T. Income Taxes

The components of income (loss) before income taxes were as follows:


	2014			2013			2012
United States	$	(125	)	$	(1,269	)	$	394
Foreign		622			(547	)		(70	)
	$	497		$	(1,816	)	$	324

The provision for income taxes consisted of the following:


	2014			2013			2012
Current:
Federal*	$	(3	)	$	14		$	85
Foreign		357			235			167
State and local		1			1			9
		355			250			261
Deferred:
Federal*		7			84			129
Foreign		(41	)		95			(227	)
State and local		(1	)		(1	)		(1	)
		(35	)		178			(99	)
Total	$	320		$	428		$	162

*	Includes U.S. taxes related to foreign income

The exercise of employee stock options generated a tax benefit of $9 in 2014 and a tax charge of $1 in both 2013 and 2012, representing only the difference between compensation expense recognized for financial reporting and tax purposes. These amounts decreased equity and increased either current taxes payable or deferred tax assets (not operating losses) in the respective periods.

Alcoa has unamortized tax-deductible goodwill of $30 resulting from intercompany stock sales and reorganizations. Alcoa recognizes the tax benefits (at a 30% rate in 2014 and will be a rate of 28% in 2015 and 25% in 2016 and later years) associated with this tax-deductible goodwill as it is being amortized for local income tax purposes rather than in the period in which the transaction is consummated.

A reconciliation of the U.S. federal statutory rate to Alcoa’s effective tax rate was as follows (the effective tax rate for both 2014 and 2012 was a provision on income and for 2013 was a provision on a loss):


	2014			2013			2012
U.S. federal statutory rate		35.0	%		35.0	%		35.0	%
Taxes on foreign operations		(2.7	)		(0.3	)		(0.1	)
Permanent differences on restructuring and other charges and asset disposals		(3.5	)		(0.8	)		10.8
Audit and other adjustments to prior years’ accruals		-			(0.9	)		3.5
Noncontrolling interests⁽¹⁾		6.8			(3.1	)		3.8
Statutory tax rate and law changes⁽²⁾		17.9			0.6			(0.4	)
Tax holidays⁽³⁾		6.1			-			-
Changes in valuation allowances		6.6			(23.2	)		15.2
Impairment of goodwill		-			(33.3	)		-
Amortization of goodwill related to intercompany stock sales/reorganizations		-			1.1			(7.7	)
Change in legal structure of investments		-			-			(4.1	)
Interest income related to income tax positions		(0.5	)		-			(1.3	)
Company-owned life insurance/split-dollar net premiums		(2.2	)		1.1			(3.9	)
Other		0.9			0.2			(0.8	)
Effective tax rate		64.4	%		(23.6	)%		50.0	%

(1)	In 2014, the noncontrolling interests’ impact on Alcoa’s effective tax rate was mostly due to the noncontrolling interest’s share of a loss on the divestiture of an ownership interest in a mining and refining joint venture in Jamaica (see Note F).

(2)	In November 2014, Spain enacted corporate tax reform that changed the corporate tax rate from 30% in 2014 to 28% in 2015 to 25% in 2016. As a result, Alcoa remeasured certain deferred tax assets related to Spanish subsidiaries.

(3)	In 2014, a tax holiday for certain Alcoa subsidiaries in Brazil became effective (see below).

The components of net deferred tax assets and liabilities were as follows:


	2014					2013
December 31,	Deferred tax assets			Deferred tax liabilities		Deferred tax assets			Deferred tax liabilities
Depreciation	$	147		$	1,187	$	185		$	1,150
Employee benefits		2,413			37		2,499			36
Loss provisions		441			10		437			14
Deferred income/expense		30			230		87			188
Tax loss carryforwards		2,075			-		2,229			-
Tax credit carryforwards		625			-		567			-
Derivatives and hedging activities		5			39		74			25
Other		521			297		310			261
		6,257			1,800		6,388			1,674
Valuation allowance		(1,668	)		-		(1,804	)		-
	$	4,589		$	1,800	$	4,584		$	1,674

The following table details the expiration periods of the deferred tax assets presented above:


