Income Taxes

Earnings before income taxes and discontinued operations are:



(in millions)	2014		2013		2012
U.S. Operations	$	1,665	$	651	$	1,514
Non-U.S. Operations	133		237		184
Earnings before income taxes and discontinued operations	$	1,798	$	888	$	1,698

The provision for income taxes from continuing operations consists of the following:



(in millions)	2014			2013			2012
Current:
Federal	$	521		$	451		$	430
State and local	51			62			27
Non-U.S.	37			19			13
Total current	$	609		$	532		$	470

Deferred:
Federal	$	24		$	28		$	124
State and local	3			(5		)	28
Non-U.S.	(1		)	(2		)	6
Total deferred	26			21			158
Provision for income taxes	$	635		$	553		$	628

The following table presents a reconciliation of the provision based on the federal statutory income tax rate to our effective income tax rate from continuing operations:



	2014		2013		2012
Provision at Federal statutory rate	35.0	%	35.0	%	35.0	%
State and local income taxes, net of federal benefit	2.2		2.5		2.3
Foreign tax rate differential	(1.2	)	(4.0	)	(2.2	)
Nondeductible/nontaxable items	(0.2	)	(0.5	)	—
Nondeductible goodwill impairment	—		33.2		—
Change in measurement of an uncertain tax position and impact of IRS settlements	(0.4	)	(5.7	)	0.9
Other	(0.1	)	1.8		1.0
Effective income tax rate	35.3	%	62.3	%	37.0	%

The fiscal 2014 effective tax rate was impacted by net favorable discrete items of $37 million, which reduced the rate by 2.1 percentage points. The discrete items include the favorable impact of the settlement of federal and state tax controversies ($80 million) and release of valuation allowances ($12 million) and the unfavorable impact of remeasurement of unrecognized tax benefits ($65 million), primarily as a result of proposed assessments of additional tax.

The fiscal 2013 effective tax rate was unfavorably impacted by 33.2 percentage points ($295 million) due to the nondeductibility of substantially all of the goodwill impairment which was partially offset by the favorable impact of the revaluation of our deferred tax liability and related interest on unrepatriated foreign earnings as a result of an agreement with tax authorities ($64 million or 7.2 percentage points). During the fourth quarter of fiscal 2013, we recorded an out-of-period increase in income tax expense of $14 million (of which generally less than $1 million pertained to each of the first three quarters of fiscal 2013 and each of the quarters in fiscal 2012 through 2008), which related to uncertain tax benefits, and a decrease in retained earnings of $15 million, which related to the adoption of accounting guidance for uncertain tax benefits in 2008. The amounts were not material individually or in the aggregate to current or prior periods.

At June 30, 2014, we had $1.7 billion of undistributed earnings from non-U.S. subsidiaries that are intended to be permanently reinvested in non-U.S. operations. Because these earnings are considered permanently reinvested, no U.S. tax provision has been accrued related to the repatriation of these earnings. It is not practicable to estimate the amount of U.S. tax that might be payable on the eventual remittance of such earnings.

Deferred income taxes arise from temporary differences between financial reporting and tax reporting bases of assets and liabilities and operating loss and tax credit carryforwards for tax purposes. The following table presents the components of the deferred income tax assets and liabilities at June 30:



(in millions)	2014			2013
Deferred income tax assets:
Receivable basis difference	$	59		$	50
Accrued liabilities	111			115
Share-based compensation	51			66
Loss and tax credit carryforwards	191			158
Deferred tax assets related to uncertain tax positions	84			127
Other	42			82
Total deferred income tax assets	538			598
Valuation allowance for deferred income tax assets	(94		)	(88		)
Net deferred income tax assets	$	444		$	510

Deferred income tax liabilities:
Inventory basis differences	$	(1,164	)	$	(1,160	)
Property-related	(142		)	(173		)
Goodwill and other intangibles	(340		)	(299		)
Other	(7		)	(6		)
Total deferred income tax liabilities	(1,653		)	(1,638		)
Net deferred income tax liability	$	(1,209	)	$	(1,128	)

Deferred income tax assets and liabilities in the preceding table, after netting by taxing jurisdiction, are in the following captions in the consolidated balance sheets at June 30:



(in millions)	2014			2013
Current deferred income tax asset (1)	$	18		$	15
Noncurrent deferred income tax asset (2)	15			17
Current deferred income tax liability (3)	(918		)	(908		)
Noncurrent deferred income tax liability (4)	(324		)	(252		)
Net deferred income tax liability	$	(1,209	)	$	(1,128	)


(1)	Included in prepaid expenses and other in the consolidated balance sheets.


