Note 8 — Income Taxes
The components of the provision for income taxes from operations for the years ended December 31 were as follows:
| 2013 | 2012 | 2011 | ||||||||||
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Current: |
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Federal |
$ | 563 | $ | 647 | $ | 572 | ||||||
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State and other |
148 | 78 | 108 | |||||||||
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| 711 | 725 | 680 | ||||||||||
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Deferred: |
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Federal |
254 | (45 | ) | 80 | ||||||||
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State and other |
58 | 1 | 20 | |||||||||
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| 312 | (44 | ) | 100 | |||||||||
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| $ | 1,023 | $ | 681 | $ | 780 | |||||||
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Significant components of deferred tax assets and liabilities for the years ended December 31 included the following:
| 2013 | 2012 | |||||||
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Deferred tax assets: |
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Pension and other postretirement liabilities |
$ | 522 | $ | 726 | ||||
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Tobacco settlement accruals |
677 | 990 | ||||||
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Other accrued liabilities |
71 | 62 | ||||||
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Other noncurrent liabilities |
150 | 153 | ||||||
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Subtotal |
1,420 | 1,931 | ||||||
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Less: valuation allowance |
(36 | ) | (33 | ) | ||||
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| 1,384 | 1,898 | |||||||
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Deferred tax liabilities: |
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LIFO inventories |
(156 | ) | (158 | ) | ||||
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Property and equipment |
(232 | ) | (242 | ) | ||||
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Trademarks and other intangibles |
(916 | ) | (936 | ) | ||||
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Other |
(120 | ) | (115 | ) | ||||
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| (1,424 | ) | (1,451 | ) | |||||
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Net deferred tax asset (liability) |
$ | (40 | ) | $ | 447 | |||
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The current and noncurrent components of deferred tax assets and liabilities for the years ended December 31 were as follows:
| 2013 | 2012 | |||||||
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Current deferred tax assets |
$ | 606 | $ | 908 | ||||
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Noncurrent deferred tax assets |
12 | — | ||||||
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Noncurrent deferred tax liabilities |
(658 | ) | (461 | ) | ||||
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| $ | (40 | ) | $ | 447 | ||||
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RAI had a $105 million and $99 million federal capital loss carryforward at December 31, 2013, and December 31, 2012, respectively. The increase in 2013 resulted from the termination of an investment during 2013. The federal capital loss carryforwards will expire in 2015, 2016 and 2018 and can be utilized only to the extent net capital gains are generated during the carryforward period.
In 2011, a $33 million valuation allowance was established to fully offset a deferred tax asset related to the federal capital loss carryforward. In 2013, the valuation allowance was increased by $3 million to $36 million to fully offset a deferred tax asset related to a capital loss resulting from the termination of an investment. RAI believes it is unlikely that this deferred tax asset will be realized through the expected generation of future net capital gains. No valuation allowance was established on other deferred tax assets as of the years ended December 31, 2013, 2012, or 2011, as RAI believes it is more likely than not that all of such deferred tax assets will be realized through the expected generation of future taxable income.
Pre-tax income (loss) for domestic and foreign operations for the years ended December 31 consisted of the following:
| 2013 | 2012 | 2011 | ||||||||||
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Domestic (includes U.S. exports) |
$ | 2,737 | $ | 1,983 | $ | 2,157 | ||||||
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Foreign |
4 | (30 | ) | 29 | ||||||||
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| $ | 2,741 | $ | 1,953 | $ | 2,186 | |||||||
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The differences between the provision for income taxes from operations and income taxes computed at statutory U.S. federal income tax rates for the years ended December 31 were as follows:
| 2013 | 2012 | 2011 | ||||||||||
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Income taxes computed at the statutory U.S. federal income tax rate |
$ | 959 | $ | 684 | $ | 765 | ||||||
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State and local income taxes, net of federal tax benefits |
135 | 107 | 96 | |||||||||
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Domestic manufacturing deduction |
(55 | ) | (60 | ) | (60 | ) | ||||||
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Other items, net |
(16 | ) | (50 | ) | (21 | ) | ||||||
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Provision for income taxes from operations |
$ | 1,023 | $ | 681 | $ | 780 | ||||||
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Effective tax rate |
37.3 | % | 34.9 | % | 35.7 | % | ||||||
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The effective tax rate for 2013, as compared to 2012, was unfavorably impacted by an increase in tax attributable to a decrease in the domestic production activities deduction of the American Jobs Creation Act of 2004. The effective tax rate for 2012 was favorably impacted by a decrease in tax attributable to the reversal of tax reserves and interest related to various state statute expirations and audit settlements. The effective tax rate for 2011 was favorably impacted by a decrease in tax attributable to the reversal of tax reserves and interest on a state statute expiration. The effective tax rate for each period differed from the federal statutory rate of 35% due to the impact of state taxes and certain nondeductible items, offset by the favorable impact of the domestic production activities deduction.
