Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

Income Taxes

7.Income Taxes

Income tax expense (benefit) is summarized as follows:

	Years Ended December 31,
	2011			2010			2009
				(Thousands)
Current:
Federal	$	39,867		$	(25,377	)	$	(134,763	)
State	6,076			(388		)	(2,712		)
Subtotal	$	45,943		(25,765		)	(137,475		)
Deferred:
Federal	$	202,392		132,161			223,177
State	31,627			21,751			11,599
Subtotal	$	234,019		153,912			234,776
Amortization of deferred investment tax credit	(602		)	(627		)	(633		)
Total	$	279,360		$	127,520		$	96,668

The current tax expense recorded in 2011 primarily related to alternative minimum tax and state taxes due as a result of the Company’s sales of Langley and  Big Sandy.  The current federal tax benefit recorded in 2010 and 2009 primarily related to additional cash refunds received related to the 2009 and 2008 tax net operating loss carrybacks.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) extended the research and experimentation (R&E) tax credit for 2010 and 2011 and increased bonus depreciation from 50% to 100% for qualified investments made after September 8, 2010 and before January 1, 2012.  The 2010 Tax Relief Act also extended the 50% bonus depreciation for property placed in service after December 31, 2011 and before January 1, 2013.

The Company carried back its 2009 tax net operating loss under 2009 legislation allowing a five-year carryback of net operating losses, and received a refund of $123.4 million in 2010.  EQT also received a refund of $115.2 million in 2009, relating to a 2008 net operating loss carryback.  The Company generated net operating losses for federal tax purposes from 2008 to 2011, primarily as a result of intangible drilling costs (IDCs) which are deducted for tax purposes but capitalized for financial statement purposes and from accelerated and bonus tax depreciation associated with the expansion of the Company’s midstream business.  For federal income tax purposes, the Company deducts approximately 84% of drilling costs as IDCs in the year incurred.  The Company expects to pay minimal federal income taxes for the next few years as the Company’s drilling program in Appalachia continues to generate tax losses.

Income tax expense differs from amounts computed at the federal statutory rate of 35% on pre-tax income as follows:

	Years Ended December 31,
	2011		2010		2009
			(Thousands)
Tax at statutory rate	$	265,695	$	124,327	$	88,759
State income taxes	25,416		14,585		8,681
Incentive or deferred compensation	–		–		8,925
Federal tax credits and incentives	(660)		(600)		1,613
Regulatory basis differences	(1,251)		(2,713)		(9,336)
Permanent basis differences	(2,411)		(1,258)		(3,025)
Other	(7,429)		(6,821)		1,051
Income tax expense	$	279,360	$	127,520	$	96,668
Effective tax rate	36.8%		35.9%		38.1%

The Company received consent in 2009 from the Internal Revenue Service (IRS) for a change in accounting method that allows current income tax deductions for certain repair costs that are capitalized for book purposes.  The Company’s regulated business accounts for these tax deductible repair costs as a permanent difference, which reduce the effective tax rate in the year of deduction, because the related deferred taxes are recoverable in rates.

The Company’s effective tax rate for the year ended December 31, 2011 was 36.8% compared to 35.9% for the year ended December 31, 2010.  The increase in the rate from 2010 to 2011 was partly a result of a higher tax benefit for repair costs in 2010 than in 2011.  In addition, state income taxes were higher due to a shift in the Company’s non-regulated business to states with higher income tax rates.  Other rate reconciling items had a larger percentage impact on the effective tax rate in 2010 than 2011 due to significantly higher pre-tax income in 2011.

The Company’s effective tax rate for its continuing operations for the year ended December 31, 2010 was 35.9% compared to 38.1% for the year ended December 31, 2009.  The higher tax rate in 2009 was primarily the result of the impact in 2009 of certain nondeductible expenses and the loss of certain prior year deductions as a result of carrying 2009 losses back to receive a cash refund of taxes paid.  These higher rates in 2009 were partially mitigated by the regulatory asset for repairs costs capitalized for financial accounting purposes.  Rates were also lower in 2010 due to the reduction of the reserve for uncertain tax positions as a result of the lapse of applicable statutes of limitation.

