Entity information:
NOTE 2:  INCOME TAX EXPENSE

Under ASC 740, we recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. From time to time, the Company is assessed interest and penalties by taxing authorities.  In those cases, the charges are recorded on the “Other” line item, within the “Other Income (Deductions), Net of Taxes” section of the Consolidated Statements of Income.  There were no such charges or accruals for the years ended December 31, 2017, 2016, and 2015.

On December 22, 2017 H.R. 1, originally known as the Tax Act was enacted. Among the significant changes to the U.S. Internal Revenue Code, the Tax Act lowers the U.S. federal corporate income tax rate (“Federal Tax Rate”) from 35% to 21% effective January 1, 2018. In December 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118, which addresses how a company recognizes provisional amounts when a company does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the effect of the changes in the Tax Act. The measurement period ends when a company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. While we are able to make reasonable estimates of the impact of the reduction in corporate rate, the final impact of the Tax Act may differ from these estimates, due to, among other things, changes in our interpretations and assumptions, additional guidance that may be issued by the IRS, and other actions we may take. We are continuing to gather additional information to determine the final impact. Provisional amounts have been recorded as a Regulatory Liability to the extent that the tax savings over time will be returned to customers in utility rates, and a non-cash adjustment was recognized to record additional income tax expense to the extent revalued deferred income taxes are not believed to be recoverable in utility customer rates. Accounting for the income tax effects of the Tax Act is expected to be completed when a decision is reached by both PURA and the MPUC regarding the impact that shall be included in utility customer rates.

As of December 31, 2017, the Company can determine a reasonable estimate for remeasuring its net deferred tax assets and liabilities using the Federal Tax Rate that will apply when these amounts are expected to reverse. The Company is recording that estimate as a provisional amount. The effect of the remeasurement is reflected entirely in the interim period that includes the enactment date and is allocated directly to income tax expense from continuing operations. The remeasurement of the deferred tax assets and liabilities resulted in a $1.5 million discrete tax expense which increased the effective tax rate by 6.1% in the year ended December 31, 2017. The Company remeasured Deferred Tax Assets and Liabilities to reflect the enacted legislation and recorded a Regulatory Liability of $27.1 million to capture the excess accumulated deferred income taxes for items included in rates that follow the normalized method of accounting. Unrecovered Income Taxes and Unfunded Future Income Taxes were written down by $32 million to reflect the reduced tax rate for items that follow the flow-through method of accounting.

On June 11, 2013, the Company was notified by the Connecticut Department of Revenue Services that its state tax filings for the years 2009 through 2011 would be reviewed beginning in the fourth quarter of 2013.  On March 24, 2015, the Company was notified by the Connecticut Department of Revenue Services that the audit was expanded to include the 2012 and 2013 tax years. The State focused its review on tax credits associated with fixed capital investment. The Company and the State came to an agreement (“Closing Agreement”) regarding investments eligible for the credit. The Closing Agreement was executed on May 4, 2015. The Company had previously recorded a provision for the possible disallowance of these credits and, therefore, there was minimal impact in 2015.

On the 2012 tax return, filed in September 2013, Connecticut Water filed a change in accounting method to adopt the IRS temporary tangible property regulations. On the 2013 Federal tax return, filed in September 2014, Maine Water filed the same change in accounting method. This method change allowed the Company to take a current year deduction for expenses that were previously capitalized for tax purposes. Since the filing of the 2012 tax return, the IRS has issued final regulations. On February 11, 2014, the Company was notified by the IRS that its Federal tax filing for 2012 would be reviewed. This review, which began in the first quarter of 2014 and was completed in the first quarter of 2015, resulted in no change to the tax liability. Since the Company had previously recorded a provision for the possible disallowance of the repair deduction in those prior periods, the completion of the audit resulted in the reversal of the reserves in the amount of $1,185,000. During the year ended December 31, 2017 new information caused the Company to undertake a review of its provision recorded associated with the repair deduction. While the Company maintains the belief that the deduction taken on its tax return is appropriate, the methodology for determining the deduction has not been agreed to by the taxing authorities. During the Company’s review of the position through the quarter ended March 31, 2017, new information caused management to reassess the previously recorded provision. This reassessment resulted in the reversal of a portion of the provision related to the Maine subsidiary, in the amount of $1,164,000 in the first quarter of 2017. During the Company’s review of the position through the quarter ended June 30, 2017, the impact of new information on Connecticut Water caused management to reassess the previously recorded provision. The reassessment resulted in the reversal of a portion of the provision in the amount of $2,445,000. During the quarter ended September 30, 2017 an additional $810,000 was reversed due to statute expiration. In the quarter ended December 31, 2017, continued analysis resulted in the reversal of a portion of the provision in the amount of $1,620,000 for a total reversal of $6,039,000. In addition, as required by FASB ASC 740, during the year ended December 31, 2017, the Company recorded a provision of $1.2 million for a portion of the benefit that is not being returned to customers resulting from any possible tax authority challenge. The Company had previously recorded a provision of $9.4 million in the prior year for a cumulative total of $4.6 million.

