INCOME TAXES
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| | | | | | | | | | | | |
millions | | 2013 | | 2012 | | 2011 |
Income (loss) before income taxes: | | | | | | |
U.S. | | $ | (1,610 | ) | | $ | (1,226 | ) | | $ | (1,809 | ) |
Foreign | | 638 |
| | 216 |
| | 58 |
|
Total | | $ | (972 | ) | | $ | (1,010 | ) | | $ | (1,751 | ) |
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| | |
| | |
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Income tax expense (benefit): | | |
| | |
| | |
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Current: | | |
| | |
| | |
|
Federal | | $ | 2 |
| | $ | 17 |
| | $ | 19 |
|
State and local | | (6 | ) | | 15 |
| | — |
|
Foreign | | 47 |
| | 27 |
| | 2 |
|
Total current | | 43 |
| | 59 |
| | 21 |
|
| | | | |
| | |
|
Deferred: | | | | |
| | |
|
Federal | | 96 |
| | 8 |
| | 1,357 |
|
State and local | | (42 | ) | | (41 | ) | | (35 | ) |
Foreign | | 47 |
| | 18 |
| | 26 |
|
Total deferred | | 101 |
| | (15 | ) | | 1,348 |
|
Total | | $ | 144 |
| | $ | 44 |
| | $ | 1,369 |
|
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| | | | | | | | | |
| | 2013 | | 2012 | | 2011 |
Effective tax rate reconciliation: | | | | | | |
Federal income tax rate (benefit rate) | | (35.0 | )% | | (35.0 | )% | | (35.0 | )% |
State and local tax (benefit) net of federal tax benefit | | (3.5 | ) | | (3.0 | ) | | (1.3 | ) |
Federal and state valuation allowance | | 74.0 |
| | 23.5 |
| | 104.1 |
|
Tax on separation of Sears Hometown and Outlet Stores, Inc. | | — |
| | 10.3 |
| | — |
|
Nondeductible goodwill impairment | | — |
| | 10.2 |
| | 11.4 |
|
Tax on partial spin-off of Sears Canada | | — |
| | 3.9 |
| | — |
|
Adjust foreign statutory rates | | (15.7 | ) | | (3.2 | ) | | — |
|
Tax benefit resulting from Other Comprehensive Income allocation | | (9.9 | ) | | — |
| | — |
|
Tax credits | | (1.3 | ) | | (1.0 | ) | | (1.5 | ) |
Long life land and intangibles | | 0.6 |
| | (0.8 | ) | | — |
|
Resolution of income tax matters | | (1.4 | ) | | (0.5 | ) | | 0.7 |
|
Canadian repatriation cost on Sears Canada dividend received | | 6.1 |
| | 0.5 |
| | — |
|
Other | | 0.9 |
| | (0.5 | ) | | (0.2 | ) |
| | 14.8 | % | | 4.4 | % | | 78.2 | % |
|
| | | | | | | | |
millions | | February 1,
2014 | | February 2,
2013 |
Deferred tax assets and liabilities: | | | | |
Deferred tax assets: | | | | |
Federal benefit for state and foreign taxes | | $ | 147 |
| | $ | 151 |
|
Accruals and other liabilities | | 144 |
| | 179 |
|
Capital leases | | 96 |
| | 114 |
|
NOL carryforwards | | 1,187 |
| | 722 |
|
Postretirement benefit plans | | 74 |
| | 78 |
|
Pension | | 961 |
| | 1,208 |
|
Deferred revenue | | 171 |
| | 202 |
|
Credit carryforwards | | 721 |
| | 605 |
|
Other | | 149 |
| | 163 |
|
Total deferred tax assets | | 3,650 |
| | 3,422 |
|
Valuation allowance | | (3,366 | ) | | (2,743 | ) |
Net deferred tax assets | | 284 |
| | 679 |
|
| | |
| | |
|
Deferred tax liabilities: | | |
| | |
|
Trade names/Intangibles | | 1,059 |
| | 1,071 |
|
Property and equipment | | — |
| | 156 |
|
Inventory | | 421 |
| | 453 |
|
Other | | 126 |
| | 117 |
|
Total deferred tax liabilities | | 1,606 |
| | 1,797 |
|
Net deferred tax liability | | $ | (1,322 | ) | | $ | (1,118 | ) |
Income tax expense or benefit from continuing operations is generally determined without regard to other categories of earnings, such as discontinued operations and other comprehensive income ("OCI"). An exception is provided in the authoritative accounting guidance when there is income from categories other than continuing operations and a loss from continuing operations in the current year. In this case, the tax benefit allocated to continuing operations is the amount by which the loss from continuing operations reduces the tax expense recorded with respect to the other categories of earnings, even when a valuation allowance has been established against the deferred tax assets. In instances where a valuation allowance is established against current year losses, income from other sources, including gain from pension and other postretirement benefits recorded as a component of OCI, is considered when determining whether sufficient future taxable income exists to realize the deferred tax assets. As a result, for the year ended February 1, 2014, the Company recorded a tax expense of $97 million in OCI related to the gain on pension and other postretirement benefits, and recorded a corresponding tax benefit of $97 million in continuing operations.
