PUGET ENERGY INC /WA

Income Taxes

The details of income tax (benefit) expense are as follows:



Puget Energy	Year Ended December 31,
(Dollars in Thousands)	2017			2016			2015
Charged to operating expenses:
Current:
Federal	$	1,127		$	—		$	—
State	17			20			—
Deferred:
Federal	254,420			140,315			91,968
State	(421		)	(131		)	(192		)
Total income tax expense	$	255,143		$	140,204		$	91,776



Puget Sound Energy	Year Ended December 31,
(Dollars in Thousands)	2017		2016		2015
Charged to operating expenses:
Current:
Federal	$	1,127	$	—	$	—
State	17		20		—
Deferred:
Federal	210,842		175,327		125,900
State	—		—		—
Total income tax expense	$	211,986	$	175,347	$	125,900

The following reconciliation compares pre-tax book income at the federal statutory rate of 35.0% to the actual income tax expense in the Statements of Income:



Puget Energy	Year Ended December 31,
(Dollars in Thousands)	2017			2016			2015
Income taxes at the statutory rate	$	148,847		$	158,586		$	116,534
Increase (decrease):
Production tax credit¹	—			(12,925		)	(19,470		)
Utility plant differences	—			3,966			5,671
Treasury grant amortization	(9,537		)	(9,788		)	(8,807		)
Tax reform	117,185			—			—
Other - net	(1,352		)	365			(2,152		)
Total income tax expense	$	255,143		$	140,204		$	91,776
Effective tax rate	60.0		%	30.9		%	27.6		%



Puget Sound Energy	Year Ended December 31,
(Dollars in Thousands)	2017			2016			2015
Income taxes at the statutory rate	$	185,430		$	194,572		$	150,531
Increase (decrease):
Production tax credit¹	—			(12,925		)	(19,470		)
Utility plant differences	—			3,966			5,671
Treasury grant amortization	(9,537		)	(9,788		)	(8,807		)
Tax reform	36,328			—			—
Other - net	(235		)	(478		)	(2,025		)
Total income tax expense	$	211,986		$	175,347		$	125,900
Effective tax rate	40.0		%	31.5		%	29.3		%

_______________


¹	PSE's Wild Horse wind plant and Hopkins Ridge wind plant earned their last PTCs in December 2016 and 2015, respectively. No further PTCs are expected.

The Company’s net deferred tax liability at December 31, 2017 and 2016 is composed of amounts related to the following types of temporary differences:



Puget Energy	At December 31,
(Dollars in Thousands)	2017			2016
Utility plant and equipment	$	2,034,328		$	1,880,782
Regulatory asset for income taxes	—			72,038
Fair value of debt instruments	38,777			67,444
Pensions and other compensation	46,338			77,230
Other deferred tax liabilities	86,933			119,050
Subtotal deferred tax liabilities	2,206,376			2,216,544
Net operating loss carryforward	(212,168		)	(352,827		)
Net regulatory liability for income taxes	(1,011,626		)	—
Production tax credit carryforward	(187,617		)	(190,999		)
Regulatory liability on production tax credit	(49,873		)	(101,787		)
Net other deferred tax assets	1,776			—
Subtotal deferred tax assets	(1,459,508		)	(645,613		)
Total net deferred tax liabilities	$	746,868		$	1,570,931



Puget Sound Energy	At December 31,
(Dollars in Thousands)	2017			2016
Utility plant and equipment	$	2,034,328		$	1,880,782
Regulatory asset for income taxes	—			71,517
Other, net deferred tax liabilities	86,933			113,938
Subtotal deferred tax liabilities	2,121,261			2,066,237
Net regulatory liability for income taxes	(1,012,260		)	—
Net operating loss carryforward	—			(41,061		)
Production tax credit carryforward	(187,617		)	(190,999		)
Regulatory liability on production tax credit	(49,873		)	(101,787		)
Net other deferred tax assets	(2,038		)	—
Subtotal deferred tax assets	(1,251,788		)	(333,847		)
Total net deferred tax liabilities	$	869,473		$	1,732,390

On December 22, 2017, President Trump signed into law legislation referred to as the “Tax Cuts and Jobs Act” (the TCJA). 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 Internal Revenue Code of 1986 (as amended, the Code), including amendments which significantly change the taxation of business entities and includes specific provisions related to regulated public utilities including PSE. The most significant change that impacts the Company included in the TCJA is the reduction in the corporate federal income tax rate from 35.0% percent to 21.0% percent. The specific provisions related to regulated public utilities in the TCJA 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 continues normalization requirements for accelerated depreciation benefits. For Puget Energy, TCJA provides for full expensing of property acquired after September 27, 2017 and limits a deduction for interest expense to 30.0% percent of adjusted taxable income (which resembles earnings before interest, taxes, depreciation and amortization or “EBITDA”).