Section 162(m) of the Internal Revenue Code disallows, with certain exceptions such as performance based compensation paid pursuant to a shareholder approved plan, a federal income tax deduction for annual compensation over $1 million paid to any covered employee.  The covered employees are the principal executive officer and the three most highly-compensated officers other than the principal executive officer and the principal financial officer. During 2009, payments awarded under the 2009 Shareholder Value Plan were subject to this limitation which resulted in $8.9 million of tax expense.  The establishment of the regulatory asset for the accounting method change on repairs costs resulted in a decrease in tax expense of $9.8 million in 2009.

In December 2011, the IRS issued temporary and proposed regulations related to costs incurred in years beginning after 2011 for the repair or replacement of tangible personal property.  Additional guidance is expected from the IRS regarding the implementation of these regulations.  Adoption of these regulations should not have a material impact on the Company’s financial statements.

The following table reconciles the beginning and ending amount of reserve for uncertain tax positions (excluding interest and penalties):

	2011		2010		2009
	(Thousands)
Balance at January 1	$37,943		$  40,726		$ 34,171
Additions based on tax positions related to current year	1,245		2,524		10,622
Additions for tax positions of prior years	184		3,391		672
Reductions for tax positions of prior years	(7,886	)	(4,618	)	(1,550	)
Settlements	-		–		–
Lapse of statute of limitations	(756	)	(4,080	)	(3,189	)
Balance at December 31	$ 30,730		$  37,943		$ 40,726

Included in the tabular reconciliation above at December 31, 2011, 2010 and 2009 are $15.9 million, $21.2 million and $29.5 million, respectively, for tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of tax deductions.  Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash taxes to an earlier period.  Uncertain tax positions of $19.4 million and $8.5 million for the periods ending December 31, 2011 and 2010, respectively, are recorded in the Consolidated Balance Sheets as a reduction of the deferred tax asset for net operating loss carryforwards rather than as a portion of uncertain tax positions.

The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense.  The Company reversed approximately $9.7 million and $3.9 million of previously recorded interest expense in 2011 and 2010, respectively, and recognized approximately $2.5 million of interest expense for the year ended December 31, 2009.  Interest and penalty of $2.3 million, $12.0 million and $15.9 million was included in the balance sheet reserve at December 31, 2011, 2010 and 2009, respectively.

The total amount of unrecognized tax benefits, inclusive of interest and penalties, was $33.0 million, $49.9 million and $56.6 million as of December 31, 2011, 2010 and 2009, respectively.  The total amount of unrecognized tax benefits (excluding interest and penalties) that, if recognized, would affect the effective tax rate was $5.2 million, $8.9 million and $8.9 million as of December 31, 2011, 2010 and 2009, respectively.

As of December 31, 2011, it was reasonably possible that the total amount of unrecognized tax benefits could decrease by up to $18.0 million within the next 12 months due to potential settlements with taxing authorities, legal or administrative guidance by relevant taxing authorities or the lapse of applicable statutes of limitation.

There were no material changes to the Company’s methodology for unrecognized tax benefits during 2011.  Because the Company is in a net operating loss position, the Company did not create unrecognized tax benefits for certain tax positions in 2011 and 2010; such amounts instead reduce the net operating loss carryforward for those periods.  Decreases to the unrecognized tax benefit balance during 2011 and 2010 were primarily attributable to the reversal of certain prior year tax positions related to timing differences and the related interest expense as well as the lapse of applicable statutes of limitations.

During the second quarter of 2011, the Company finalized a settlement with the IRS relating to research and experimentation tax credits claimed from 2001 to 2005.  Except for claims related to tax losses for those years, the consolidated federal income tax liability of the Company has been settled with the IRS through 2005.  The Company is currently under audit for the 2006 to 2009 periods.  The examination of these periods began in the second quarter of 2010.  The Company also is the subject of various state income tax examinations.  The Company believes that it is appropriately reserved for any uncertain tax positions.