The Company remains subject to examination by federal and state tax authorities for the 2014 through 2016 tax years. On April 26, 2017, Avon Water was notified by the IRS that its stand-alone Federal tax filing for 2015 was selected to be reviewed beginning in the second quarter of 2017. The Company believes that the deductions taken on Avon Water’s tax return are appropriate; therefore no provision was recorded during the year ended December 31, 2017 as required by FASB ASC 740.

Income Tax (Benefit) Expense for the years ended December 31, is comprised of the following:

(in thousands)
 
2017
 
2016
 
2015
Federal Classified as Operating (Benefit) Expense
 
$
(1,277
)
 
$
1,782

 
$
(562
)
Federal Classified as Other Utility Income
 
434

 
385

 
409

Federal Classified as Other Income (Deduction)
 
 

 
 

 
 

Land Sales and Donations
 
17

 
57

 
(70
)
Non-Water Sales
 
774

 
702

 
664

Other
 
503

 
(686
)
 
(832
)
Total Federal Income Tax (Benefit) Expense
 
451

 
2,240

 
(391
)
State Classified as Operating (Benefit) Expense
 
(716
)
 
788

 
(257
)
State Classified as Other Utility Income
 
104

 
92

 
98

State Classified as Other Income (Expense)
 
 

 
 

 
 

Land Sales and Donations
 
5

 
—

 
(287
)
Non-Water Sales
 
175

 
172

 
196

Other
 
149

 
(126
)
 
(128
)
Total State Income Tax (Benefit) Expense
 
(283
)
 
926

 
(378
)
Total Income Tax (Benefit) Expense
 
$
168

 
$
3,166

 
$
(769
)


The components of the Federal and State income tax provisions are:

(in thousands)
 
2017
 
2016
 
2015
Current Income Taxes
 
 
 
 
 
 
Federal
 
$
—

 
$
(15
)
 
$
315

State
 
521

 
463

 
201

Total Current
 
521

 
448

 
516

Deferred Income Taxes, Net
 
 

 
 

 
 

Federal
 
 

 
 

 
 

Investment Tax Credit
 
(76
)
 
(75
)
 
(75
)
Excess Accumulated Deferred Taxes
 
(293
)
 
(110
)
 
192

Excess Accumulated Deferred Taxes - Tax Act
 
1,538

 
—

 
—

Deferred Revenue
 
731

 
(353
)
 
(754
)
Land Donations
 
—

 
37

 
(179
)
Depreciation
 
2,151

 
1,769

 
660

Net Operating Loss Carry-forwards
 
817

 
(1,258
)
 
(1,171
)
NOL Carry-forwards valuation allowance
 
(613
)
 
—

 
—

Provision for uncertain positions
 
(3,876
)
 
2,487

 
874

Other
 
72

 
(242
)
 
(253
)
Total Federal
 
451

 
2,255

 
(706
)
State
 
 

 
 

 
 

Land Donations
 
—

 
55

 
41

Provision for uncertain positions
 
(958
)
 
611

 
41

Other
 
154

 
(203
)
 
(661
)
Total State
 
(804
)
 
463

 
(579
)
Total Deferred Income Taxes
 
(353
)
 
2,718

 
(1,285
)
Total Income Tax
 
$
168

 
$
3,166

 
$
(769
)


Deferred income tax (assets) and liabilities are categorized as follows on the Consolidated Balance Sheets:

(in thousands)
 
2017
 
2016
Unrecovered Income Taxes - Regulatory Asset
 
$
(66,631
)
 
$
(93,264
)
Deferred Federal and State Income Taxes
 
33,579

 
50,558

Unfunded Future Income Taxes
 
58,384

 
90,977

Unamortized Investment Tax Credits - Regulatory Liability
 
1,133

 
1,189

Net Deferred Income Tax Liability
 
$
26,465

 
$
49,460



Net deferred income tax liability decreased from December 31, 2016 to December 31, 2017. The increase from recording the acquisitions of HVWC and Avon Water, along with the increase attributed to the current year tax effects of temporary differences, mostly related to plant items, was offset by the remeasurement due to the Tax Act and the releasing of provisions for uncertain tax positions.
Deferred income tax (assets) and liabilities are comprised of the following:

