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INCOME TAXES
 12 Months Ended
Dec. 31, 2023
INCOME TAXES
9. INCOME TAXES
The components of income tax expense from our wholly owned operations and investments and our controlling interest in CIAC and joint ventures with Carrier are as follows:
 
Years Ended December 31,
   
2023
     
2022
     
2021
  
Current:
         
U.S. Federal
   
$
119,133
 
    $ 71,475      $ 91,162  
State
   
 
29,749
 
      27,202        20,703  
Foreign
   
 
14,048
 
      13,574        10,993  
  
 
 
     
 
 
     
 
 
  
  
 
162,930
 
      112,251        122,858  
  
 
 
     
 
 
     
 
 
  
Deferred:
         
U.S. Federal
   
 
(5,581
) 
      10,766        6,434  
State
   
 
(1,301
) 
      3,695        1,374  
Foreign
   
 
(297
) 
      (995 )       (1,869 ) 
  
 
 
     
 
 
     
 
 
  
  
 
(7,179
) 
      13,466        5,939  
  
 
 
     
 
 
     
 
 
  
Income tax expense
   
$
155,751
 
    $ 125,717      $ 128,797  
  
 
 
     
 
 
     
 
 
  
We calculate our income tax expense and our effective tax rate for 100% of income attributable to our wholly owned operations and for our controlling interest of income attributable to CIAC and our joint ventures with Carrier, which are primarily taxed as partnerships for income tax purposes.
Following is a reconciliation of the effective income tax rate:
 
Years Ended December 31,
   
2023
    
2022
    
2021
  
U.S. federal statutory rate
   
 
21.0
% 
     21.0 %      21.0 % 
State income taxes, net of federal benefit and other
   
 
3.5
 
     4.6       3.5  
Excess tax benefits from share-based compensation
   
 
(1.8
) 
     (8.6 )      (1.7 ) 
Tax effects on foreign income
   
 
0.2
 
     0.3       0.4  
FDII
   
 
(0.1
) 
     (0.1 )      (0.1 ) 
Change in valuation allowance
   
 
0.3
 
     0.4       0.8  
Tax credits and other
   
 
(0.8
) 
     (0.4 )      (0.5 ) 
  
 
 
    
 
 
    
 
 
  
Effective income tax rate attributable to Watsco, Inc.
   
 
22.3
 
     17.2       23.4  
Taxes attributable to
non-controlling
interest
   
 
(2.6
) 
     (2.0 )      (2.9 ) 
  
 
 
    
 
 
    
 
 
  
Effective income tax rate
   
 
19.7
% 
     15.2 %      20.5 % 
  
 
 
    
 
 
    
 
 
  
 
The following is a summary of the significant components of our net deferred tax liabilities:
 
December 31,
   
2023
     
2022
  
Deferred tax assets:
      
Share-based compensation
   
$
30,847
 
    $ 27,037  
Capitalized inventory costs and adjustments
   
 
5,387
 
      4,366  
Allowance for doubtful accounts
   
 
4,096
 
      3,326  
Self-insurance reserves
   
 
1,701
 
      1,975  
Capitalized research and development costs
   
 
6,712
 
      —   
Other
   
 
7,678
 
      8,711  
Net operating loss carryforwards
   
 
4,584
 
      3,899  
  
 
 
     
 
 
  
  
 
61,005
 
      49,314  
Valuation allowance
   
 
(10,468
) 
      (8,171 ) 
  
 
 
     
 
 
  
Total deferred tax assets
   
 
50,537
 
      41,143  
  
 
 
     
 
 
  
Deferred tax liabilities:
      
Deductible goodwill
   
 
(104,026
) 
      (88,316 ) 
Depreciation
   
 
(24,973
) 
      (23,806 ) 
Unremitted earnings of domestic affiliates
   
 
(5,008
) 
      (6,618 ) 
Other
   
 
(4,390
) 
      (3,761 ) 
  
 
 
     
 
 
  
Total deferred tax liabilities
   
 
(138,397
) 
      (122,501 ) 
  
 
 
     
 
 
  
Net deferred tax liabilities (1)
   
$
(87,860
) 
    $ (81,358 ) 
  
 
 
     
 
 
  
