of $3 million arising from a note receivable. This loss will carryforward for 5 years after realization. The Company has U.S. state credits of $2 million that can be carried forward indefinitely. The Company has Canadian provincial credit carryforwards of $1 million expiring between 2016 and 2017. The Company has international operating loss carryforwards with a potential tax benefit of $2 million, expiring between 2013 and 2032.

At February 2, 2013 and January 28, 2012, the Company had $54 million and $65 million, respectively, of gross unrecognized tax benefits, and $52 million and $64 million, respectively, of net unrecognized tax benefits that would, if recognized, affect the Company’s annual effective tax rate. The Company has classified certain income tax liabilities as current or noncurrent based on management’s estimate of when these liabilities will be settled. Interest expense and penalties related to unrecognized tax benefits are classified as income tax expense. The Company recognized $1 million of interest expense in each of 2012, 2011, and 2010. The total amount of accrued interest and penalties was $3 million, $4 million, and $3 million in 2012, 2011, and 2010, respectively.

The following table summarizes the activity related to unrecognized tax benefits:


	2012			2011			2010
	(in millions)
Unrecognized tax benefits at beginning of year	$	65		$	62		$	70
Foreign currency translation adjustments		1			(1	)		3
Increases related to current year tax positions		4			7			4
Increases related to prior period tax positions		3			1			3
Decreases related to prior period tax positions		(3	)		—			(7	)
Settlements		(15	)		(3	)		(9	)
Lapse of statute of limitations		(1	)		(1	)		(2	)
Unrecognized tax benefits at end of year	$	54		$	65		$	62

It is reasonably possible that the liability associated with the Company’s unrecognized tax benefits will increase or decrease within the next twelve months. These changes may be the result of foreign currency fluctuations, ongoing audits or the expiration of statutes of limitations. Settlements could increase earnings in an amount ranging from $0 to $7 million based on current estimates. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. Although management believes that adequate provision has been made for such issues, the ultimate resolution of these issues could have an adverse effect on the earnings of the Company. Conversely, if these issues are resolved favorably in the future, the related provision would be reduced, generating a positive effect on earnings. Due to the uncertainty of amounts and in accordance with its accounting policies, the Company has not recorded any potential impact of these settlements.