Note 7 – Income Taxes



The provision for income taxes consists of:





The statutory Federal tax rate is 35% and for states with a corporate net income tax, the state corporate net income tax rates range from 3% to 9.99% for all years presented.



The reasons for the differences between amounts computed by applying the statutory Federal corporate income tax rate to income before income tax expense are as follows:





In 2012, the Company changed its tax method of accounting for qualifying utility system repairs in Aqua Pennsylvania effective with the tax year ended December 31, 2012 and for prior tax years.  The tax accounting method was changed to permit the expensing of qualifying utility asset improvement costs that were previously being capitalized and depreciated for book and tax purposes.  This change was implemented in response to a June 2012 rate order issued by the Pennsylvania Public Utility Commission to Aqua Pennsylvania which provides for a reduction in current income tax expense as a result of the flow-through recognition of some income tax benefits due to the income tax accounting change.  The Company recorded income tax benefits of $84,766,  $78,530, and $72,944 during 2017, 2016, and 2015, respectively.  The Company recognized a tax deduction on its 2012 Federal tax return of $380,000 for qualifying capital expenditures made prior to 2012, and based on the rate order, in 2013, the Company began to amortize 1/10th of these expenditures.  In accordance with the rate order, the amortization is expected to reduce current income tax expense during periods when qualifying parameters are met.  Beginning in 2013, the Company amortized the qualifying capital expenditures made prior to 2012 and recognized $38,000, annually, of deferred income tax benefits, which reduced current income tax expense and increased the Company’s net income by $16,734.  The Company’s effective income tax rate for 2017, 2016, and 2015 was 6.6%,  8.2%, and 6.9%, respectively.



The Company establishes reserves for uncertain tax positions based upon management’s judgment as to the sustainability of these positions.  These accounting estimates related to the uncertain tax position reserve require judgments to be made as to the sustainability of each uncertain tax position based on its technical merits.  The Company believes its tax positions comply with applicable law and that it has adequately recorded reserves as required.  However, to the extent the final tax outcome of these matters is different than the estimates recorded, the Company would then adjust its tax reserves or unrecognized tax benefits in the period that this information becomes known.  The Company has elected to recognize accrued interest and penalties related to uncertain tax positions as income tax expense.   



The following table provides the changes in the Company’s unrecognized tax benefits:





The unrecognized tax benefits relate to the income tax accounting change, and the tax position is attributable to a temporary difference.  The Company does not anticipate material changes to its unrecognized tax benefits within the next year.  As a result of the regulatory treatment afforded by the income tax accounting change in Pennsylvania and despite this position being a temporary difference, as of December 31, 2017 and 2016, $24,243 and $20,674 and, respectively, of these tax benefits would have an impact on the Company’s effective income tax rate in the event the Company does sustain all, or a portion, of its tax position.     



The following table provides the components of net deferred tax liability:





At December 31, 2017, the Company has a cumulative Federal NOL of $63,302.  The Company believes the Federal NOLs are more likely than not to be recovered and require no valuation allowance.  The Company’s Federal NOLs do not begin to expire until 2032.



In 2012 and 2011, as a result of the Company’s Federal cumulative NOLs the Company ceased recognizing the windfall tax benefit associated with stock-based compensation, because the deduction did not reduce income taxes payable.  As of December 31, 2015, the Company utilized all of the 2011 NOL and recognized a windfall tax benefit of $588.  As a result of the adoption on January 1, 2017 of the FASB’s updated accounting guidance on simplifying the accounting for share-based payments, the Company recognized a windfall tax benefit of $982 associated with the Company's 2012 Federal NOL, which was recorded as an adjustment to retained earnings.



At December 31, 2017, the Company has a cumulative state NOL of $627,258, a portion of which is offset by a valuation allowance because the Company does not believe these NOLs are more likely than not to be realized.   The state NOLs do not begin to expire until 2023. 



The Company has unrecognized tax positions that result in the associated tax benefit being unrecognized.  The Company’s Federal and state NOL carryforwards are reduced by an unrecognized tax position, on a gross basis, of $64,476 and $85,380, respectively, which results from the Company’s adoption in 2013 of the FASB’s accounting guidance on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists.  The amounts of the Company’s Federal and state NOL carryforwards prior to being reduced by the unrecognized tax positions are $127,778 and $712,638, respectively.  The Company records its unrecognized tax benefit as a reduction to its deferred income tax liability. 



As of December 31, 2017, the Company’s Federal income tax returns for all years through 2011 have been closed.  Tax years 2012 through 2017 remain open to Federal examination.  The statute remains open for the Company’s state income tax returns for tax years 2014 through 2017 in the various states in which it  conducts business.



