Annual report pursuant to Section 13 and 15(d)

INCOME TAXES

v2.4.0.6
INCOME TAXES
 12 Months Ended
Dec. 31, 2012
Income Tax Disclosure [Abstract]  
INCOME TAXES
INCOME TAXES
The income tax expense (benefit) for the years ended December 31 consists of the following (in millions):
 
2012
 
2011
 
2010
Current:
 
 
 
 
 
U.S. Federal
$
1,901

 
$
1,371

 
$
776

U.S. State and Local
182

 
121

 
119

Non-U.S.
167

 
166

 
161

Total Current
2,250

 
1,658

 
1,056

Deferred:
 
 
 
 
 
U.S. Federal
(1,871
)
 
262

 
828

U.S. State and Local
(201
)
 
44

 
98

Non-U.S.
(11
)
 
8

 
(30
)
Total Deferred
(2,083
)
 
314

 
896

Total
$
167

 
$
1,972

 
$
1,952


Income before income taxes includes the following components (in millions):
 
2012
 
2011
 
2010
United States
$
384

 
$
5,309

 
$
4,586

Non-U.S.
590

 
467

 
704

 
$
974

 
$
5,776

 
$
5,290



A reconciliation of the statutory federal income tax rate to the effective income tax rate for the years ended December 31 consists of the following:
 
2012
 
2011
 
2010
Statutory U.S. federal income tax rate
35.0
 %
 
35.0
 %
 
35.0
 %
U.S. state and local income taxes (net of federal benefit)
—

 
2.0

 
2.4

Non-U.S. tax rate differential
(6.1
)
 
(0.4
)
 
(0.7
)
Nondeductible/nontaxable items
(0.4
)
 
(0.1
)
 
0.3

U.S. federal tax credits
(7.4
)
 
(1.7
)
 
(1.9
)
Other
(4.0
)
 
(0.7
)
 
1.8

Effective income tax rate
17.1
 %
 
34.1
 %
 
36.9
 %

Our effective tax rate declined to 17.1% in 2012 compared with 34.1% in 2011 largely due to the significance of U.S. Federal tax credits and the proportion of taxable income in certain non-U.S. jurisdictions relative to total pre-tax income.
In the third quarter of 2010, we recognized a $40 million tax benefit associated with the release of a valuation allowance against deferred tax assets in our international package operations, partially offset by tax provided for interest earned on refunds.
In the first quarter of 2010, we changed the tax status of a German subsidiary that was taxable in the U.S. and its local jurisdiction to one that is taxed solely in its local jurisdiction. This change was made primarily to allow for more flexibility in funding this subsidiary’s operations with local liquidity sources, improve the cash flow position in the U.S., and help mitigate future currency remeasurement risk. As a result of this change in tax status, we recorded a non-cash charge of $76 million, which resulted primarily from the write-off of related deferred tax assets which will not be realizable following the change in tax status.
Beginning in 2012, we were granted a tax incentive for certain of our non-U.S. operations, which is effective through December 31, 2017 and may be extended through December 31, 2022 if additional requirements are satisfied. The tax incentive is conditional upon our meeting specific employment and investment thresholds. The impact of this tax incentive decreased non-U.S. tax expense by $22 million, or $0.02 per share, for 2012.
Deferred tax liabilities and assets are comprised of the following at December 31 (in millions):
 
2012
 
2011
Property, plant and equipment
$
(3,624
)
 
$
(3,607
)
Goodwill and intangible assets
(1,035
)
 
(951
)
Other
(617
)
 
(554
)
Deferred tax liabilities
(5,276
)
 
(5,112
)
Pension and postretirement benefits
4,608

 
2,106

Loss and credit carryforwards (non-U.S. and state)
258

 
259

Insurance reserves
737

 
696

Vacation pay accrual
209

 
208

Stock compensation
159

 
211

Other
708

 
635

Deferred tax assets
6,679

 
4,115

Deferred tax assets valuation allowance
(220
)
 
(205
)
Deferred tax asset (net of valuation allowance)
6,459

 
3,910

Net deferred tax asset (liability)
$
1,183

 
$
(1,202
)
 
 
 
 
Amounts recognized in the consolidated balance sheets:
 
 
 
Current deferred tax assets
$
583

 
$
611

Current deferred tax liabilities (included in other current liabilities)
(36
)
 
(31
)
Non-current deferred tax assets
684

 
118

Non-current deferred tax liabilities
(48
)
 
(1,900
)
Net deferred tax asset (liability)
$
1,183

 
$
(1,202
)

The valuation allowance increased by $15, $2 and $30 million during the years ended December 31, 2012, 2011 and 2010, respectively.
We have U.S. state and local operating loss and credit carryforwards as follows (in millions):
 
2012
 
2011
U.S. state and local operating loss carryforwards
$
608

 
$
859

U.S. state and local credit carryforwards
$
61

 
$
77


The operating loss carryforwards expire at varying dates through 2032. The state credits can be carried forward for periods ranging from three years to indefinitely.
We also have non-U.S. loss carryforwards of approximately $842 million as of December 31, 2012, the majority of which may be carried forward indefinitely. As indicated in the table above, we have established a valuation allowance for certain non-U.S. and state carryforwards, due to the uncertainty resulting from a lack of previous taxable income within the applicable tax jurisdictions.
Undistributed earnings of foreign subsidiaries amounted to approximately $3.575 billion at December 31, 2012. Those earnings are considered to be indefinitely reinvested and, accordingly, no deferred income taxes have been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to income taxes and withholding taxes payable in various jurisdictions, which could potentially be offset by foreign tax credits. Determination of the amount of unrecognized deferred income tax liability is not practicable because of the complexities associated with its hypothetical calculation.