 
(1)
Net deferred tax liabilities have been included in the consolidated balance sheets in deferred income taxes and other liabilities.
Provisions of the Tax Cuts and Jobs Act of 2017 (the “TCJA”)
,
such as the
one-time
repatriation transition tax and the global intangible
low-taxed
income (“GILTI”) for years beginning in 2018, effectively taxed the undistributed earnings previously deferred from U.S. federal and certain state income taxes and eliminated any additional U.S. taxation resulting from repatriation of earnings on
non-
U.S.
 subsidiaries. GILTI is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. We have elected to provide for the tax expense related to GILTI in the year the tax was incurred as a period expense. As of December 31, 2023, we have accumulated undistributed earnings generated by our foreign subsidiaries of approximately $190,000. Any additional taxes due with respect to such previously taxed earnings, if repatriated, would generally be limited to certain state income taxes and foreign withholding. Deferred taxes have been recorded for foreign withholding taxes on certain earnings of our foreign consolidated subsidiaries expected to be repatriated. We do not intend to distribute the remaining previously taxed foreign earnings and therefore have not recorded deferred taxes for certain state income taxes and foreign withholding on such earnings. The amount of certain state income taxes and foreign withholding that might be payable on the remaining amounts at December 31, 2023 is not practicable to estimate.
On March 11, 2021, the America Rescue Plan Act of 2021 (the “ARPA”) was enacted. The ARPA expanded IRC Section 162(m) to include five additional most highly compensated individuals. The expansion of Section 162(m) coverage is effective for tax years beginning after December 31, 2026. Unlike the employees subject to Section 162(m) by virtue of being the Chief Executive Officer (“CEO”), Chief Financial Officer, or three most highly compensated named executive officers, an employee who is identified as one of the “additional” five employees is not considered to be a covered employee indefinitely. The five additional employees will be subject to the annual $1,000 cap on compensation, and will be determined annually.
On August 16, 2022, the Inflation Reduction Act (the “IRA”) was enacted, which introduces a new 15% corporate minimum tax based on adjusted financial statement income and a 1% excise tax on stock repurchases, effective January 1, 2023, and provisions intended to mitigate climate change, including tax credit incentives for investments that reduce greenhouse gas emissions. This legislation did not have a material impact on our consolidated financial statements.
 
Valuation allowances are provided to reduce the related deferred income tax assets to an amount which will, more likely than not, be realized. The valuation allowance was $10,468 and $8,171 at December 31, 2023 and 2022, respectively. The increase was primarily attributable to the impact on U.S deferred tax assets from share-based compensation deduction limitations related to the expansion of IRC Section 162(m).
At December 31, 2023, there were state net operating loss carryforwards of $29,881, some of which expire in 2026, with the majority having an indefinite carryforward period. At December 31, 2023, there were foreign net operating loss carryforwards of $17,723, which expire in varying amounts from 2035 through 2043. These amounts are available to offset future taxable income. There were no federal net operating loss carryforwards at December 31, 2023.
We are subject to U.S. federal income tax, income tax of multiple state jurisdictions and foreign income tax. We are subject to tax audits in the various jurisdictions until the respective statutes of limitations expire. We are no longer subject to U.S. federal tax examinations for tax years prior to 2020. For the majority of states and foreign jurisdictions, we are no longer subject to tax examinations for tax years prior to 2019. In addition, we are no longer subject to U.S. Virgin Islands federal tax examinations for tax years prior to 2015.
At December 31, 2023 and 2022, the total amount of gross unrecognized tax benefits (excluding the federal benefit received from state positions) was $7,874 and $7,752, respectively. Of these totals, $6,559 and $6,457, respectively, (net of the federal benefit received from state positions) represent the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Our policy is to recognize penalties within selling, general and administrative expenses and interest related to income tax matters in income tax expense in the consolidated statements of income. At December 31, 2023 and 2022, the cumulative amount of estimated accrued interest and penalties resulting from such unrecognized tax benefits was $1,471 and $1,343, respectively, and is included in deferred income taxes and other current liabilities in the accompanying consolidated balance sheets. 
The changes in gross unrecognized tax benefits were as follows:
 
Balance at December 31, 2020
   
$
 6,505
 
Additions based on tax positions related to the current year
      1,143  
Reductions due to lapse of applicable statute of limitations
      (921 ) 
  
 
 
  
Balance at December 31, 2021
   
 
 6,727
 
Additions based on tax positions related to the current year
      1,867  
Reductions due to lapse of applicable statute of limitations
      (842 ) 
  
 
 
  
Balance at December 31, 2022
      7,752  
Additions based on tax positions related to the current year
      1,215  
Reductions due to lapse of applicable statute of limitations
      (1,093 ) 
  
 
 
  
Balance at December 31, 2023
   
$
7,874