Income Taxes

The components of pretax income and provision for income taxes for 2016, 2015 and 2014, consisted of the following:



	Year ended December 31,
(in millions)	2016			2015			2014
Components of pretax income (loss):
Domestic	$	492		$	(1,332	)	$	(378	)
Foreign	249			165			195
	$	741		$	(1,167	)	$	(183	)
Provision for income taxes:
Federal	$	20		$	7		$	16
State and local	20			14			22
Foreign	41			80			44
Income tax expense	$	81		$	101		$	82

Effective income tax rate	11		%	(9		)%	(45		)%

The Company’s effective tax rates differ from statutory rates as follows:



	Year ended December 31,
	2016		2015		2014
Federal statutory rate	35	%	35	%	35	%
State income taxes, net of federal income tax benefit	1		3		(1	)
Nontaxable income from noncontrolling interests	(11	)	6		37
Impact of foreign operations (a)	13		—		(9	)
Tax effects of foreign exchange gains/losses	—		(1	)	(6	)
Valuation allowances	(35	)	(54	)	(103	)
Liability for unrecognized tax benefits	—		(2	)	12
Prior year adjustments	3		4		(7	)
Nondeductible bad debts	—		—		(3	)
Equity Compensation	5		—		—
Effective tax rate	11	%	(9	)%	(45	)%


(a)	The impact of foreign operations includes the effects of earnings and profits adjustments, foreign losses, and differences between foreign tax expense and foreign taxes eligible for the U.S. foreign tax credit.

The Company’s income tax provisions (benefits) consisted of the following components:



	Year ended December 31,
(in millions)	2016			2015			2014
Current:
Federal	$	22		$	5		$	—
State and local	24			23			39
Foreign	73			80			61
	119			108			100
Deferred:
Federal	(2		)	2			17
State and local	(4		)	(9		)	(18		)
Foreign	(32		)	—			(17		)
	(38		)	(7		)	(18		)
	$	81		$	101		$	82

Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the book and tax bases of the Company’s assets and liabilities. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred tax assets are included in "Other long-term assets" and deferred tax liabilities are included in "Deferred tax liabilities" on the Company’s consolidated balance sheets.

The following table outlines the principal components of deferred tax items:



	As of December 31,
(in millions)	2016			2015
Deferred tax assets related to:
Reserves and other accrued expenses	$	—		$	90
Pension obligations	—			6
Employee related liabilities	176			171
Deferred revenues	34			44
Net operating losses and tax credit carryforwards	3,122			3,116
U.S. foreign tax credits on undistributed earnings	252			330
Foreign exchange loss	33			32
Total deferred tax assets	3,617			3,789
Valuation allowance	(2,520		)	(2,694		)
Realizable deferred tax assets	1,097			1,095
Deferred tax liabilities related to:
Property, equipment, and intangibles	(969		)	(1,019		)
Reserves and other accrued expenses	(49		)	—
Pension obligations	(4		)	—
Investment in affiliates and other	(217		)	(306		)
U.S. tax on foreign undistributed earnings	(252		)	(192		)
Total deferred tax liabilities	(1,491		)	(1,517		)
Net deferred tax liabilities	$	(394	)	$	(422	)

The Company’s deferred tax assets and liabilities included in the consolidated balance sheets was as follows:



	As of December 31,
(in millions)	2016			2015
Deferred tax assets	$	15		$	9
Deferred tax liabilities	(409		)	(431		)
Net deferred tax liabilities	$	(394	)	$	(422	)

As of December 31, 2016 and 2015, the Company had recorded valuation allowances of $2.5 billion and $2.7 billion, respectively, against its net deferred tax assets. The decrease to the valuation allowance of $174 million in 2016 was primarily due to utilization of federal and state net operating losses in 2016. In determining the necessary amount of valuation allowance, the Company has considered a tax planning strategy related to its investments in affiliates. Implementation of this strategy would result in the immediate reversal of temporary differences associated with the excess of book basis over tax basis in the investments. This planning strategy would be implemented only in the event of anticipated expiration of significant net operating losses in the United States federal jurisdiction, which is not expected in the near term.

The following table presents the amounts of federal, state, and foreign net operating loss carryforwards and foreign tax credit, general business credit, and minimum tax credit carryforwards:



	As of December 31,
(in millions)	2016
Federal net operating loss carryforwards (a)	$	4,766
State net operating loss carryforwards (b)	5,893
Foreign net operating loss carryforwards (c)	3,079
Foreign tax credit carryforwards (d)	289
General business credit carryforwards (e)	12
Minimum tax credit carryforwards (f)	18


(a)	If not utilized, these carryforwards will expire in years 2024 through 2036.


(b)	If not utilized, these carryforwards will expire in years 2017 through 2036.


(c)	Foreign net operating loss carryforwards of $66 million, if not utilized, will expire in years 2017 through 2036. The remaining foreign net operating loss carryforwards of $3.0 billion have an indefinite life.


(d)	If not utilized, these carryforwards will expire in years 2018 through 2026.


(e)	If not utilized, these carryforwards will expire in years 2027 through 2035.


(f)	These carryforwards have an indefinite life.

The Company intends to indefinitely invest its net equity in its foreign operations, with the exception of any undistributed foreign earnings in those jurisdictions with positive earnings. As of December 31, 2016, the cumulative amount of temporary differences related to investments in foreign subsidiaries was lower than the amount of undistributed earnings. As such, the Company provided for U.S. federal and state income taxes on the entire cumulative temporary difference and has no unrecognized deferred tax liability as of December 31, 2016.