On December 22, 2017, President Trump signed the TCJA into law.  Substantially all of the provisions of the TCJA are effective for taxable years beginning after December 31, 2017.  The TCJA includes significant changes to the Code and the taxation of business entities, and includes specific provisions related to regulated public utilities.  Significant changes that impact the Company included in the TCJA are a reduction in the corporate federal income tax rate from 35% to 21%, effective January 1, 2018, and a limitation of the utilization of NOLs arising after December 31, 2017 to 80% of taxable income with an indefinite carryforward.  The specific TCJA provisions related to our regulated entities generally allow for the continued deductibility of interest expense, the elimination of full expensing for tax purposes of certain property acquired after September 27, 2017 and the continuation of certain rate normalization requirements for accelerated depreciation benefits.  Our market-based companies still qualify for 100% deductibility of qualifying property acquired after September 27, 2017.



Changes in the Code from the TCJA had a material impact on our financial statements in 2017.  In accordance with the FASB’s accounting guidance for income taxes, the tax effects of changes in tax laws must be recognized in the period in which the law is enacted, or December 22, 2017 for the TCJA.  Additionally, deferred tax assets and liabilities are required to be measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled.  Thus, at the date of enactment, the Company’s deferred taxes were re-measured based upon the new tax rate.  For our regulated entities, the change in deferred taxes is recorded as either an offset to a regulatory asset or liability and may be subject to refund to customers.  In instances where the deferred tax balances are not in ratemaking, such as the Company’s market-based operations, the change in deferred taxes is recorded as an adjustment to our deferred tax provision. To the extent the revalued deferred income tax assets and liabilities were outside of our regulated operations and are not believed to be recoverable in utility customer rates, the revalued amount of $3,141 was recognized as additional deferred income tax expense during the quarter ended December 31, 2017.



The staff of the SEC has recognized the complexity of reflecting the impacts of the TCJA, and on December 22, 2017 issued guidance, which clarifies accounting for income taxes if information is not yet available or complete and provides for up to a one year period in which to complete the required analyses and accounting (the measurement period).  The guidance describes three scenarios (or “buckets”) associated with a company’s status of accounting for income tax reform:  (1) a company is complete with its accounting for certain effects of tax reform, (2) a company is able to determine a reasonable estimate for certain effects of tax reform and records that estimate as a provisional amount, or (3) a company is not able to determine a reasonable estimate and therefore continues to apply the FASB’s accounting guidance, based on the provisions of the tax laws that were in effect immediately prior to the TCJA being enacted.



The Company has completed or has made a reasonable estimate for the measurement and accounting of the effect of the TCJA which have been reflected in the December 31, 2017 financial statements.  The accounting for these completed and provisional items, described below, increased the 2017 deferred income tax provision by $3,141 for the year ending December 31, 2017, and decreased the accumulated deferred income tax liability by $303,320 at December 31, 2017.



One of our states, Pennsylvania, has not yet issued an accounting or procedural order addressing how the TCJA changes are to be reflected in our utility customer rates.  As of December 31, 2017, the Company has provisionally estimated that $175,108 of deferred income tax liabilities for our Pennsylvania subsidiary will be a regulatory liability.  Additionally, two operating divisions in one of our states operate under locally-negotiated contractual rates with their respective counties, and it is expected that negotiations will results in a contract that will pass back the effects of the reduction in the corporate net income tax rate under the TCJA; however, these negotiations have not yet started.  As of December 31, 2017, the Company has provisionally estimated that $9,419 of deferred income tax liabilities for these two divisions will be a regulatory liability.  Overall, the Company has applied a reasonable interpretation of the impact of the TCJA and a reasonable estimate of the regulatory resolution.  Further clarification of the TCJA and regulatory resolution may change the amounts estimated of the deferred income tax provision and the accumulated deferred income tax liability.      



The Company’s regulated operations accounting for income taxes are impacted by the FASB’s accounting guidance for regulated operations.  Reductions in accumulated deferred income tax balances due to the reduction in the Federal corporate income tax rates to 21% under the provisions of the TCJA will result in amounts previously collected from utility customers for these deferred taxes to be refundable to such customers, generally through reductions in future rates.  The TCJA includes provisions that stipulate how these excess deferred taxes related to certain accelerated tax depreciation deduction benefits are to be passed back to customers.  Potential refunds of other deferred taxes will be determined by our state regulators.  Our state regulatory commissions have or are in the process of issuing procedural orders directing how the tax law changes are to be reflected in our utility customer rates.  In addition, we have two rate cases currently in progress in two states in which the TCJA is expected to be addressed in the new base rates.  The December 31, 2017 consolidated balance sheet reflects the impact of the TCJA on our regulatory assets and liabilities which reduced our regulatory assets by $357,262 and increased our regulatory liabilities by $303,320.  These adjustments had no impact on our 2017 cash flows.