The following table summarizes the source and tax effects of temporary differences between financial reporting and tax bases of assets and liabilities:

	December 31,
	2011	2010
	(Thousands)
Deferred income taxes:
Total deferred income tax assets	$(449,888)	$ (385,948)
Total deferred income tax liabilities	2,038,225	1,622,520
Total net deferred income tax liabilities	1,588,337	1,236,572
Total deferred income tax liabilities (assets)
Tax depreciation in excess of book depreciation	1,037,691	918,567
Drilling and development costs expensed for income tax reporting	836,219	632,985
Accumulated other comprehensive income	120,295	21,217
Regulatory temporary differences	43,005	44,335
Deferred purchased gas cost	1,015	5,113
Financial instruments	(1,303)	302
Incentive compensation	(1,324)	(15,971)
Investment tax credit	(1,467)	(1,856)
Uncollectible accounts	(3,953)	(4,092)
Post-retirement benefits	(8,140)	(6,630)
Deferred compensation plans	(10,814)	(15,698)
Alternative minimum tax credit carryforward	(65,509)	(26,017)
Net operating loss carryforwards	(337,921)	(305,787)
Other	(19,457)	(9,896)
Total (including amounts classified as current (assets) of ($26,867) and ($33,586), respectively)	$1,588,337	$1,236,572

The net deferred tax liability relating to the Company’s accumulated other comprehensive income balance as of December 31, 2011 was comprised of a $149.8 million deferred tax liability related to the Company’s net unrealized gain from hedging transactions, a $7.8 million deferred tax asset related to other post-retirement benefits, a $15.9 million deferred tax asset related to the Company’s pension plans and a $5.7 million deferred tax asset related to interest rate swaps.  The net deferred tax liability relating to the Company’s accumulated other comprehensive loss balance as of December 31, 2010 was comprised of a $39.6 million deferred tax liability related to the Company’s net unrealized gain from hedging transactions, a $2.6 million deferred tax liability related to the unrealized gain on available-for-sale securities, a $7.0 million deferred tax asset related to other post-retirement benefits and a $14.0 million deferred tax asset related to the Company’s pension plans.

The Company also has a total deferred tax asset of $278.8 million related to the federal net operating loss carryforward created in 2011, 2010 and 2008 of $54.9 million, $229.2 million and $2.2 million, respectively.  The deferred tax asset has been reduced for uncertain tax positions of approximately $7.5 million and $0.8 million as of December 31, 2011 and 2010, respectively.  The federal net operating loss carryforward period is 20 years and, if unused, the loss carryforward for 2008, 2010 and 2011 will expire in 2028, 2030 and 2031, respectively.

The Company is subject to the alternative minimum tax (AMT) if the computed AMT liability exceeds the regular tax liability for the year.  As a result of certain AMT preference items related to intangible drilling costs, the Company has generated AMT carryforwards totaling $65.5 million.  Since AMT taxes paid can be credited against regular tax and have an indefinite carryforward period, this item is reflected as a deferred tax asset on the Company’s balance sheet.

As of December 31, 2011, the Company has recorded a deferred tax asset of $59.1 million, which is net of valuation allowances of $0.8 million, related to tax benefits from state net operating loss carryforwards with various expiration dates ranging from 2012 to 2031.  As of December 31, 2010, the Company had recorded a deferred tax asset of $52.2 million, which is net of valuation allowances of $3.3 million, related to tax benefits from state net operating loss carryforwards with various expiration dates ranging from 2011 to 2030.  The deferred tax asset has been reduced for uncertain tax positions of approximately $8.8 million and $5.7 million as of December 31, 2011 and 2010, respectively.

During the years ended December 31, 2011 and 2010, share-based payment arrangements paid in stock generated a $6.6 million and $5.0 million excess tax benefit, respectively, which was not recorded in the financial statements as an addition to common stockholders’ equity due to the Company’s net operating loss position.  An income tax benefit of approximately $1 million for the year ended December 31, 2009 triggered by the exercise of nonqualified employee stock options and vesting of restricted share awards is reflected as an addition to common stockholders’ equity.