A reconciliation of the unrecognized tax benefits was as follows:



(in millions)	Unrecognized Tax Benefits
Balance as of January 1, 2014	$	279
Increases for tax positions of prior years	3
Decreases for tax positions of prior years	(29		)
Increases for tax positions related to the current period	1
Decreases for cash settlements with taxing authorities	(13		)
Decreases due to the lapse of the applicable statute of limitations	(5		)
Balance as of December 31, 2014	236
Increases for tax positions of prior years	25
Decreases for tax positions of prior years	(4		)
Increases for tax positions related to the current period	1
Decreases for cash settlements with taxing authorities	(3		)
Decreases due to the lapse of the applicable statute of limitations	(6		)
Balance as of December 31, 2015	249
Increases for tax positions of prior years	2
Decreases for tax positions of prior years	(1		)
Increases for tax positions related to the current period	—
Decreases for cash settlements with taxing authorities	(1		)
Decreases due to the lapse of the applicable statute of limitations	(9		)
Balance as of December 31, 2016	$	240

Most of the unrecognized tax benefits are included in “Other long-term liabilities” on the consolidated balance sheets, net of the federal benefit on state income taxes (approximately $21 million as of December 31, 2016). However, those unrecognized tax benefits that affect the federal consolidated tax years ending December 31, 2008 through December 31, 2016 are included in “Deferred tax liabilities” on the consolidated balance sheets, as these items reduce the Company’s net operating loss and credit carryforwards from those periods. The unrecognized tax benefits as of December 31, 2016, 2015, and 2014 included approximately $133 million, $136 million, and $126 million, respectively, of tax positions that, if recognized, would affect the effective tax rate.

The Company recognizes interest and penalties related to unrecognized tax benefits in “Income tax expense” in the consolidated statements of operations. Cumulative accrued interest and penalties (net of related tax benefits) are not included in the ending balances of unrecognized tax benefits. Cumulative accrued interest and penalties are included in “Other long-term liabilities” on the consolidated balance sheets while the related tax benefits are included in “Deferred tax liabilities” on the consolidated balance sheets. The following table presents the approximate amounts associated with accrued interest expense and the cumulative accrued interest and penalties:



	Year ended December 31,
(in millions)	2016		2015		2014
Current year accrued interest expense (net of related tax benefits)	$	5	$	7	$	1
Cumulative accrued interest and penalties (net of related tax benefits)	48		45		39

As of December 31, 2016, the Company anticipates it is reasonably possible that its liability for unrecognized tax benefits may decrease by approximately $123 million within the next 12 months as a result of the possible closure of federal tax audits, potential settlements with certain states and foreign countries, and the lapse of the statute of limitations in various state and foreign jurisdictions.

The Company or one or more of its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. As of December 31, 2016, the Company was no longer subject to income tax examination by the U.S. federal jurisdiction for years before 2005. State and local examinations are substantially complete through 2006. Foreign jurisdictions generally remain subject to examination by their respective authorities from 2007 forward, none of which are considered major jurisdictions.

Under the Tax Allocation Agreement executed at the time of the spin-off of The Western Union Company (Western Union) on September 29, 2006, Western Union is responsible for and must indemnify the Company against all taxes, interest, and penalties that relate to Western Union for periods prior to the spin-off date. If Western Union were to agree to or be finally determined to owe any amounts for such periods but were to default in its indemnification obligation under the Tax Allocation Agreement, the Company, as parent of the tax filing group during such periods, generally would be required to pay the amounts to the relevant tax authority, resulting in a potentially material adverse effect on the Company’s financial position and results of operations. As of December 31, 2016, the Company had approximately $123 million of income taxes payable, including approximately $3 million of uncertain income tax liabilities, recorded related to Western Union for periods prior to the spin-off date. The Company has recorded a corresponding account receivable of equal amount from Western Union, which is included as a long-term account receivable in “Other long-term assets” on the Company’s consolidated balance sheets, reflecting the indemnification obligation. The uncertain income tax liabilities and corresponding receivable are based on information provided by Western Union regarding its tax contingency reserves for periods prior to the spin-off date. There is no assurance that a Western Union-related issue raised by the IRS or other tax authority will be finally resolved at a cost not in excess of the amount reserved and reflected in the Company’s uncertain income tax liabilities and corresponding receivable from Western Union. The Western Union contingent liability is in addition to the Company’s liability for unrecognized tax benefits discussed above.

The IRS completed its examination of the U.S. federal consolidated income tax returns of the Company for 2005 through 2007 and issued a 30-Day letter in October 2012. The 30-Day letter claims that the Company and its subsidiaries, which included Western Union during some of the years at issue, owe additional taxes with respect to a variety of adjustments. The Company and Western Union agree with several of the adjustments in the 30-Day letter, such adjustments representing tax due of approximately $40 million. This undisputed tax and associated interest due (pretax) of approximately $23 million through December 31, 2016, have been fully reserved. The undisputed tax for which Western Union would be required to indemnify the Company is greater than the total tax due, such that settlement of the undisputed tax would result in a net refund to the Company. As to the adjustments that are disputed, such issues represent total taxes allegedly due of approximately $59 million, of which $40 million relates to the Company and $19 million relates to Western Union. The Company estimates that total interest due (pretax) on the disputed amounts is approximately $26 million through December 31, 2016, of which $15 million relates to the Company and $11 million relates to Western Union. As to the disputed issues, the Company and Western Union are contesting the asserted deficiencies with the Appeals Office of the IRS, with anticipated resolution during the next twelve months. The Company believes that it has adequately reserved for the disputed issues in its liability for unrecognized tax benefits described above and that final resolution of those issues will not have a material adverse effect on its financial position or results of operations.