December 31, 2014	Expires within 10 years			Expires within 11-20 years			No expiration*			Other*			Total
Tax loss carryforwards	$	330		$	619		$	1,126		$	-		$	2,075
Tax credit carryforwards		428			86			111			-			625
Other		-			-			488			3,069			3,557
Valuation allowance		(341	)		(645	)		(392	)		(290	)		(1,668	)
	$	417		$	60		$	1,333		$	2,779		$	4,589

Deferred tax assets with no expiration may still have annual limitations on utilization. Other represents deferred tax assets whose expiration is dependent upon the reversal of the underlying temporary difference. A substantial amount of Other relates to employee benefits that will become deductible for tax purposes over an extended period of time as contributions are made to employee benefit plans and payments are made to retirees.

The total deferred tax asset (net of valuation allowance) is supported by projections of future taxable income exclusive of reversing temporary differences (64%), taxable temporary differences that reverse within the carryforward period (35%), and tax planning strategies (1%).

Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not (greater than 50%) that a tax benefit will not be realized. In evaluating the need for a valuation allowance, management considers all potential sources of taxable income, including income available in carryback periods, future reversals of taxable temporary differences, projections of taxable income, and income from tax planning strategies, as well as all available positive and negative evidence. Positive evidence includes factors such as a history of profitable operations, projections of future profitability within the carryforward period, including from tax planning strategies, and Alcoa’s experience with similar operations. Existing favorable contracts and the ability to sell products into established markets are additional positive evidence. Negative evidence includes items such as cumulative losses, projections of future losses, or carryforward periods that are not long enough to allow for the utilization of a deferred tax asset based on existing projections of income. In certain jurisdictions, deferred tax assets related to cumulative losses exist without a valuation allowance where in management’s judgment the weight of the positive evidence more than offsets the negative evidence of the cumulative losses. Upon changes in facts and circumstances, management may conclude that deferred tax assets for which no valuation allowance is currently recorded may not be realized, resulting in a future charge to establish a valuation allowance. Existing valuation allowances are re-examined under the same standards of positive and negative evidence. If it is determined that it is more likely than not that a deferred tax asset will be realized, the appropriate amount of the valuation allowance, if any, is released. Deferred tax assets and liabilities are also re-measured to reflect changes in underlying tax rates due to law changes and the granting and lapse of tax holidays.

In 2013, Alcoa recognized a $372 discrete income tax charge for valuation allowances on certain deferred tax assets in Spain and the United States. Of this amount, a $237 valuation allowance was established on the full value of the deferred tax assets related to a Spanish consolidated tax group. These deferred tax assets have an expiration period ranging from 2016 (for certain credits) to an unlimited life (for operating losses). After weighing all available positive and negative evidence, as described above, management determined that it was no longer more likely than not that Alcoa will realize the tax benefit of these deferred tax assets. This was mainly driven by a decline in the outlook of the Primary Metals business (2013 realized prices were the lowest since 2009) combined with prior year cumulative losses of the Spanish consolidated tax group. During 2014, the underlying value of the deferred tax assets decreased due to a remeasurement as a result of the enactment of new tax rates in Spain beginning in 2015, the sale of a member of the Spanish consolidated tax group, and a change in foreign currency exchange rates. As a result the valuation allowance decreased by the same amount. At December 31, 2014, the amount of the valuation allowance was $163. This valuation allowance was reevaluated as of December 31, 2014, and no change to the allowance was deemed necessary based on all available evidence. The need for this valuation allowance will be assessed on a continuous basis in future periods and, as a result, a portion or all of the allowance may be reversed based on changes in facts and circumstances.

The remaining $135 relates to a valuation allowance established on a portion of available foreign tax credits in the United States. These credits can be carried forward for 10 years, and have an expiration period ranging from 2016 to 2023 as of December 31, 2013 (2015 to 2019 as of December 31, 2014). After weighing all available positive and negative evidence, as described above, management determined that it was no longer more likely than not that Alcoa will realize the full tax benefit of these foreign tax credits. This was primarily due to lower foreign sourced taxable income after consideration of tax planning strategies and after the inclusion of earnings from foreign subsidiaries projected to be distributable as taxable foreign dividends. This valuation allowance was reevaluated as of December 31, 2014, and no change to the allowance was deemed necessary based on all available evidence. The need for this valuation allowance will be assessed on a continuous basis in future periods and, as a result, an increase or decrease to this allowance may result based on changes in facts and circumstances.