The following table summarizes the activity related to our unrecognized tax benefits (in millions):
 
Tax
 
Interest
 
Penalties
Balance at January 1, 2010
$
266

 
$
86

 
$
8

Additions for tax positions of the current year
16

 
—

 
—

Additions for tax positions of prior years
45

 
25

 
2

Reductions for tax positions of prior years for:
 
 
 
 
 
Changes based on facts and circumstances
(27
)
 
(10
)
 
(3
)
Settlements during the period
(6
)
 
(3
)
 
—

Lapses of applicable statute of limitations
(10
)
 
(3
)
 
—

Balance at December 31, 2010
284

 
95

 
7

Additions for tax positions of the current year
13

 
—

 
—

Additions for tax positions of prior years
17

 
6

 
—

Reductions for tax positions of prior years for:
 
 
 
 
 
Changes based on facts and circumstances
(50
)
 
(9
)
 
(2
)
Settlements during the period
(11
)
 
(19
)
 
(1
)
Lapses of applicable statute of limitations
(1
)
 
—

 
(1
)
Balance at December 31, 2011
252

 
73

 
3

Additions for tax positions of the current year
13

 
—

 
—

Additions for tax positions of prior years
7

 
9

 
1

Reductions for tax positions of prior years for:
 
 
 
 
 
Changes based on facts and circumstances
(22
)
 
(18
)
 
—

Settlements during the period
(3
)
 
(7
)
 
—

Lapses of applicable statute of limitations
(15
)
 
(4
)
 
—

Balance at December 31, 2012
$
232

 
$
53

 
$
4


The total amount of gross unrecognized tax benefits as of December 31, 2012, 2011 and 2010 that, if recognized, would affect the effective tax rate was $224, $247 and $283 million, respectively. We also had gross recognized tax benefits of $280, $291 and $326 million recorded as of December 31, 2012, 2011 and 2010, respectively, associated with outstanding refund claims for prior tax years. Therefore, we had a net receivable recorded with respect to prior years’ income tax matters in the accompanying consolidated balance sheets. Additionally, we have recognized a receivable for interest of $23, $27 and $32 million for the recognized tax benefits associated with outstanding refund claims as of December 31, 2012, 2011 and 2010, respectively. Our continuing practice is to recognize interest and penalties associated with income tax matters as a component of income tax expense.
We file income tax returns in the U.S. federal jurisdiction, most U.S. state and local jurisdictions, and many non-U.S. jurisdictions. We have substantially resolved all U.S. federal income tax matters for tax years prior to 2005. During the fourth quarter of 2010, we received a refund of $139 million as a result of the resolution of tax years 2003 through 2004 with the IRS Appeals Office. We have filed all required U.S. state and local returns reporting the result of the resolution of the U.S. federal income tax audit of the tax years 2003 and 2004. A limited number of U.S. state and local matters are the subject of ongoing audits, administrative appeals or litigation.
In June 2011, we received an IRS Revenue Agent Report (RAR) covering income taxes for tax years 2005 through 2007, in addition to the excise tax matters described in note 8. The income tax RAR proposed adjustments related to the value of acquired software and intangibles, research credit expenditures, and the amount of deductible costs associated with our British Pound Sterling Notes exchange offer completed in May 2007. Receipt of the RAR represents only the conclusion of the examination process. We disagree with some of the proposed adjustments related to these matters. Therefore, we filed protests and, in the third quarter of 2011, the IRS responded to our protests and forwarded the case to IRS Appeals.
We expect to begin discussions of these income tax matters with IRS Appeals within the next twelve months. It should be noted, however, that the ultimate resolution of these matters will result in a refund to UPS - even according to the adjustments proposed by the IRS.
At this time, we do not believe the ultimate resolution of these income tax matters will have a material effect on our financial condition, results of operations, or liquidity.
A number of years may elapse before an uncertain tax position is audited and ultimately settled. It is difficult to predict the ultimate outcome or the timing of resolution for uncertain tax positions. It is reasonably possible that the amount of unrecognized tax benefits could significantly increase or decrease within the next twelve months. Items that may cause changes to unrecognized tax benefits include the timing of interest deductions and the allocation of income and expense between tax jurisdictions. These changes could result from the settlement of ongoing litigation, the completion of ongoing examinations, the expiration of the statute of limitations or other unforeseen circumstances. At this time, an estimate of the range of the reasonably possible change cannot be made.