(in thousands)
 
2017
 
2016
Tax Credit Carry-forward (1)
 
$
(1,092
)
 
$
(968
)
Charitable Contribution Carry-forwards (2)
 
(257
)
 
(389
)
Valuation Allowance on Charitable Contributions
 
63

 
107

Prepaid Income Taxes on CIAC
 
31

 
58

Net Operating Loss Carry-forwards (3)
 
(3,806
)
 
(5,132
)
Valuation Allowance on Net Operating Losses
 
1,671

 
1,471

Deferred Revenue
 
1,644

 
1,513

Other Comprehensive Income
 
(158
)
 
(589
)
Accelerated Depreciation
 
34,989

 
51,119

Provision on Repair Deductions
 
4,630

 
9,464

Long-Term Compensation Agreements
 
(3,260
)
 
(4,416
)
Unamortized Investment Tax Credits
 
1,133

 
1,189

Gross-up on Regulatory Liability - Excess Accumulated Deferred Taxes
 
(8,247
)
 
(2,287
)
Other
 
(876
)
 
(1,680
)
Net Deferred Income Tax Liability
 
$
26,465

 
$
49,460



(1)
State tax credit carry-forwards expire beginning in 2019 and ending in 2040.
(2)
Charitable Contribution carry-forwards expire beginning with the filing of the 2017 Federal and State Tax Returns in 2018 and ending in 2021.
(3)
Net operating loss carry-forwards expire beginning in 2029 and ending in 2036.

The calculation of Pre-Tax Income is as follows:

(in thousands)
 
2017
 
2016
 
2015
Pre-Tax Income
 
 
 
 
 
 
Net Income
 
$
25,054

 
$
23,387

 
$
22,761

Income Taxes
 
168

 
3,166

 
(769
)
Total Pre-Tax Income
 
$
25,222

 
$
26,553

 
$
21,992



In accordance with required regulatory treatment, certain deferred income taxes are not provided for certain timing differences. This treatment, along with other items, causes differences between the statutory income tax rate and the effective income tax rate.  The differences between the effective income tax rate recorded by the Company and the statutory federal tax rate are as follows:

 
 
2017
 
2016
 
2015
Federal Statutory Tax Rate
 
34.0
 %
 
34.0
 %
 
34.0
 %
Tax Effect Differences:
 
 

 
 

 
 

State Income Taxes Net of Federal Benefit
 
(0.9
)%
 
2.6
 %
 
—
 %
Property Related Items
 
(19.9
)%
 
(30.4
)%
 
(19.2
)%
Pension Costs
 
(2.3
)%
 
(0.4
)%
 
(1.7
)%
Repair Regulatory Liability
 
(1.2
)%
 
(3.9
)%
 
(11.5
)%
Change in Estimate of Prior Year Income Tax Expense
 
2.7
 %
 
0.3
 %
 
(10.6
)%
Provision for Uncertain Tax Positions
 
(16.7
)%
 
10.2
 %
 
4.1
 %
Valuation Allowance
 
(2.3
)%
 
0.2
 %
 
—
 %
Impact of Tax Act
 
6.1
 %
 
—
 %
 
—
 %
Other
 
1.2
 %
 
(0.7
)%
 
1.4
 %
Effective Income Tax Rate
 
0.7
 %
 
11.9
 %
 
(3.5
)%


In the second quarter of 2015, the MPUC approved the flow through treatment of the repair tax deduction. The flow through treatment of the deductions taken on the Company’s 2013 tax return is reflected in the change in estimate of prior year income tax expense. In addition, the adoption of the repair tax deduction allowed for a benefit which is reflected in property related items.  Beginning in the second quarter of 2014, the return to customers of the repair tax benefit is reflected under Repair Regulatory Liability. This will be fully returned to customers in 2018. Provisions for uncertain tax positions were recorded to reflect the possible challenge of the Company’s methodology for determining its repair deduction as required by FASB ASC 740. In 2017, the Company assessed new information in regards the previously recorded provision for uncertain tax positions and released a portion of the provision. In the quarter ended December 31, 2017 the Company recorded provisional charges to tax expense to account for the estimated impact of the Tax Act.