(2)	Included in other assets in the consolidated balance sheets.


(3)	Included in other accrued liabilities in the consolidated balance sheets.


(4)	Included in deferred income taxes and other liabilities in the consolidated balance sheets.

At June 30, 2014, we had gross federal, state and international loss and credit carryforwards of $210 million, $1.3 billion and $85 million, respectively, the tax effect of which is an aggregate deferred tax asset of $191 million. Substantially all of these carryforwards are available for at least three years. Approximately $92 million of the valuation allowance at June 30, 2014 applies to certain federal, state and international loss carryforwards that, in our opinion, are more likely than not to expire unutilized. However, to the extent that tax benefits related to these carryforwards are realized in the future, the reduction in the valuation allowance would reduce income tax expense.

We had $510 million, $650 million and $654 million of unrecognized tax benefits at June 30, 2014, 2013 and 2012, respectively. The June 30, 2014, 2013 and 2012 balances include $322 million, $371 million and $337 million, respectively, of unrecognized tax benefits that, if recognized, would have an impact on the effective tax rate. The remaining unrecognized tax benefits relate to tax positions for which ultimate deductibility is highly certain but for which there is uncertainty as to the timing of such deductibility. Recognition of these tax benefits would not affect our effective tax rate. We include the full amount of unrecognized tax benefits in deferred income taxes and other liabilities in the consolidated balance sheets. The following table presents a reconciliation of the beginning and ending amounts of unrecognized tax benefits:



(in millions)	2014			2013			2012
Balance at beginning of fiscal year	$	650		$	654		$	747
Additions for tax positions of the current year	16			22			16
Additions for tax positions of prior years	94			97			68
Reductions for tax positions of prior years	(40		)	(30		)	(3		)
Settlements with tax authorities	(210		)	(93		)	(172		)
Expiration of the statute of limitations	—			—			(2		)
Balance at end of fiscal year	$	510		$	650		$	654

It is reasonably possible that there could be a change in the amount of unrecognized tax benefits within the next 12 months due to activities of the U.S. Internal Revenue Service ("IRS") or other taxing authorities, including proposed assessments of additional tax, possible settlement of audit issues, reassessment of existing unrecognized tax benefits or the expiration of applicable statutes of limitations. We estimate that the range of the possible change in unrecognized tax benefits within the next 12 months is a decrease of approximately $25 million to an increase of approximately $10 million, exclusive of penalties and interest.

We recognize accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. At June 30, 2014, 2013 and 2012 we had $143 million, $198 million and $209 million, respectively, accrued for the payment of interest and penalties. These balances are gross amounts before any tax benefits and are included in deferred income taxes and other liabilities in the consolidated balance sheets. During fiscal 2014 and 2012, we recognized $46 million and $28 million of benefit for interest and penalties in income tax expense, respectively. During fiscal 2013, we recognized $24 million of interest and penalties in income tax expense.

We file income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and various foreign jurisdictions. We are subject to audit by the IRS for fiscal years 2006 through the current fiscal year. We are generally subject to audit by taxing authorities in various U.S. state and foreign jurisdictions for fiscal years 2003 through the current fiscal year.

During fiscal 2014, the IRS closed audits of fiscal years 2003 through 2005. The IRS is currently conducting audits of fiscal years 2006 through 2010, and our transfer pricing arrangements continue to be under consideration as part of these audits. While the IRS has made and could make proposed adjustments to our transfer pricing arrangements, or other matters, we are defending our reported tax positions, and have accounted for the unrecognized tax benefits associated with our tax positions.

We are a party to a tax matters agreement with CareFusion Corporation ("CareFusion"), under which CareFusion is obligated to indemnify us for certain tax exposures and transaction taxes prior to our fiscal 2010 spin-off of CareFusion. The indemnification receivable was $210 million and $186 million at June 30, 2014 and 2013, respectively, and is included in other assets in the consolidated balance sheets.