Taxes on Income

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



	2018					2017					2016
	Amount			Tax Rate		Amount			Tax Rate		Amount			Tax Rate
U.S. statutory rate applied to income before taxes	$	1,827		21.0	%	$	2,282		35.0	%	$	1,631		35.0	%
Differential arising from:
Impact of the TCJA	289			3.3		2,625			40.3		—			—
Valuation allowances	269			3.1		632			9.7		(5		)	(0.1	)
Impact of purchase accounting adjustments, including amortization	267			3.1		713			10.9		623			13.4
State taxes	201			2.3		77			1.2		173			3.7
Restructuring	56			0.6		142			2.2		145			3.1
Foreign earnings	(245		)	(2.8	)	(1,654		)	(25.4	)	(1,546		)	(33.2	)
R&D tax credit	(96		)	(1.1	)	(71		)	(1.1	)	(58		)	(1.3	)
Tax settlements	(22		)	(0.3	)	(356		)	(5.5	)	—			—
Other ⁽¹⁾	(38		)	(0.4	)	(287		)	(4.4	)	(245		)	(5.2	)
	$	2,508		28.8	%	$	4,103		62.9	%	$	718		15.4	%


⁽¹⁾	Other includes the tax effects of losses on foreign subsidiaries and miscellaneous items.

The Company’s 2017 effective tax rate reflected 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 reduced 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 reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA. In 2018, these amounts were finalized as described below.

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 in 2017 for its one-time transition tax liability of $5.3 billion. 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. On the basis of revised calculations of post-1986 undistributed foreign E&P and finalization of the amounts held in cash or other specified assets, the Company recognized a measurement-period adjustment of $124 million in 2018 related to the transition tax obligation, with a corresponding adjustment to income tax expense during the period, resulting in a revised transition tax obligation of $5.5 billion. The Company anticipates that it will be able to utilize certain foreign tax credits to partially reduce the transition tax payment. As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years. After payment of the amount due in 2018, the remaining transition tax liability at December 31, 2018, is $4.9 billion, of which $275 million is included in Income Taxes Payable and the remainder of $4.6 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.

In 2017, 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. On the basis of clarifications to the deferred tax benefit calculation, the Company recorded measurement-period adjustments in 2018 of $32 million related to deferred income taxes.

Beginning in 2018, the TCJA includes a tax on “global intangible low-taxed income” (GILTI) as defined in the TCJA. The Company has made an accounting policy election to account for the tax effects of the GILTI tax in the income tax provision in future periods as the tax arises.

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 compared with the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018. 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 compared to the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018.

Income before taxes consisted of:



Years Ended December 31	2018		2017		2016
Domestic	$	3,717	$	3,483	$	518
Foreign	4,984		3,038		4,141
	$	8,701	$	6,521	$	4,659

Taxes on income consisted of:



Years Ended December 31	2018			2017			2016
Current provision
Federal	$	536		$	5,585		$	1,166
Foreign	2,281			1,229			916
State	200			(90		)	157
	3,017			6,724			2,239
Deferred provision
Federal	(402		)	(2,958		)	(1,255		)
Foreign	(64		)	75			(225		)
State	(43		)	262			(41		)
	(509		)	(2,621		)	(1,521		)
	$	2,508		$	4,103		$	718

Deferred income taxes at December 31 consisted of:



	2018					2017
	Assets			Liabilities		Assets			Liabilities
Product intangibles and licenses	$	720		$	1,640	$	307		$	2,256
Inventory related	32			377		29			499
Accelerated depreciation	—			582		28			642
Pensions and other postretirement benefits	565			151		498			192
Compensation related	291			—		314			—
Unrecognized tax benefits	174			—		156			—
Net operating losses and other tax credit carryforwards	715			—		654			—
Other	621			66		909			52
Subtotal	3,118			2,816		2,895			3,641
Valuation allowance	(1,348		)			(900		)
Total deferred taxes	$	1,770		$	2,816	$	1,995		$	3,641
Net deferred income taxes				$	1,046				$	1,646
Recognized as:
Other assets	$	656				$	573
Deferred income taxes				$	1,702				$	2,219

The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2018, $715 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $1.3 billion have been established on these foreign NOL carryforwards and other foreign deferred tax assets. The Company has no NOL carryforwards relating to U.S. jurisdictions.

Income taxes paid in 2018, 2017 and 2016 were $1.5 billion, $4.9 billion and $1.8 billion, respectively. Tax benefits relating to stock option exercises were $77 million in 2018, $73 million in 2017 and $147 million in 2016.

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



	2018			2017			2016
Balance January 1	$	1,723		$	3,494		$	3,448
Additions related to current year positions	221			146			196
Additions related to prior year positions	142			520			75
Reductions for tax positions of prior years ⁽¹⁾	(73		)	(1,038		)	(90		)
Settlements⁽¹⁾	(91		)	(1,388		)	(92		)
Lapse of statute of limitations	(29		)	(11		)	(43		)
Balance December 31	$	1,893		$	1,723		$	3,494


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

If the Company were to recognize the unrecognized tax benefits of $1.9 billion at December 31, 2018, the income tax provision would reflect a favorable net impact of $1.8 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, 2018 could decrease by up to approximately $750 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 $51 million in 2018, $183 million in 2017 and $134 million in 2016. These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $372 million and $341 million as of December 31, 2018 and 2017, 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.

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 and for these jurisdictions, the Company’s income tax returns are open for examination for the period 2003 through 2018.