We account for income taxes in accordance with accounting standards for such taxes, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the financial reporting and tax bases of recorded assets and liabilities. Accounting standards also require that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion of or all of the deferred tax asset will not be realized.
Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year periods ended February 1, 2014, February 2, 2013 and January 28, 2012. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth.
On the basis of this analysis and the significant negative objective evidence, for the year ended January 28, 2012, a valuation allowance of $2.1 billion was added to record only the portion of the deferred tax asset that more likely than not will be realized. Of the total valuation allowance recorded, $317 million was recorded through other comprehensive income. For the year ended February 2, 2013, $213 million of the valuation allowance increase was recorded through other comprehensive income. For the year ended February 1, 2014, the valuation allowance increased by $623 million, but none of the increase was recorded through other comprehensive income. Included in the $623 million valuation allowance increase was $138 million for state separate entity deferred tax assets, as Kmart Corporation incurred a three-year cumulative loss in 2013.
At February 1, 2014 and February 2, 2013, we had a valuation allowance of $3.4 billion and $2.7 billion, respectively, to record only the portion of the deferred tax asset that more likely than not will be realized. The amount of the deferred tax asset considered realizable, however, could be adjusted in the future if estimates of future taxable income during the carryforward period are reduced or increased, or if the objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as our projections for growth. We will continue to evaluate our valuation allowance in future years for any change in circumstances that causes a change in judgment about the realizability of the deferred tax asset.
At the end of 2013 and 2012, we had a federal and state net operating loss (“NOL”) deferred tax asset of $1.2 billion and $722 million, respectively, which will expire predominately between 2019 and 2034. We have credit carryforwards of $721 million, which will expire between 2015 and 2034.
In connection with Sears Canada’s sale of real estate during 2013, Sears Canada declared an extraordinary dividend of $5 Canadian per share on November 19, 2013. The Company received a taxable dividend of $260 million Canadian or $243 million resulting in a taxable income inclusion of $280 million, which includes a Section 78 Gross-up of $37 million. The amount of taxes otherwise payable resulting from the taxable dividend was reduced by the utilization of $59 million of net deferred tax assets, primarily NOL carryforwards. As the Company had previously recorded a valuation allowance against these NOL carryforwards, $59 million of the related valuation allowance was released upon their utilization.
In connection with the separation of SHO in 2012, the Company incurred a taxable gain of $266 million. The gain primarily related to the determination that the fair value of the consideration received exceeded the tax basis of the net assets of SHO at the date of the separation. The amount of taxes otherwise payable resulting from the gain was reduced by utilization of $105 million of deferred tax assets, primarily NOL carryforwards. As the Company had previously recorded a valuation allowance against these NOL carryforwards, $105 million of the related valuation allowance was released upon their utilization.
