INCOME TAXES

Our income (loss) before income taxes consisted of the following:



	Year Ended December 31,
(in millions)	2013			2012			2011
Domestic	$	(774	)	$	(1,265	)	$	(437	)
Foreign	551			(2,842		)	1,079
	$	(223	)	$	(4,107	)	$	642

The related provision (benefit) for income taxes consisted of the following:



	Year Ended December 31,
(in millions)	2013			2012			2011
Current
Federal	$	46		$	33		$	45
State	(9		)	—			8
Foreign	105			139			91
	142			172			144

Deferred
Federal	(212		)	(204		)	86
State	(17		)	(7		)	(8		)
Foreign	(15		)	—			(21		)
	(244		)	(211		)	57
	$	(102	)	$	(39	)	$	201

The reconciliation of income taxes at the federal statutory rate to the actual provision (benefit) for income taxes is as follows:



	Year Ended December 31,
	2013		2012		2011
U.S. federal statutory income tax rate	(35.0	)%	(35.0	)%	35.0	%
State income taxes, net of federal benefit	(7.9	)%	(0.2	)%	0.5	%
State law changes on deferred tax	—	%	—	%	(1.2	)%
Effect of foreign taxes	(63.4	)%	(3.7	)%	(63.7	)%
Non-deductible acquisition expenses	3.5	%	—	%	(1.9	)%
Research credit	(12.2	)%	—	%	(3.4	)%
Valuation allowance	(12.0	)%	0.3	%	(2.9	)%
Divestitures	—	%	—	%	25.4	%
Goodwill impairment charges	65.2	%	36.4	%	38.0	%
Non-deductible expenses	10.7	%	0.1	%	5.7	%
Uncertain domestic tax positions	7.0	%	0.8	%	5.6	%
Other, net	(1.9	)%	0.3	%	(5.8	)%
	(46.0	)%	(1.0	)%	31.3	%

We had net deferred tax liabilities of $1.074 billion as of December 31, 2013 and $1.237 billion as of December 31, 2012. Gross deferred tax liabilities of $2.203 billion as of December 31, 2013 and $2.310 billion as of December 31, 2012 relate primarily to intangible assets acquired in connection with our prior acquisitions. Gross deferred tax assets of $1.129 billion as of December 31, 2013 and $1.073 billion as of December 31, 2012 relate primarily to the establishment of inventory and product-related reserves; litigation, product liability and other reserves and accruals; stock-based compensation; net operating loss carryforwards and tax credit carryforwards; and the federal benefit of uncertain tax positions.

We reduce our deferred tax assets by a valuation allowance if, based upon the weight of available evidence, it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider relevant evidence, both positive and negative, to determine the need for a valuation allowance. Information evaluated includes our financial position and results of operations for the current and preceding years, the availability of deferred tax liabilities and tax carrybacks, as well as an evaluation of currently available information about future years.

Significant components of our deferred tax assets and liabilities are as follows:



	As of December 31,
(in millions)	2013			2012
Deferred Tax Assets:
Inventory costs, intercompany profit and related reserves	$	116		$	136
Tax benefit of net operating loss and credits	513			497
Reserves and accruals	221			300
Restructuring-related charges and purchased research and development	17			13
Litigation and product liability reserves	198			48
Unrealized gains and losses on derivative financial instruments	—			—
Investment write-down	15			13
Compensation related	143			171
Federal benefit of uncertain tax positions	166			157
Other	39			54
	1,428			1,389
Less valuation allowance	(299		)	(316		)
	1,129			1,073
Deferred Tax Liabilities:
Property, plant and equipment	78			101
Unrealized gains and losses on derivative financial instruments	80			21
Intangible assets	2,045			2,187
Other	—			1
	2,203			2,310
Net Deferred Tax Liabilities	$	1,074		$	1,237

Our deferred tax assets and liabilities are included in the following locations within our accompanying consolidated balance sheets (in millions):



	Location in	As of December 31,
Component	Balance Sheet	2013		2012
Current deferred tax asset	Deferred income taxes	$	288	$	433
Non-current deferred tax asset	Other long-term assets	42		54
Deferred Tax Assets		330		487
Current deferred tax liability	Other current liabilities	2		11
Non-current deferred tax liability	Deferred income taxes	1,402		1,713
Deferred Tax Liabilities		1,404		1,724
Net Deferred Tax Liabilities		$	1,074	$	1,237

As of December 31, 2013, we had U.S. tax net operating loss carryforwards and tax credits, the tax effect of which was $216 million, as compared to $184 million as of December 31, 2012. In addition, we had foreign tax net operating loss carryforwards and tax credits, the tax effect of which was $313 million as of December 31, 2013, as compared to $341 million as of December 31, 2012. These tax attributes will expire periodically beginning in 2014. After consideration of all positive and negative evidence, we believe that it is more likely than not that a portion of the deferred tax assets will not be realized. As a result, we established a valuation allowance of $299 million as of December 31, 2013 and $316 million as of December 31, 2012. The decrease in the valuation allowance as of December 31, 2013, as compared to December 31, 2012, is attributable primarily due to greater than expected net operating loss utilization as well as a change in judgment related to expected ability to realize certain deferred tax assets. The income tax impact of the unrealized gain or loss component of other comprehensive income was a charge of $72 million in 2013, a charge of $43 million in 2012, and a benefit of $1 million in 2011.

