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Notes to Consolidated Financial Statements

Note 5. Income Taxes

                 
   
2008
   
2007
   
2006
 
Income before income taxes
                 
U.S.
$
3,274
 
$
4,085
 
$
3,844
 
Foreign
 
3,747
   
3,546
   
3,145
 
   
$7,021
 
$
7,631
 
$
6,989
 
Provision for income taxes
                 
Current: U.S. Federal
$
815
 
$
1,422
 
$
776
 
Foreign
 
732
   
489
   
569
 
State
 
87
   
104
   
56
 
   
1,634
   
2,015
   
1,401
 
Deferred: U.S. Federal
 
313
   
22
   
(31
)
Foreign
 
(69
)
 
(66
)
 
(16
)
State
 
1
   
2
   
(7
)
   
245
   
(42
)
 
(54
)
 
$
1,879
 
$
1,973
 
$
1,347
 
Tax rate reconciliation
                 
U.S. Federal statutory tax rate
 
35.0
%
 
35.0
%
 
35.0
%
State income tax, net of U.S. Federal tax benefit
 
0.8
   
0.9
   
0.5
 
Lower taxes on foreign results
 
(7.9
)
 
(6.5
)
 
(6.5
)
Tax settlements
 
   
(1.7
)
 
(8.6
)
Other, net
 
(1.1
)
 
(1.8
)
 
(1.1
)
Annual tax rate
 
26.8
%
 
25.9
%
 
19.3
%
Deferred tax liabilities
                 
Investments in noncontrolled affiliates
$
1,193
 
$
1,163
       
Property, plant and equipment
 
881
   
828
       
Intangible assets other than nondeductible goodwill
 
295
   
280
       
Pension benefits
 
   
148
       
Other
 
73
   
136
       
Gross deferred tax liabilities
 
2,442
   
2,555
       
Deferred tax assets
                 
Net carryforwards
 
682
   
722
       
Stock-based compensation
 
410
   
425
       
Retiree medical benefits
 
495
   
528
       
Other employee-related benefits
 
428
   
447
       
Pension benefits
 
345
   
       
Deductible state tax and interest benefits
 
230
   
189
       
Other
 
677
   
618
       
Gross deferred tax assets
 
3,267
   
2,929
       
Valuation allowances
 
(657
)
 
(695
)
     
Deferred tax assets, net
 
2,610
   
2,234
       
Net deferred tax (assets)/liabilities
$
(168
)
$
321
       

 

                 
 
2008
 
2007
 
2006
 
Deferred taxes included within:
                 
Assets:
                 
Prepaid expenses and other current assets
$
372
 
$
325
 
$
223
 
Other assets
$
22
   
   
 
Liabilities:
                 
Deferred income taxes
$
226
 
$
646
 
$
528
 
Analysis of valuation allowances
                 
Balance, beginning of year
$
695
 
$
624
 
$
532
 
(Benefit)/provision
 
(5
)
 
39
   
71
 
Other (deductions)/additions
 
(33
)
 
32
   
21
 
Balance, end of year
$
657
 
$
695
 
$
624
 

For additional unaudited information on our income tax policies, including our reserves for income taxes, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

In 2007, we recognized $129 million of non-cash tax benefits related to the favorable resolution of certain foreign tax matters. In 2006, we recognized non-cash tax benefits of $602 million, substantially all of which related to the IRS’s examination of our consolidated income tax returns for the years 1998 through 2002.

Reserves

A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows:

While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution.

For further unaudited information on the impact of the resolution of open tax issues, see “Other Consolidated Results.”

In 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109, (FIN 48), which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that we recognize in our financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. We adopted the provisions of FIN 48 as of the beginning of our 2007 fiscal year.

As of December 27, 2008, the total gross amount of reserves for income taxes, reported in other liabilities, was $1.7 billion. Any prospective adjustments to these reserves will be recorded as an increase or decrease to our provision for income taxes and would impact our effective tax rate. In addition, we accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $427 million as of December 27, 2008, of which $95 million was recognized in 2008. The gross amount of interest accrued was $338 million as of December 29, 2007, of which $34 million was recognized in 2007.

A rollforward of our reserves for all federal, state and foreign tax jurisdictions, is as follows:

           
   
2008
   
2007
 
Balance, beginning of year
$
1,461
 
$
1,435
 
FIN 48 adoption adjustment to retained earnings
 
   
(7
)
Reclassification of deductible state tax and interest benefits to other balance sheet accounts
 
   
(144
)
Adjusted balance, beginning of year
 
1,461
   
1,284
 
Additions for tax positions related to the current year
 
272
   
264
 
Additions for tax positions from prior years
 
76
   
151
 
Reductions for tax positions from prior years
 
(14
)
 
(73
)
Settlement payments
 
(30
)
 
(174
)
Statute of limitations expiration
 
(20
)
 
(7
)
Translation and other
 
(34
)
 
16
 
Balance, end of year
$
1,711
 
$
1,461
 

Carryforwards and Allowances

Operating loss carryforwards totaling $7.2 billion at year-end 2008 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.3 billion in 2009, $6.2 billion between 2010 and 2028 and $0.7 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Undistributed International Earnings

At December 27, 2008, we had approximately $17.1 billion of undistributed international earnings. We intend to continue to reinvest earnings outside the U.S. for the foreseeable future and, therefore, have not recognized any U.S. tax expense on these earnings.