Note 8—Income Taxes

Income before income taxes is comprised of the following:



	2016		2015		2014
Domestic (including Puerto Rico)	$	2,622	$	2,574	$	2,145
Foreign	997		1,030		1,052
Total	$	3,619	$	3,604	$	3,197

The provisions for income taxes for 2016, 2015, and 2014 are as follows:



	2016		2015			2014
Federal:
Current	$	468	$	766		$	696
Deferred	233		(12		)	(105		)
Total federal	701		754			591
State:
Current	108		131			107
Deferred	21		1			(3		)
Total state	129		132			104
Foreign:
Current	398		399			369
Deferred	15		(90		)	45
Total foreign	413		309			414
Total provision for income taxes	$	1,243	$	1,195		$	1,109

Tax benefits associated with the exercise of employee stock programs were allocated to equity attributable to Costco in the amount of $74, $86, and $84, in 2016, 2015, and 2014, respectively.

The reconciliation between the statutory tax rate and the effective rate for 2016, 2015, and 2014 is as follows:



	2016					2015					2014
Federal taxes at statutory rate	$	1,267		35.0	%	$	1,262		35.0	%	$	1,119		35.0	%
State taxes, net	91			2.5		85			2.3		66			2.1
Foreign taxes, net	(21		)	(0.6	)	(125		)	(3.5	)	(85		)	(2.7	)
Employee stock ownership plan (ESOP)	(17		)	(0.5	)	(66		)	(1.8	)	(11		)	(0.3	)
Other	(77		)	(2.1	)	39			1.2		20			0.6
Total	$	1,243		34.3	%	$	1,195		33.2	%	$	1,109		34.7	%

The Company’s provision for income taxes for 2015 was favorably impacted by a $57 tax benefit in connection with the special cash dividend of $5.00 per share paid by the Company to employees, through shares owned in the Company's 401(k) Retirement Plan. Dividends paid on these shares are deductible for U.S. income tax purposes. There was no similar special cash dividend in 2016 and 2014.

The components of the deferred tax assets (liabilities) are as follows:



	2016			2015
Equity compensation	$	99		$	90
Deferred income/membership fees	177			90
Accrued liabilities and reserves	601			641
Other⁽¹⁾	63			107
Property and equipment	(779		)	(560		)
Merchandise inventories	(256		)	(200		)
Net deferred tax (liabilities)/assets	$	(95	)	$	168

_______________


(1)	Includes foreign tax credits of $78 and $33 for 2016 and 2015, respectively, which will expire beginning in 2025.

The deferred tax accounts at the end of 2016 and 2015 include non-current deferred income tax assets of $202 and $219, respectively, included in other assets; and non-current deferred income tax liabilities of $297 and $51, respectively, included in other liabilities.

The Company has not provided for U.S. deferred taxes on cumulative undistributed earnings of certain non-U.S. consolidated subsidiaries as such earnings are deemed by the Company to be indefinitely reinvested because its subsidiaries have invested or will invest the undistributed earnings indefinitely, or the earnings if repatriated would not result in an adverse tax consequence. Deferred taxes are recorded for earnings of foreign operations when it is determined that such earnings are no longer indefinitely reinvested.

During 2015, the Company repatriated a portion of the earnings in the Canadian operations that, in 2014, the Company determined were no longer considered indefinitely reinvested. In the fourth quarter of 2015, the Company changed its position regarding an additional portion of the undistributed earnings of the Canadian operations, which are no longer considered indefinitely reinvested. These earnings were distributed in 2016. Current exchange rates compared to historical rates when these earnings were generated resulted in an immaterial U.S. benefit, which was recorded at the end of 2015. Subsequent to the end of fiscal 2016, the Company determined that a portion of the undistributed earnings of its Canadian operations could be repatriated without adverse tax consequences. Accordingly, the Company no longer considers that portion to be indefinitely reinvested.

The Company has not provided for U.S. deferred taxes on cumulative undistributed earnings of $3,280 and $2,845 at the end of 2016 and 2015, respectively, of certain non-U.S. consolidated subsidiaries because the subsidiaries have invested or will invest the undistributed earnings indefinitely, or the earnings, if repatriated would not result in an adverse tax consequence. Because of the availability of U.S. foreign tax credits and complexity of the computation, it is not practicable to determine the U.S. federal income tax liability that would be associated with such earnings if such earnings were not deemed to be indefinitely reinvested.

The Company believes that its U.S. current and projected asset position is sufficient to meet its U.S. liquidity requirements and has no current plans to repatriate for use in the U.S. the cash and cash equivalents and short-term investments held by these non-U.S. subsidiaries whose earnings are considered indefinitely reinvested.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2016 and 2015 is as follows:



	2016			2015
Gross unrecognized tax benefit at beginning of year	$	158		$	75
Gross increases—current year tax positions	2			26
Gross increases—tax positions in prior years	1			63
Gross decreases—tax positions in prior years	(47		)	(1		)
Settlements	(25		)	(3		)
Lapse of statute of limitations	(37		)	(2		)
Gross unrecognized tax benefit at end of year	$	52		$	158

The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2016 and 2015, these amounts were immaterial and $50, respectively. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period. At the end of 2015, the Company recorded an offsetting long-term asset of $48. There was no offsetting long-term asset at the end of 2016.

The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $46 and $98 at the end of 2016 and 2015, respectively.

Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Interest and penalties recognized by the Company were not material in 2016 and 2015. Accrued interest and penalties were not material at the end of 2016 and 2015.

The Company is currently under audit by several taxing jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits we have recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months.

The Company files income tax returns in the United States, various state and local jurisdictions, in Canada and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2013. The Company is currently subject to examination in Canada for fiscal years 2012 to present and in California for fiscal years 2007 to present. No other examinations are believed to be material.