Cummins Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

INCOME TAXES

INCOME TAXES

12 Months Ended

Dec. 31, 2019

Income Tax Disclosure [Abstract]

INCOME TAXES

NOTE 5. INCOME TAXES

The following table summarizes income before income taxes:



	Years ended December 31,
In millions	2019		2018		2017
U.S. income	$	1,677	$	1,239	$	1,237
Foreign income	1,157		1,514		1,128
Income before income taxes	$	2,834	$	2,753	$	2,365

Income tax expense (benefit) consists of the following:



	Years ended December 31,
In millions	2019			2018			2017
Current
U.S. federal and state	$	288		$	303		$	355
Foreign	282			348			289
Impact of tax legislation	—			153			349
Total current income tax expense	570			804			993
Deferred
U.S. federal and state	(32		)	(71		)	(42		)
Foreign	28			(26		)	(12		)
Impact of tax legislation	—			(141		)	432
Total deferred income tax (benefit) expense	(4		)	(238		)	378
Income tax expense	$	566		$	566		$	1,371

A reconciliation of the statutory U.S. federal income tax rate to the effective tax rate was as follows:



	Years ended December 31,
	2019		2018		2017
Statutory U.S. federal income tax rate	21.0	%	21.0	%	35.0	%
State income tax, net of federal effect	1.1		0.9		0.6
Differences in rates and taxability of foreign subsidiaries and joint ventures	1.5		(0.2	)	(6.4	)
Research tax credits	(1.5	)	(1.2	)	(1.4	)
Foreign derived intangible income	(1.3	)	(1.3	)	—
Impact of tax legislation	—		0.5		33.1
Other, net	(0.8	)	0.9		(2.9	)
Effective tax rate	20.0	%	20.6	%	58.0	%

Our effective tax rate for 2019 was 20.0 percent compared to 20.6 percent for 2018 and 58.0 percent for 2017. The year ended December 31, 2019, contained $34 million of favorable net discrete tax items, primarily due to withholding taxes and provision to return adjustments.

The year ended December 31, 2018, contained $14 million of favorable net discrete tax items, primarily due to $26 million of other favorable discrete tax items, partially offset by $12 million of unfavorable discrete tax items related to the tax legislation.

On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (Tax Legislation) which changed the U.S. statutory rate to 21 percent effective January 1, 2018 and required companies to pay a one-time transition tax on certain previously undistributed earnings on certain foreign subsidiaries and foreign joint ventures that were tax deferred. The impacts of the Tax Legislation resulted in additional tax expense of $12 million in 2018 and $781 million in 2017. See Tax Legislation Summary below for additional information.

Carryforward tax benefits and the tax effect of temporary differences between financial and tax reporting that give rise to net deferred tax (liabilities) assets were as follows:



	December 31,
In millions	2019			2018
Deferred tax assets
U.S. state carryforward benefits	$	207		$	191
Foreign carryforward benefits	157			149
Employee benefit plans	279			245
Warranty expenses	427			401
Lease liabilities	122			—
Accrued expenses	76			94
Other	44			65
Gross deferred tax assets	1,312			1,145
Valuation allowance	(317		)	(327		)
Total deferred tax assets	995			818
Deferred tax liabilities
Property, plant and equipment	(260		)	(255		)
Unremitted income of foreign subsidiaries and joint ventures	(181		)	(184		)
Employee benefit plans	(222		)	(202		)
Lease assets	(120		)	—
Other	(77		)	(30		)
Total deferred tax liabilities	(860		)	(671		)
Net deferred tax assets	$	135		$	147

Our 2019 U.S. carryforward benefits include $207 million of state credit and net operating loss carryforward benefits that begin to expire in 2020. Our foreign carryforward benefits include $157 million of net operating loss carryforwards that begin to expire in 2020. A valuation allowance is recorded to reduce the gross deferred tax assets to an amount we believe is more likely than not to be realized. The valuation allowance is $317 million and decreased in 2019 by a net $10 million. The valuation allowance is primarily attributable to the uncertainty regarding the realization of a portion of the U.S. state and foreign net operating loss and tax credit carryforward benefits.

