Taxes on Income

A reconciliation between the effective tax rate and the U.S. statutory rate is as follows:



	2017					2016					2015
	Amount			Tax Rate		Amount			Tax Rate		Amount			Tax Rate
U.S. statutory rate applied to income before taxes	$	2,282		35.0	%	$	1,631		35.0	%	$	1,890		35.0	%
Differential arising from:
Provisional impact of the TCJA	2,625			40.3		—			—		—			—
Impact of purchase accounting adjustments, including amortization	713			10.9		623			13.4		797			14.8
Valuation allowances	632			9.7		(5		)	(0.1	)	39			0.7
Restructuring	142			2.2		145			3.1		167			3.1
State taxes	77			1.2		173			3.7		159			2.9
U.S. health care reform legislation	74			1.1		68			1.4		66			1.2
Foreign currency devaluation related to Venezuela	—			—		—			—		321			5.9
Foreign earnings	(1,725		)	(26.5	)	(1,646		)	(35.3	)	(2,144		)	(39.7	)
Tax settlements	(356		)	(5.5	)	—			—		(417		)	(7.7	)
Unremitted foreign earnings	—			—		(30		)	(0.6	)	260			4.8
Other ⁽¹⁾	(361		)	(5.5	)	(241		)	(5.2	)	(196		)	(3.6	)
	$	4,103		62.9	%	$	718		15.4	%	$	942		17.4	%


⁽¹⁾	Other includes the tax effect of contingency reserves, research credits, losses on foreign subsidiaries and miscellaneous items.

The Company’s 2017 effective tax rate reflects a provisional impact of 40.3% for the Tax Cuts and Jobs Act (TCJA), which was enacted on December 22, 2017. Among other provisions, the TCJA reduces the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, requires companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and creates new taxes on certain foreign sourced earnings.

The Company has reflected the impact of the TCJA in its financial statements as described below. However, application of certain provisions of the TCJA remains subject to further interpretation and in these instances the Company has made a reasonable estimate of the effects of the TCJA.

The one-time transition tax is based on the Company’s post-1986 undistributed earnings and profits (E&P). For a substantial portion of these undistributed E&P, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount for its one-time transition tax liability of $5.3 billion. Merck has not yet finalized its calculation of the total post-1986 undistributed E&P for these foreign subsidiaries. The transition tax is based in part on the amount of undistributed E&P held in cash and other specified assets; therefore, this amount may change when the Company finalizes its calculation of post-1986 undistributed foreign E&P and finalizes the amounts held in cash or other specified assets. This provisional amount was reduced by the reversal of $2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign E&P. The Company anticipates that it will be able to utilize certain foreign tax credits to partially reduce the transition tax payment, resulting in a net transition tax payment of $5.1 billion. As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years. The current portion of the transition tax liability of $545 million is included as reduction to prepaid income taxes included in Other Current Assets and the remainder of $4.5 billion is included in Other Noncurrent Liabilities. As a result of the TCJA, the Company has made a determination it is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for withholding tax that would apply.

The Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $779 million. The deferred tax benefit calculation remains subject to certain clarifications, particularly related to executive compensation and benefits.

Beginning in 2018, the TCJA includes a tax on “global intangible low-taxed income” (GILTI) as defined in the TCJA. The Company is allowed to make an accounting policy election to account for the tax effects of the GILTI tax either in the income tax provision in future periods as the tax arises, or as a component of deferred taxes on the related investments in foreign subsidiaries. The Company is currently evaluating the GILTI provisions of the TCJA and the implications on its tax provision and has not finalized the accounting policy election; therefore, the Company has not recorded deferred taxes for GILTI as of December 31, 2017.

The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate as compared with the 35% U.S. statutory rate. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate as compared to the 35% U.S. statutory rate.

The Company’s 2015 effective tax rate reflects the impact of the Protecting Americans From Tax Hikes Act, which was signed into law on December 18, 2015, extending the research credit permanently and the controlled foreign corporation look-through provisions for five years.

Income before taxes consisted of:



Years Ended December 31	2017		2016		2015
Domestic	$	3,483	$	518	$	2,247
Foreign	3,038		4,141		3,154
	$	6,521	$	4,659	$	5,401

Taxes on income consisted of:



Years Ended December 31	2017			2016			2015
Current provision
Federal	$	5,585		$	1,166		$	732
Foreign	1,229			916			844
State	(90		)	157			130
	6,724			2,239			1,706
Deferred provision
Federal	(2,958		)	(1,255		)	(552		)
Foreign	75			(225		)	(163		)
State	262			(41		)	(49		)
	(2,621		)	(1,521		)	(764		)
	$	4,103		$	718		$	942

Deferred income taxes at December 31 consisted of:



	2017					2016
	Assets			Liabilities		Assets			Liabilities
Intangibles	$	307		$	2,435	$	86		$	3,854
Inventory related	29			499		30			660
Accelerated depreciation	28			642		28			927
Unremitted foreign earnings	—			33		—			2,044
Pensions and other postretirement benefits	498			192		727			109
Compensation related	314			—		438			—
Unrecognized tax benefits	156			—		383			—
Net operating losses and other tax credit carryforwards	654			—		437			—
Other	1,088			19		1,248			46
Subtotal	3,074			3,820		3,377			7,640
Valuation allowance	(900		)			(268		)
Total deferred taxes	$	2,174		$	3,820	$	3,109		$	7,640
Net deferred income taxes				$	1,646				$	4,531
Recognized as:
Other assets	$	573				$	546
Deferred income taxes				$	2,219				$	5,077

The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2017, $630 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $900 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $24 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry.

Income taxes paid in 2017, 2016 and 2015 were $4.9 billion, $1.8 billion and $1.8 billion, respectively. Tax benefits relating to stock option exercises were $73 million in 2017, $147 million in 2016 and $109 million in 2015.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	2017			2016			2015
Balance January 1	$	3,494		$	3,448		$	3,534
Additions related to current year positions	146			196			198
Additions related to prior year positions	520			75			53
Reductions for tax positions of prior years ⁽¹⁾	(1,038		)	(90		)	(59		)
Settlements⁽¹⁾	(1,388		)	(92		)	(184		)
Lapse of statute of limitations	(11		)	(43		)	(94		)
Balance December 31	$	1,723		$	3,494		$	3,448


⁽¹⁾	Amounts reflect the settlements with the IRS as discussed below.

If the Company were to recognize the unrecognized tax benefits of $1.7 billion at December 31, 2017, the income tax provision would reflect a favorable net impact of $1.6 billion.

The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2017 could decrease by up to approximately $165 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Company’s examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures.

Expenses for interest and penalties associated with uncertain tax positions amounted to $183 million in 2017, $134 million in 2016 and $102 million in 2015. These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $341 million and $886 million as of December 31, 2017 and 2016, respectively.

In 2017, the Internal Revenue Service (IRS) concluded its examinations of Merck’s 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $2.8 billion. The Company’s reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement.

Although the IRS’s examination of the Company’s 2002-2005 federal tax returns was concluded prior to 2015, one issue relating to a refund claim remained open. During 2015, this issue was resolved and the Company received a refund of approximately $715 million, which exceeded the receivable previously recorded by the Company, resulting in a tax benefit of $410 million.

The IRS is currently conducting examinations of the Company’s tax returns for the years 2012 through 2014. In addition, various state and foreign tax examinations are in progress. For most of its other significant tax jurisdictions (both U.S. state and foreign), the Company’s income tax returns are open for examination for the period 2003 through 2017.