Note 3—Income Taxes

Consolidated pre-tax income consists of the following:


	For the Year
	2014		2013		2012
	(In thousands)
US operations	$	39,149	$	231,372	$	104,707
Foreign operations		547,761		867,756		840,338

	$	586,910	$	1,099,128	$	945,045

The provision (benefit) for current and deferred income taxes consists of the following:


	For the Year
	2014			2013			2012
	(In thousands)
Current
Federal	$	(25,075	)	$	38,227		$	69,639
State		(2,029	)		6,447			8,660
Foreign		106,998			130,878			126,465

		79,894			175,552			204,764

Deferred
Federal		21,987			30,342			(26,489	)
State		8,233			(512	)		520
Foreign		(22,078	)		(10,198	)		(10,214	)

		8,142			19,632			(36,183	)

Provision for income taxes	$	88,036		$	195,184		$	168,581

Deferred income taxes are provided principally for tax credit carryforwards, research and development expenses, net operating loss carryforwards, employee compensation-related expenses, and certain other reserves that are recognized in different years for financial statement and income tax reporting purposes. Mattel’s deferred income tax assets (liabilities) are composed of the following:


	December 31,
	2014			2013
	(In thousands)
Tax credit carryforwards	$	54,674		$	77,396
Research and development expenses		189,694			187,477
Loss carryforwards		172,347			124,201
Allowances and reserves		233,434			202,141
Deferred compensation		91,530			111,850
Postretirement benefits		50,235			37,479
Intangible assets		30,803			—
Other		68,604			66,599

Gross deferred income tax assets		891,321			807,143

Intangible assets		(298,444	)		(282,737	)
Other		(3,868	)		(5,555	)

Gross deferred income tax liabilities		(302,312	)		(288,292	)

Deferred income tax asset valuation allowances		(133,297	)		(64,641	)

Net deferred income tax assets	$	455,712		$	454,210

The table of deferred tax assets and liabilities as shown above does not include $4.6 million of deferred tax assets for net operating losses as of December 31, 2013 that arose directly from tax deductions attributable to windfall income tax benefits. In 2014, these deferred tax assets were realized and additional paid-in-capital was increased by $4.6 million. Mattel uses tax law ordering when determining when excess tax benefits have been realized.

Net deferred income tax assets are reported in the consolidated balance sheets as follows:


	December 31,
	2014			2013
	(In thousands)
Prepaid expenses and other current assets	$	195,841		$	195,872
Other noncurrent assets		385,434			373,638
Accrued liabilities		(181	)		(109	)
Other noncurrent liabilities		(125,382	)		(115,191	)

	$	455,712		$	454,210

As of December 31, 2014, Mattel has federal and foreign loss carryforwards totaling $869.9 million and tax credit carryforwards of $72.5 million, which excludes carryforwards that do not meet the threshold for recognition in the financial statements. Utilization of these loss and tax credit carryforwards is subject to annual limitations. Mattel’s loss and tax credit carryforwards expire in the following periods:


	Loss Carryforwards		Tax Credit Carryforwards
	(In thousands)
2015 – 2019	$	251,698	$	25,620
Thereafter		376,764		42,890
No expiration date		241,478		3,959

Total	$	869,940	$	72,469

Management considered all available evidence under existing tax law and anticipated expiration of tax statutes and determined that a valuation allowance of $92.6 million was required as of December 31, 2014 for those loss and tax credit carryforwards that are not expected to provide future tax benefits. In addition, management determined that a valuation allowance of $40.7 million was required as of December 31, 2014 for those deferred tax assets for which there is not sufficient evidence as to their ultimate utilization, primarily related to certain foreign affiliates. Changes in the valuation allowance for 2014 primarily relate to (1) increases in the valuation allowance related to certain MEGA Brands losses and deferred tax assets, 2014 foreign losses without benefits, and for certain deferred tax assets and (2) decreases in the valuation allowance for expirations and projected utilization of tax loss and tax credit carryforwards. Management believes it is more-likely-than-not (a greater than 50 percent likelihood) that Mattel will generate sufficient taxable income in the appropriate future periods to realize the benefit of the remaining net deferred income tax assets of $455.7 million. Changes in enacted tax laws, audits in various jurisdictions around the world, settlements, or acquisitions could negatively impact Mattel’s ability to fully realize all of the benefits of its remaining net deferred tax assets.

Differences between the provision for income taxes at the US federal statutory income tax rate and the provision in the consolidated statements of operations are as follows:


	For the Year
	2014			2013			2012
	(In thousands)
Provision at US federal statutory rate	$	205,419		$	384,695		$	330,766
(Decrease) increase resulting from:
Foreign earnings taxed at different rates, including withholding taxes		(107,409	)		(165,768	)		(157,488	)
Foreign losses without income tax benefit		20,140			3,215			1,047
State and local taxes, net of US federal benefit		3,760			4,854			6,856
Adjustments to previously accrued taxes		(55,026	)		(32,200	)		(16,000	)
Tax restructuring		12,400			—			—
Other		8,752			388			3,400

Provision for income taxes	$	88,036		$	195,184		$	168,581

In assessing whether uncertain tax positions should be recognized in its financial statements, Mattel first determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, Mattel presumes that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. For tax positions that meet the more-likely-than-not recognition threshold, Mattel measures the amount of benefit recognized in the financial statements at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Mattel recognizes unrecognized tax benefits in the first financial reporting period in which information becomes available indicating that such benefits will more-likely-than-not be realized.