On January 2, 2013, the American Taxpayer Relief Act of 2012, referred to as the ATRA, was signed into law. The ATRA retroactively reinstated and extended the Federal Research and Development Tax Credit from January 2, 2012 to December 31, 2013. The impact of the ATRA did not significantly impact RAI’s annual effective income tax rate in 2012 and 2013.
At December 31, 2013, there were $464 million of accumulated and undistributed foreign earnings. Of this amount, RAI has invested $27 million and has plans to invest $54 million overseas. RAI has recorded either current or deferred income taxes related to the $383 million of accumulated foreign earnings in excess of its historical and planned overseas investments.
The deferred tax benefits included in accumulated other comprehensive loss were $63 million for retirement benefits, $11 million for unrealized losses on long-term investments and $8 million for realized loss on hedging instruments as of December 31, 2013, and $223 million for retirement benefits, $14 million for unrealized losses on long-term investments and $9 million for realized loss on hedging instruments as of December 31, 2012. RAI has recorded deferred tax benefits of $4 million and $16 million for cumulative translation adjustments and other in accumulated other comprehensive loss as of December 31, 2013 and 2012, respectively.
The accruals for gross unrecognized income tax benefits, including interest and penalties, reflected in other noncurrent liabilities were $70 million and $77 million at December 31, 2013 and 2012, respectively. RAI accrues interest and penalties related to accruals for income taxes and reflects these amounts in income tax expense. The gross amount of interest accrued at December 31, 2013 and 2012, was $7 million and $9 million, respectively. The gross amount of penalties accrued was $1 million at December 31, 2013 and 2012.
A reconciliation of the gross unrecognized income tax benefits is as follows:
| 2013 | 2012 | 2011 | ||||||||||
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Balance at beginning of year |
$ | 68 | $ | 128 | $ | 127 | ||||||
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Gross increases related to current period tax positions |
4 | 4 | 6 | |||||||||
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Gross increases related to tax positions in prior periods |
— | 1 | 1 | |||||||||
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Gross decreases related to tax positions in prior periods |
(3 | ) | (7 | ) | (1 | ) | ||||||
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Gross increases (decreases) related to audit settlements |
(1 | ) | (31 | ) | 1 | |||||||
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Gross decreases related to lapse of applicable statute of limitations |
(6 | ) | (27 | ) | (6 | ) | ||||||
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Balance at end of year |
$ | 62 | $ | 68 | $ | 128 | ||||||
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At December 31, 2013, $50 million of unrecognized income tax benefits including interest and penalties, if recognized, would decrease RAI’s effective tax rate.
RAI and its subsidiaries are subject to income taxes in the United States, certain foreign jurisdictions and multiple state jurisdictions. A number of years may elapse before a particular matter, for which RAI has established an accrual, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. RAI’s major taxing jurisdictions and related open tax audits are discussed below.
RAI and its subsidiaries file income tax returns in the U.S. federal and various state and foreign jurisdictions. The U.S. federal statute of limitations remains open for the year 2010 and forward, with 2010 and 2011 currently under examination by the Internal Revenue Service as part of a routine audit conducted in the ordinary course of business. State and foreign jurisdictions have statutes of limitations generally ranging from three to five years. Certain of RAI’s state tax returns are currently under examination by various states as part of routine audits conducted in the ordinary course of business.