We do not provide income taxes on unremitted earnings of our foreign subsidiaries where we have indefinitely reinvested such earnings in our foreign operations. We do not believe it is practicable to estimate the amount of income taxes payable on the earnings that are indefinitely reinvested in foreign operations due to the complexities of this calculation. Unremitted earnings of our foreign subsidiaries that we have indefinitely reinvested in foreign operations were $11.902 billion as of December 31, 2013 and $11.041 billion as of December 31, 2012.

We obtain tax incentives through Free Trade Zone Regime offered in Costa Rica which allows 100% exemption from income tax in the first eight years of operations and 50% exemption in the following four years. This tax incentive resulted in income tax savings of $6 million, $7 million, and $2 million for the years 2013, 2012 and 2011, respectively. The tax incentive for 100% exemption from income tax is expected to expire in 2015. The impact of per share earnings is immaterial for 2013, 2012, and 2011.

As of December 31, 2013, we had $1.069 billion of gross unrecognized tax benefits, of which a net $939 million, if recognized, would affect our effective tax rate. As of December 31, 2012, we had $1.052 billion of gross unrecognized tax benefits, of which a net $902 million, if recognized, would affect our effective tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in millions):



	Year Ended December 31,
	2013			2012			2011

Beginning Balance	$	1,052		$	987		$	965
Additions based on positions related to the current year	58			54			104
Additions based on positions related to prior years	45			43			8
Reductions for tax positions of prior years	(40		)	(27		)	(72		)
Settlements with taxing authorities	(15		)	(1		)	(3		)
Statute of limitation expirations	(31		)	(4		)	(15		)
Ending Balance	$	1,069		$	1,052		$	987

We are subject to U.S. Federal income tax as well as income tax of multiple state and foreign jurisdictions. We have concluded all U.S. federal income tax matters through 2000 and substantially all material state, local and foreign income tax matters through 2003.

We have received Notices of Deficiency from the IRS reflecting proposed audit adjustments for Guidant Corporation for its 2001 through 2006 tax years and Boston Scientific Corporation for its 2006 and 2007 tax years. Subsequent to issuing these Notices, the IRS conceded a portion of its original assessment. The total incremental tax liability now asserted by the IRS for the applicable periods is $1.162 billion plus interest. The primary issue in dispute for all years is the transfer pricing in connection with the technology license agreements between domestic and foreign subsidiaries of Guidant. In addition, the IRS has proposed adjustments in connection with the financial terms of our Transaction Agreement with Abbott Laboratories pertaining to the sale of Guidant's vascular intervention business to Abbott in April 2006. We do not agree with the transfer pricing methodologies applied by the IRS or its resulting assessment and we believe that the IRS has exceeded its authority by attempting to adjust the terms of our negotiated third-party agreement with Abbott. In addition, we believe that the IRS positions with regard to these matters are inconsistent with the applicable tax laws and the existing Treasury regulations.

We believe we have meritorious defenses for our tax filings and we have filed, or will timely file, petitions with the U.S. Tax Court contesting the Notices of Deficiency for the tax years in challenge. No payments on the net assessment would be required until the dispute is definitively resolved, which, based on experiences of other companies, could take several years. The IRS is currently examining the 2008 through 2010 tax years of Boston Scientific. During the first quarter of 2014 we were notified by the IRS of their intent to propose significant adjustments to our tax returns for these tax years based upon the same transfer pricing methodologies that are currently being contested in U.S. Tax Court for our tax years prior to 2008. As with the prior years, we disagree with the transfer pricing methodologies being applied by the IRS and we expect to contest any adjustments received through applicable IRS and judicial procedures, as appropriate. We believe that our income tax reserves associated with these matters are adequate and the final resolution will not have a material impact on our financial condition or results of operations. However, final resolution is uncertain and could have a material impact on our financial condition or results of operations.

We recognize interest and penalties related to income taxes as a component of income tax expense. We had $402 million accrued for gross interest and penalties as of December 31, 2013 and $364 million as of December 31, 2012. The increase in gross interest and penalties was the result of $38 million recognized in our consolidated statements of operations. We recognized $22 million of interest and penalties related to income taxes in 2013, recognized $34 million in 2012 and released $18 million in 2011.

It is reasonably possible that within the next 12 months we will resolve multiple issues including transfer pricing and transactional related issues with foreign, federal and state taxing authorities, in which case we could record a reduction in our balance of unrecognized tax benefits of up to $27 million.

In September 2013, Treasury and the Internal Revenue Service issued final regulations regarding the deduction and capitalization of expenditures related to tangible property under Internal Revenue Code Sections (“IRC”) 162, 167 and 263(a). These regulations apply to amounts paid to acquire, produce, or improve tangible property as well as dispositions of such property. The general effective date is tax years beginning on or after January 1, 2014. We have evaluated these regulations and determined that they will not have a material impact on our results of operations.