Our Consolidated Balance Sheets contain the following tax related items:



	December 31,
In millions	2019		2018
Prepaid expenses and other current assets
Refundable income taxes	$	191	$	117
Other assets
Deferred income tax assets	441		410
Long-term refundable income taxes	23		6
Other accrued expenses
Income tax payable	52		97
Other liabilities
One-time transition tax	293		293
Deferred income tax liabilities	306		263

A reconciliation of unrecognized tax benefits for the years ended December 31, 2019, 2018 and 2017 was as follows:



	December 31,
In millions	2019			2018			2017
Balance at beginning of year	$	71		$	41		$	59
Additions to current year tax positions	23			10			11
Additions to prior years' tax positions	5			27			9
Reductions to prior years' tax positions	(11		)	(2		)	(3		)
Reductions for tax positions due to settlements with taxing authorities	(11		)	(5		)	(35		)
Balance at end of year	$	77		$	71		$	41

Included in the December 31, 2019, 2018 and 2017, balances are $69 million, $62 million and $32 million, respectively, related to tax positions that, if released, would favorably impact the effective tax rate in future periods. We have also accrued interest expense related to the unrecognized tax benefits of $5 million, $4 million and $4 million as of December 31, 2019, 2018 and 2017, respectively. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.

Audit outcomes and the timing of audit settlements are subject to significant uncertainty. Although we believe that adequate provision has been made for such issues, there is the possibility that the ultimate resolution of such issues could have an adverse effect on our earnings. Conversely, if these issues are resolved favorably in the future, the related provision would be reduced, thus having a positive impact on earnings.

As a result of our global operations, we file income tax returns in various jurisdictions including U.S. federal, state and foreign jurisdictions. We are routinely subject to examination by taxing authorities throughout the world, including Australia, Belgium, Brazil, Canada, China, France, India, Mexico, the U.K. and the U.S. With few exceptions, our U.S. federal, major state and foreign jurisdictions are no longer subject to income tax assessments for years before 2015.

TAX LEGISLATION SUMMARY

The Securities and Exchange Commission (SEC) issued guidance which addressed the uncertainty in the application of GAAP to the Tax Legislation where certain income tax effects could not be finalized at December 31, 2017. This guidance allowed entities to record provisional amounts based on current estimates that were updated on a quarterly basis in 2018. The SEC required final calculations to be completed within the one year measurement period ending December 22, 2018 and reflect any additional guidance issued throughout the year. We made provisional estimates of the effects of the Tax Legislation in three primary areas: (1) our existing deferred tax balances; (2) the one-time transition tax and (3) the withholding tax accrued on those earnings no longer considered permanently reinvested at December 31, 2017. Each of these items is described in more detail below.

2017 Impact of Tax Legislation

Deferred tax assets and liabilities

We remeasured certain deferred tax assets and liabilities based on the rates at which they were expected to reverse in the future, which was generally 21 percent. The provisional amount related to the remeasurement of our deferred tax balance was an incremental tax expense of $152 million in 2017. See Note 3, "INVESTMENTS IN EQUITY INVESTEES," for the impact to our equity investees.

One-time transition tax

The one-time transition tax was based on our total post-1986 unrepatriated earnings and profits not previously subject to U.S. income tax. The recorded provisional amount for our one-time transition tax was a tax expense of $298 million with a cash impact of $338 million.

Withholding tax

Withholding tax is an additional cost associated with the distribution of earnings from some jurisdictions. As a result of the Tax Legislation, we reconsidered previous assertions regarding earnings that were considered permanently reinvested, which required us to record withholding taxes on earnings likely to be distributed in the foreseeable future. The assertion as to which earnings are permanently reinvested for purposes of calculating withholding tax was provisional as we refined the underlying calculations of the amount of earnings subject to the tax and the rate at which it will be taxed. The recorded provisional amount for the withholding tax resulted in an incremental tax expense of $331 million. See Note 3, "INVESTMENTS IN EQUITY INVESTEES," and Note 18, "NONCONTROLLING INTERESTS," for the impact of withholding taxes to our equity investees and noncontrolling interests.

2018 Adjustments to Tax Legislation

We completed accounting for the tax effects of the enactment of the Tax Legislation as of December 31, 2018 and included $12 million of unfavorable discrete tax items in our 2018 tax provision.

The adjustments for income tax expense (benefit) during the one-year Tax Legislation measurement period for each group and other Tax Legislation adjustments consisted of the following:



	Years Ended December 31,
In millions	2018			2017		Total Impact
One-year measurement adjustments to 2017 estimates
Withholding tax accrued	$	(148	)	$	331	$	183
Deferred tax balances	7			152		159
One-time transition tax	111			298		409
Net impact of measurement period changes	(30		)	781		751
Other 2018 adjustments
Deferred tax charges⁽¹⁾	35			—		35
Foreign currency adjustment related to Tax Legislation	7			—		7
Net impact of 2018 adjustments	42			—		42
Total Tax Legislation impact	$	12		$	781	$	793

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⁽¹⁾ Charges relate to one-time recognition of deferred tax charges at historical tax rates on intercompany profit in inventory.