Mattel records unrecognized tax benefits for US federal, state, local, and foreign tax positions related primarily to transfer pricing, tax credits claimed, tax nexus, and apportionment. For each reporting period, management applies a consistent methodology to measure unrecognized tax benefits, and all unrecognized tax benefits are reviewed periodically and adjusted as circumstances warrant. Mattel’s measurement of its unrecognized tax benefits is based on management’s assessment of all relevant information, including prior audit experience, the status of audits, conclusions of tax audits, lapsing of applicable statutes of limitations, identification of new issues, and any administrative guidance or developments.

A reconciliation of unrecognized tax benefits is as follows:


	For the Year
	2014			2013			2012
	(In thousands)
Unrecognized tax benefits at January 1	$	111,370		$	285,560		$	262,560
Increases for positions taken in current year		9,886			12,997			14,800
Increases for positions taken in a prior year		53,221			14,289			21,030
Decreases for positions taken in a prior year		(51,421	)		(186,555	)		(700	)
Decreases for settlements with taxing authorities		(9,493	)		(5,135	)		(800	)
Decreases for lapses in the applicable statute of limitations		(13,206	)		(9,786	)		(11,330	)

Unrecognized tax benefits at December 31	$	100,357		$	111,370		$	285,560

Of the $100.4 million of unrecognized tax benefits as of December 31, 2014, $96.8 million would impact the effective tax rate if recognized.

During 2014, Mattel recognized $2.4 million of interest and penalties related to unrecognized tax benefits, which are reflected in provision for income taxes in the consolidated statements of operations. As of December 31, 2014, Mattel accrued $18.1 million in interest and penalties related to unrecognized tax benefits. Of this balance, $17.5 million would impact the effective tax rate if recognized.

In the first quarter of 2014, Mattel adopted ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which generally requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. However, to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position or the applicable tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. Mattel reclassified unrecognized tax benefits of approximately $44 million, primarily recorded within other noncurrent liabilities, against its noncurrent deferred tax assets upon adoption in the first quarter of 2014. There was no impact on Mattel’s operating results.

In the normal course of business, Mattel is regularly audited by federal, state, local and foreign tax authorities. In May 2014, the IRS completed its audit of Mattel’s 2010 and 2011 federal income tax returns. Mattel files multiple state and local income tax returns and remains subject to examination in various of these jurisdictions, including California for the 2008 through 2014 tax years, New York for the 2007 through 2014 tax years, and Wisconsin for the 2008 through 2014 tax years. Mattel files multiple foreign income tax returns and remains subject to examination in major foreign jurisdictions, including Hong Kong for the 2008 through 2014 tax years, Brazil, Mexico and Netherlands for the 2009 through 2014 tax years and Russia for the 2011 through 2014 tax years. Based on the current status of federal, state, local and foreign audits, Mattel believes it is reasonably possible that in the next 12 months, the total unrecognized tax benefits could decrease by $8.7 million related to the settlement of tax audits and/or the expiration of statutes of limitations. The ultimate settlement of any particular issue with the applicable taxing authority could have a material impact on Mattel’s consolidated financial statements.

The income tax provision included net tax benefits of $42.6 million, $32.2 million, and $16.0 million in 2014, 2013, and 2012, respectively. The 2014 net tax benefits primarily relate to reassessments of prior years’ tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes, partially offset by a tax charge related to a 2014 tax restructuring for the HIT Entertainment and MEGA Brands operations. The 2013 and 2012 net tax benefits primarily related to the reassessments of prior years’ tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes.

The cumulative amount of undistributed earnings of foreign subsidiaries that Mattel intends to indefinitely reinvest and upon which no deferred US income taxes have been provided is approximately $6.4 billion as of December 31, 2014. Management periodically reviews the undistributed earnings of its foreign subsidiaries and reassesses the intent to indefinitely reinvest such earnings. It is not practicable for Mattel to determine the deferred tax liability associated with these undistributed earnings due to the availability of foreign tax credits, the complexity of our international holding company structure, the rules governing the utilization of foreign tax credits, and the interplay between utilization of such foreign tax credits and Mattel’s other significant tax attributes.

US GAAP requires that windfall income tax benefits related to the exercise of nonqualified stock options and vesting of other stock compensation awards be credited to additional paid-in capital in the period in which such amounts reduce current taxes payable. The exercise of nonqualified stock options and vesting of other stock compensation awards resulted in an increase to additional paid-in capital for related windfall income tax benefits totaling $21.2 million, $50.4 million, and $35.8 million in 2014, 2013, and 2012, respectively.