Under generally accepted accounting principles (US GAAP) specifically ASC Topic 740, Income Taxes the tax effects of changes in tax laws must be recognized in the period in which the law is enacted and deferred tax assets and liabilities are to be re-measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled. For PSE, the change in deferred taxes is recorded as either an offset to a regulatory asset or liability and is subject to approval by the Washington Commission. For Puget Energy, the change in deferred taxes is recorded as an adjustment to Puget Energy’s income tax expense, which decreased Puget Energy’s net income.

Upon, enactment of the TCJA, the Company re-measured their deferred tax assets and liabilities based upon the TCJA’s 21.0% percent corporate federal income tax rate. The corporate tax rate change for PSE is captured in the deferred tax balance with an offset to the regulatory liability for deferred income taxes. The balance of the regulatory deferred tax account at the beginning of the year, before tax reform, was a $71.5 million asset. As a result of tax reform, the balance is a liability of $1,012.3 million which represents the excess deferred taxes that will eventually be refunded to customers. Since, PSE is in a net regulatory liability position with respect to these income tax matters, PSE netted the regulatory asset for deferred income taxes against the regulatory liability for deferred income taxes. Under the normalization requirements continued by the TCJA, $919.8 million of the net regulatory liability related to certain accelerated tax depreciation benefits is to be amortized over the remaining lives of the related assets. The remainder of the net regulatory liability of $92.5 million is available for PSE and the Washington Commission regulatory process to determine how the amounts will be refunded to customers. PSE requested to delay the impact of tax reform in an accounting petition which was filed with the Washington Commission on December 29, 2017. The income statement impact for the regulatory deferred tax will come in the future when the Washington Commission issues a final order. The timing for that is unknown but will likely occur in 2018.

The impact of the TCJA to income tax expense was $36.3 million of which $3.0 million relates to deferred tax balances that are not subject to regulatory treatment. In addition, $33.3 million relates to the revaluation of the PTC deferred taxes. The liability owed to customers for PTCs, which previously reduced revenue upon generation of the PTCs, was also revalued at the TCJAs 21 percent rate. The change in the liability owed to customers for PTCs due to TCJA increased revenue by $51.2 million, which increased tax expense by $17.9 million, to reverse the initial deferral. The changes in deferred tax and liability owed to customers for PTCs had no impact on net income. Incrementally, Puget Energy increased their tax expense by $80.9 million primarily due to the revaluation of Puget Energy's net deferred tax asset on its net operating loss carryforward.

The staff of the US Securities and Exchange Commission (SEC) has recognized the complexity of reflecting the impacts of the TCJA, and on December 22, 2017 issued guidance in Staff Accounting Bulletin 118 (SAB 118) which clarifies accounting for income taxes under ASC 740 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). SAB 118 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 ASC 740, based on the provisions of the tax laws that were in effect immediately prior to the TCJA being enacted. The Company has completed the required analysis and accounting for substantially all the effects of the TCJA's enactment and have made a reasonable estimate as to the other effects, and have reflected the measurement and accounting of the effects in the 2017 consolidated financial statements. The items reflected as provisional amounts include tax depreciation and amortization and other book to tax differences. PSE has accounted for these items based on its interpretation of the TCJA. Further interpretive guidance on the TCJA from the IRS, U.S. Treasury Department, or the Joint Committee on Taxation may require adjustments to PSE's accounting. In accordance with SAB 118, adjustments, if any, will be recorded in 2018. The Company did not identify any effects on the TCJA for which they were not able to either complete the required analysis or make a reasonable estimate.

The Company calculates its deferred tax assets and liabilities under ASC 740, “Income Taxes” (ASC 740). ASC 740 requires recording deferred tax balances, at the currently enacted tax rate, on assets and liabilities that are reported differently for income tax purposes than for financial reporting purposes. The utilization of deferred tax assets requires sufficient taxable income in future years. ASC 740 requires a valuation allowance on deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. The Company’s PTC carryforwards expire from 2027 through 2037. The Company’s net operating loss carryforwards expire from 2029 through 2036. No valuation allowance has been provided for PTC or net operating loss carryforwards.

The Company accounts for uncertain tax position under ASC 740, which clarifies the accounting for uncertainty in income taxes recognized in the financial statements. ASC 740 requires the use of a two-step approach for recognizing and measuring tax positions taken or expected to be taken in a tax return. First, a tax position should only be recognized when it is more likely than not, based on technical merits, that the position will be sustained upon challenge by the taxing authorities and taken by management to the court of last resort. Second, a tax position that meets the recognition threshold should be measured at the largest amount that has a greater than 50.0% likelihood of being sustained.

As of December 31, 2017 and 2016, the Company had no material unrecognized tax benefits. As a result, no interest or penalties were accrued for unrecognized tax benefits during the year.

The Company has open tax years from 2014 through 2017. The Company classifies interest as interest expense and penalties as other expense in the financial statements.