Notes to Consolidated Financial Statements

NOTE 16

INCOME TAXES

The components of Income Before Provision for Income Taxes, Discontinued Operations, Extraordinary Item and Cumulative Effect of Accounting Change are as follows:

(dollars in millions)

Years Ended December 31,

2008

 

2007

 

2006

 

Domestic

$

8,838

 

$

8,508

 

$

7,000

 

Foreign

 

921

 

 

984

 

 

1,154

 

 

$

9,759

 

$

9,492

 

$

8,154

 

The components of the provision for income taxes from continuing operations are as follows:

(dollars in millions)

Years Ended December 31,

2008

 

2007

 

2006

 

Current

Federal

$

365

 

$

2,568

 

$

2,364

 

Foreign

 

240

 

 

461

 

 

141

 

State and local

 

543

 

 

545

 

 

421

 

 

 

1,148

 

 

3,574

 

 

2,926

 

Deferred

Federal

 

2,214

 

 

397

 

 

(9

)

Foreign

 

(91

)

 

66

 

 

(45

)

State and local

 

66

 

 

(48

)

 

(191

)

 

 

2,189

 

 

415

 

 

(245

)

Investment tax credits

 

(6

)

 

(7

)

 

(7

)

Total income tax expense

$

3,331

 

$

3,982

 

$

2,674

 

The following table shows the principal reasons for the difference between the effective income tax rate and the statutory federal income tax rate:

Years Ended December 31,

2008

 

2007

 

2006

 

Statutory federal income tax rate

 

35.0

%

 

35.0

%

 

35.0

%

State and local income tax, net of federal tax benefits

 

4.1

 

 

3.4

 

 

1.8

 

Distributions from foreign investments

 

(0.8

)

 

5.9

 

 

 

Equity in earnings from unconsolidated businesses

 

(2.4

)

 

(2.3

)

 

(3.8

)

Other, net

 

(1.8

)

 

 

 

(0.2

)

Effective income tax rate

 

34.1

%

 

42.0

%

 

32.8

%

The effective income tax rate is the provision for income taxes as a percentage of income from continuing operations before the provision for income taxes. The effective income tax rate in 2008 was lower than 2007 primarily due to recording $610 million of foreign and domestic taxes and expenses in 2007 specifically relating to our share of Vodafone Omnitel's distributable earnings. Verizon received net distributions from Vodafone Omnitel in April 2008 and December 2007 of approximately $670 million and $2,100 million, respectively.

The effective income tax rate in 2007 compared to 2006 was higher primarily due to taxes recorded in 2007 related to distributions from Vodafone Omnitel as discussed above. The 2007 rate was also increased due to higher state taxes in 2007 as compared to 2006, as well as greater benefits from foreign operations in 2006 compared to 2007. These increases were partially offset by lower expenses recorded for unrecognized tax benefits in 2007 as compared to 2006.

Deferred taxes arise because of differences in the book and tax bases of certain assets and liabilities. Significant components of deferred tax are shown in the following table:

(dollars in millions)

At December 31,

2008

 

2007

 

Employee benefits

$

13,174

 

$

7,067

 

Tax loss and credit carry forwards

 

2,634

 

 

2,711

 

Uncollectible accounts receivable

 

341

 

 

400

 

Other – assets

 

953

 

 

852

 

 

 

17,102

 

 

11,030

 

Valuation allowance

 

(2,995

)

 

(2,944

)

Deferred tax assets

 

14,107

 

 

8,086

 

 

Former MCI intercompany accounts receivable basis difference

 

1,818

 

 

1,977

 

Depreciation

 

8,157

 

 

7,045

 

Leasing activity

 

2,218

 

 

2,307

 

Wireless joint venture including wireless licenses

 

12,957

 

 

11,634

 

Other – liabilities

 

823

 

 

349

 

Deferred tax liabilities

 

25,973

 

 

23,312

 

Net deferred tax liability

$

11,866

 

$

15,226

 

Employee benefits deferred tax assets include $10,344 million and $4,929 million at December 31, 2008 and 2007, respectively, recognized in accordance with SFAS No. 158 (see Notes 1 and 15).

At December 31, 2008, undistributed earnings of our foreign subsidiaries indefinitely invested outside of the United States amounted to approximately $800 million. We have not provided deferred taxes on these earnings because we intend that they will remain indefinitely invested outside of the United States. Determination of the amount of unrecognized deferred taxes related to these undistributed earnings is not practical.

At December 31, 2008, we had tax loss and credit carry forwards for income tax purposes of approximately $3,000 million. Of these tax loss and credit carry forwards, approximately $2,420 million will expire between 2009 and 2028 and approximately $580 million may be carried forward indefinitely. The amount of tax loss and credit carry forwards reflected as a deferred tax asset above has been reduced by approximately $614 million and $661 million at December 31, 2008 and 2007, respectively, due to federal and state tax law limitations on utilization of net operating losses.

During 2008, the valuation allowance increased $51 million. Beginning January 1, 2009, due to the issuance of SFAS No. 141(R), the valuation allowance as of December 31, 2008, if recognized, will be reflected in income tax expense.

FASB Interpretation No. 48

FIN 48 prescribes the recognition, measurement and disclosure standards for uncertainties in income tax positions. A reconciliation of the beginning and ending balance of unrecognized tax benefits is as follows:

(dollars in millions)

 

2008

 

2007

 

Balance at January 1,

$

2,883

 

$

2,958

 

Additions based on tax positions related to the current year

 

251

 

 

141

 

Additions for tax positions of prior years

 

344

 

 

291

 

Reductions for tax positions of prior years

 

(651

)

 

(420

)

Settlements

 

(126

)

 

(11

)

Lapses of statutes of limitations

 

(79

)

 

(76

)

Balance at December 31,

$

2,622

 

$

2,883

 

Included in the total unrecognized tax benefits at December 31, 2008 and 2007 is $1,631 million and $1,245 million, respectively, that if recognized, would favorably affect the effective income tax rate. Of the $1,631 million at December 31, 2008, $383 million of unrecognized tax benefits are from a prior acquisition and pursuant to SFAS No. 141(R), if recognized, would favorably affect the effective income tax rate.

We recognize any interest and penalties accrued related to unrecognized tax benefits in income tax expense. During 2008 we recognized a net after tax benefit in the income statement related to interest and penalties of approximately $55 million. We had approximately $538 million (after-tax) and $598 million (after-tax) for the payment of interest and penalties accrued in the balance sheets at December 31, 2008 and December 31, 2007, respectively.

During the year ended December 31, 2007, we recognized approximately $175 million (after-tax) in the income statement for the payment of interest and penalties. We had approximately $598 million (after-tax) and $444 million (after-tax) for the payment of interest and penalties accrued in the balance sheet at December 31, 2007 and January 1, 2007, respectively.

Verizon or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state, local and foreign jurisdictions. The Company is generally no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2004. The Internal Revenue Service (IRS) will begin its examination of the Company's U.S. income tax returns for years 2004 through 2006 in the first quarter of 2009. As a result of the anticipated resolution of various income tax audits within the next twelve months, we believe that it is reasonably possible that the amount of unrecognized tax benefits will decrease. An estimate of the range of the possible change cannot be made until issues are further developed.