In December 2011, one of Alcoa’s subsidiaries in Brazil applied for a tax holiday related to its expanded mining and refining operations. During 2013, the application was amended and re-filed and, separately, a similar application was filed for another one of the Company’s subsidiaries in Brazil. The deadline for the Brazilian government to deny the application was July 11, 2014. Since Alcoa did not receive notice that its applications were denied, the tax holiday took effect automatically on July 12, 2014. As a result, the tax rate for these subsidiaries decreased significantly (from 34% to 15.25%), resulting in future cash tax savings over the 10-year holiday period (retroactively effective as of January 1, 2013). Additionally, a portion of one of the subsidiaries net deferred tax asset that reverses within the holiday period was remeasured at the new tax rate (the net deferred tax asset of the other subsidiary was not remeasured since it could still be utilized against the subsidiary’s future earnings not subject to the tax holiday). This remeasurement resulted in a decrease to that subsidiary’s net deferred tax asset and a noncash charge to earnings of $52 ($31 after noncontrolling interest).

The following table details the changes in the valuation allowance:


December 31,	2014			2013			2012
Balance at beginning of year	$	1,804		$	1,400		$	1,398
Increase to allowance		117			471			45
Release of allowance		(77	)		(41	)		(31	)
Acquisitions and divestitures (F)		(37	)		—			—
U.S. state tax apportionment and tax rate changes		(80	)		(32	)		(17	)
Foreign currency translation		(59	)		6			5
Balance at end of year	$	1,668		$	1,804		$	1,400

The cumulative amount of Alcoa’s foreign undistributed net earnings for which no deferred taxes have been provided was approximately $4,600 at December 31, 2014. Alcoa has a number of commitments and obligations related to the Company’s growth strategy in foreign jurisdictions. As such, management has no plans to distribute such earnings in the foreseeable future, and, therefore, has determined it is not practicable to determine the related deferred tax liability.

Alcoa and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With a few minor exceptions, Alcoa is no longer subject to income tax examinations by tax authorities for years prior to 2004. All U.S. tax years prior to 2014 have been audited by the Internal Revenue Service. Various state and foreign jurisdiction tax authorities are in the process of examining Alcoa’s income tax returns for various tax years through 2013.

A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding interest and penalties) was as follows:


December 31,	2014			2013			2012
Balance at beginning of year	$	63		$	66		$	51
Additions for tax positions of the current year		2			2			-
Additions for tax positions of prior years		5			11			39
Reductions for tax positions of prior years		(4	)		(2	)		(7	)
Settlements with tax authorities		(29	)		(8	)		(18	)
Expiration of the statute of limitations		-			(2	)		-
Foreign currency translation		(2	)		(4	)		1
Balance at end of year	$	35		$	63		$	66

For all periods presented, a portion of the balance at end of year pertains to state tax liabilities, which are presented before any offset for federal tax benefits. The effect of unrecognized tax benefits, if recorded, that would impact the annual effective tax rate for 2014, 2013, and 2012 would be approximately 4%, (1)%, and 6%, respectively, of pretax book income (loss). Alcoa does not anticipate that changes in its unrecognized tax benefits will have a material impact on the Statement of Consolidated Operations during 2015 (see Other Matters in Note N for a matter for which no reserve has been recognized).

It is Alcoa’s policy to recognize interest and penalties related to income taxes as a component of the Provision for income taxes on the accompanying Statement of Consolidated Operations. In 2014, 2013, and 2012, Alcoa recognized $1, $2, and $3, respectively, in interest and penalties. Due to the expiration of the statute of limitations, settlements with tax authorities, and refunded overpayments, Alcoa also recognized interest income of $5, $12, and $7 in 2014, 2013, and 2012, respectively. As of December 31, 2014 and 2013, the amount accrued for the payment of interest and penalties was $9 and $11, respectively.