Income Taxes

12 Months Ended

Dec. 31, 2019

Note 7 – Income Taxes

Income tax (benefit) expense for the years ended December 31, is comprised of the following:



	Years Ended December 31,
		2019		2018		2017
Current:
Federal	$	(4,415)	$	-	$	1,297
State		1,834		1,281		1,837
		(2,581)		1,281		3,134
Deferred:
Federal		(3,906)		(8,721)		21,376
State		(6,530)		(6,229)		(7,596)
		(10,436)		(14,950)		13,780
Total tax expense (benefit)	$	(13,017)	$	(13,669)	$	16,914

The statutory Federal tax rate is 21% for 2019 and 2018, and 35% for 2017. For states with a corporate net income tax, the state corporate net income tax rates range from 2.5% to 9.99% for all years presented. The Company’s effective income tax rate for 2019, 2018, and 2017 was (6.2)%, (7.7)%, and 6.6%, respectively. The Company remains subject to examination by federal and state tax authorities for the 2016 through 2019 tax years.

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:



	Years Ended December 31,
		2019		2018		2017
Computed Federal tax expense at statutory rate	$	44,420	$	37,447	$	89,828
Decrease in Federal tax expense related to an income tax accounting change for qualifying utility asset improvement costs		(48,518)		(44,089)		(69,325)
State income taxes, net of Federal tax benefit		(3,616)		(4,964)		(3,743)
Increase in tax expense for depreciation expense to be recovered in future rates		347		328		199
Stock-based compensation		(167)		(414)		(595)
Deduction for Essential Utilities common dividends paid under employee benefit plan		(315)		(312)		(455)
Amortization of deferred investment tax credits		(361)		(373)		(376)
Impact of Federal rate change and amortization of excess deferred income tax		(6,323)		(313)		3,141
Other, net		1,516		(979)		(1,760)
Actual income tax expense (benefit)	$	(13,017)	$	(13,669)	$	16,914

In response to a June 2012 rate order issued by the Pennsylvania Public Utility Commission to Aqua Pennsylvania, the Company changed its tax method of accounting for qualifying utility system repairs, which provides for the expensing of qualifying utility asset improvement costs that were previously being capitalized and depreciated for book and tax purposes. The rate order allows 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 $66,816, $64,183, and $84,766 during 2019, 2018, and 2017, respectively. In May 2019 the Pennsylvania Public Utility Commission issued a rate order to Aqua Pennsylvania and commencing in 2020 the base rates are designed to include annual tax benefits for qualifying utility system improvement costs equal to $158,865, subject to $3,000 either above or below this target amount. To the extent actual tax benefits are outside this range, tax benefits will either be deferred or accrued, and settled in the next rate filing.

Aqua Pennsylvania had changed to this method of tax accounting in 2012, and for prior tax years, the qualifying utility system asset improvement costs were previously capitalized and depreciated for book and tax purposes. The Company recognized a tax deduction on its 2012 Federal tax return of $380,000 and based on a 2012 rate order, Aqua Pennsylvania began to amortize this benefit over ten years beginning in 2013. The amortization of this benefit, which annually amounted to $38,000, effectively reduced current income tax expense annually by $16,724. As a result of the May 2019 Aqua Pennsylvania rate order the amortization period was slightly shortened and now includes the tax benefits in establishing utility rates.

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


	2019		2018
Balance at January 1,	$	17,792	$	17,583
Additions based on tax position related to the current year		879		209
Balance at December 31,	$	18,671	$	17,792

In accordance with the FASB’s accounting guidance for income taxes 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 may be assessed interest and penalties by taxing authorities, which would be recorded as income tax expense. There were no expenses for interest and penalties assessed by taxing authorities for the years ended December 31, 2019, 2018, and 2017.

On its 2012 Federal tax return, filed in September 2013, Aqua Pennsylvania filed a change in accounting method to adopt the IRS temporary tangible property regulations. 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. 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. 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 the FASB’s accounting guidance for income taxes. Should the taxing authority challenge the Company’s tax treatment, and ultimately disallow a portion of the repair deduction, the Company expects Federal net operating loss carryforwards to offset any resulting liability, and state net operating loss carryforwards will offset a portion of any resulting liability.

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, 2019 and 2018, $31,015 and $26,990, 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:



	December 31,
	2019		2018
Deferred tax assets:
Customers' advances for construction	$	22,664	$	13,188
Costs expensed for book not deducted for tax, principally accrued expenses		1,473		27,711
Utility plant acquisition adjustment basis differences		-		1,053
Post-retirement benefits		20,575		39,515
Tax loss and credit carryforwards		65,438		43,637
Operating lease liabilities		3,540		-
Other		2,798		2,761
		116,488		127,865
Less valuation allowance		22,873		18,082
		93,615		109,783

Deferred tax liabilities:
Utility plant, principally due to depreciation and differences in the basis of fixed assets due to variation in tax and book accounting		909,219		837,057
Deferred taxes associated with the gross-up of revenues necessary to recover, in rates, the effect of temporary differences		101,126		72,258
Tax effect of regulatory asset for post-retirement benefits		8,973		39,515
Utility plant acquisition adjustment basis differences		827
Deferred investment tax credit		6,088		6,356
Operating lease right-of-use assets		3,540		-
		1,029,773		955,186

Net deferred tax liability	$	936,158	$	845,403

At December 31, 2019, the Company has a cumulative Federal NOL of $79,039. 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.

At December 31, 2019, the Company has a cumulative state NOL of $817,323, 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’s Federal and state NOL carryforwards are reduced by an unrecognized tax position, on a gross basis, of $73,352 and $85,645, 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 $152,391 and $902,968, respectively. The Company records its unrecognized tax benefit as a component of its net deferred income tax liability.

On December 22, 2017, President Trump signed the TCJA into law. 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 and before January 1, 2023.

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 was recorded as either an offset to a regulatory asset or liability. In instances where the deferred tax balances are not in ratemaking, such as the Company’s market-based operations, the change in deferred taxes was 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 one year measurement period concluded in the fourth quarter of 2018, and there were no material changes in the Company’s accounting for the TCJA.

At the end of the measurement period, the Pennsylvania Public Utility Commission, had not 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 provisionally classified $175,108 of deferred income tax liabilities for our Pennsylvania subsidiary as a regulatory liability. In May 2019 a final order was issued from the PA PUC affirming the Company’s regulatory liability and authorizing the Company to implement an average rate assumption method to reduce the regulatory liability as the temporary difference reverses. Beginning in June 2019 base rates reflect the fact that the benefit from the excess accumulated deferred taxes is now reflected in base rates. 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. The Company has reserved $3,907 for amounts expected to be refundable to utility customers. In 2018, Illinois, Virginia, Texas, New Jersey, and two operating divisions in Ohio which operate under locally-negotiated contractual rates with their respective counties, adjusted base rates or surcredits have been added to customer bills to reflect the lower corporate income tax rate. In North Carolina, Indiana, and our regulated operations in Ohio, no surcredits have been added to customer bills to reflect the lower corporate income tax rate in 2018. These adjustments were reflected in customer bills beginning January 1, 2019. In Pennsylvania, a procedural order was received in May 2019, which adjusted the Company’s base rate to reflect the lower corporate income tax rate.