In connection with the taxable spin of approximately 45 percent of the Company's common shares in Sears Canada Inc. in 2012, the Company incurred a taxable gain of $367 million. The gain primarily relates to the determination that the fair market value of the common shares distributed to the public shareholders exceeded the tax basis of the shares distributed. The amount of taxes otherwise payable resulting from the gain was reduced by utilization of $40 million of net deferred tax assets, primarily NOL carryforwards. As the Company had previously recorded a valuation allowance against these NOL carryforwards, $40 million of the related valuation allowance was released upon their utilization.
Accounting for Uncertainties in Income Taxes
We account for uncertainties in income taxes according to accounting standards for uncertain tax positions. We are present in a large number of taxable jurisdictions, and at any point in time, can have audits underway at various stages of completion in any of these jurisdictions. We evaluate our tax positions and establish liabilities for uncertain tax positions that may be challenged by federal, foreign and/or local authorities and may not be fully sustained, despite our belief that the underlying tax positions are fully supportable. Unrecognized tax benefits are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law, and closing of statute of limitations. Such adjustments are reflected in the tax provision as appropriate. We are generally not able to reliably estimate the ultimate settlement amounts until the close of the audit. While we do not expect material changes, it is possible that the amount of unrecognized benefit with respect to our uncertain tax positions will significantly increase or decrease within the next 12 months related to the audits described above. At this time, we are not able to make a reasonable estimate of the range of impact on the balance of unrecognized tax benefits or the impact on the effective tax rate related to these items. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits (“UTB”) is as follows:
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| | | | | | | | | | | | |
| | Federal, State, and Foreign Tax |
millions | | February 1,
2014 | | February 2,
2013 | | January 28, 2012 |
Gross UTB Balance at Beginning of Period | | $ | 161 |
| | $ | 192 |
| | $ | 192 |
|
Tax positions related to the current period: | | |
| | |
| | |
|
Gross increases | | 15 |
| | 21 |
| | 22 |
|
Gross decreases | | — |
| | (8 | ) | | (8 | ) |
Tax positions related to prior periods: | | | | |
| | |
|
Gross increases | | — |
| | — |
| | 20 |
|
Gross decreases | | (17 | ) | | (33 | ) | | (19 | ) |
Settlements | | (1 | ) | | (1 | ) | | (4 | ) |
Lapse of statute of limitations | | (6 | ) | | (10 | ) | | (10 | ) |
Exchange rate fluctuations | | (2 | ) | | — |
| | (1 | ) |
Gross UTB Balance at End of Period | | $ | 150 |
| | $ | 161 |
| | $ | 192 |
|
At the end of 2013, we had gross unrecognized tax benefits of $150 million. Of this amount, $91 million would, if recognized, impact our effective tax rate, with the remaining amount being comprised of unrecognized tax benefits related to gross temporary differences or any other indirect benefits. We expect that our unrecognized tax benefits could decrease up to $21 million over the next 12 months for tax audit settlements and the expiration of the statute of limitations for certain jurisdictions.
We classify interest expense and penalties related to unrecognized tax benefits and interest income on tax overpayments as components of income tax expense. At February 1, 2014, the total amount of interest and penalties recognized within the related tax liability in our Consolidated Balance Sheet was $53 million ($36 million net of federal benefit). The total amount of net interest expense recognized in our Consolidated Statement of Operations for 2013 was $2 million.
We file income tax returns in both the United States and various foreign jurisdictions. The U.S. Internal Revenue Service (“IRS”) has completed its examination of Holdings' 2008 through 2009 federal income tax returns, and we are currently working with the IRS appeals division to resolve a single issue arising from these exams. We have resolved all matters arising from prior IRS exams. In addition, Holdings and Sears are under examination by various state, local and foreign income tax jurisdictions for the years 2002 through 2012, and Kmart is under examination by such jurisdictions for the years 2003 through 2012.
