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NOTE 5

INCOME TAXES

Deferred income taxes reflect temporary differences between the valuation of assets and liabilities for financial and tax reporting. Pursuant to the enactment of the TCJA, the Company adjusted its existing deferred income tax balances as of December 31, 2017 to reflect the decrease in the corporate income tax rate from 34% to 21%, which resulted in an estimated decrease in the net deferred income tax liability of approximately $23.5 million. In 2018, this amount was revised to $24.3 million due to the final bonus deprecation deduction taken on the Company’s 2017 Federal income tax return. In addition, a rate change resulted in the Company recording a net benefit to continuing operations of approximately $1.0 million in 2017. As of December 31, 2017, a regulatory liability related to deferred income taxes to be passed through to Delaware water utility customers in the form of reduced tariff rates was recorded in the estimated amount of $22.5 million. In 2018, this amount was revised to $22.8 million (see Note 1). Certain Internal Revenue Service normalization rules require that the benefits to customers be spread over the remaining useful life of the underlying assets giving rise to the associated deferred income taxes. The DEPSC approved the amortization of the regulatory liability amount of $22.2 million over a period of 49.5 years beginning February 1, 2018, subject to audit at a later date. In addition, the Company recognized a one time tax benefit of $0.5 million related to the wastewater regulatory liability. The MDPSC has not issued a final order on the regulatory liability amount of $0.6 million regarding the effects of the TCJA on Maryland customers.

At December 31, 2017, for federal income tax purposes, there were alternative minimum tax, or AMT, credit carry-forwards aggregating $2.7 million resulting from the payment of AMT in prior years. Effective January 1, 2018, these AMT credit carry-forwards were available for refund. The Company reclassified all of its AMT credits into the current income tax receivable as of December 31, 2017 and fully applied them in 2018 against estimated current taxes payable.

As of December 31, 2019, the Company fully utilized all of its federal net operating loss carrybacks and carry-forwards. As of December 31, 2019, the Company has separate company state net operating loss carry-forwards aggregating approximately $10.9 million. Most of these net operating loss carry-forwards will expire if unused between 2020 and 2040. The Company has recorded a valuation allowance to reflect the estimated amount of deferred tax assets that may not be realized due to the expiration of the state net operating loss carry-forwards. The valuation allowance increased to approximately $335,000 in 2019 from approximately $396,000 in 2018. Management believes that it is more likely than not that the Company will realize the benefit of these deferred tax assets, net of the valuation allowance.

Components of Income Tax Expense
In thousands	For the Year Ended December 31,
State income taxes	2019				2018			2017
Current		$	2,405			$	1,768		$	489
Deferred			(610	)			71			1,368
Total state income tax expense		$	1,795			$	1,839		$	1,857

	For the Year Ended December 31,
Federal income taxes	2019			2018		2017
Current	$	6,015		$	2,404	$	(1,418	)
Deferred		(2,629	)		748		6,856
Total federal income tax expense	$	3,386		$	3,152	$	5,438

Reconciliation of effective tax rate:
	For the Year Ended December 31,
In thousands	2019				2019			2018				2018			2017				2017
	Amount				Percent			Amount				Percent			Amount				Percent
Reconciliation of effective tax rate
Income before federal and state income taxes		$	20,106			100.0	%		$	19,270			100.0	%		$	21,278			100.0	%

Amount computed at statutory rate			4,222			21.0	%			4,047			21.0	%			7,234			34.0	%
Reconciling items
State income tax-net of federal tax benefit			1,414			7.0	%			1,350			7.0	%			1,297			6.1	%
Regulatory liability adjustment			(451	)		(2.2	)%			(920	)		(4.8	)%			—			0.0	%
Federal rate change and TCJA effect			–			–				325			1.7	%			(957	)		(4.5	)%
Other			(4	)		0.0	%			189			1.0	%			(279	)		(1.3	)%
Total income tax expense and effective rate		$	5,181			25.8	%		$	4,991			25.9	%		$	7,295			34.3	%

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Deferred income taxes at December 31, 2019, 2018, and 2017 were comprised of the following:

	For the Year Ended December 31,
In thousands	2019			2018			2017

Deferred tax assets related to:
Federal and state operating loss carry-forwards		725			1,050			1,094
Less: valuation allowance		(335	)		(396	)		(360	)
Bad debt allowance		73			65			80
Stock options		185			202			207
Other		70			85			161
Total deferred tax assets	$	718		$	1,006		$	1,182

Deferred tax liabilities related to:
Property plant and equipment basis differences	$	(50,219	)	$	(53,296	)	$	(52,629	)
Bond retirement costs		(1,286	)		(1,361	)		(1,437	)
Uncertain tax position		(271	)		(283	)		(145	)
Expenses of rate proceedings		-			(2	)		(8	)
Property taxes		(544	)		(521	)		(500	)
Other		(657	)		(597	)		(600	)
Total deferred tax liabilities	$	(52,977	)	$	(56,060	)	$	(55,319	)


Net deferred tax liability	$	(52,259	)	$	(55,054	)	$	(54,137	)

Schedule of Valuation Allowance
	Balance at Beginning of Period			Additions Charged to Costs and Expenses			Deductions			Balance at End of Period
In thousands

Classification
For the Year Ended December 31, 2019 Valuation allowance for deferred tax assets		$	396		$	41		(102	)		$	335
For the Year Ended December 31, 2018 Valuation allowance for deferred tax assets		$	360		$	36		—			$	396
For the Year Ended December 31, 2017 Valuation allowance for deferred tax assets		$	286		$	74		—			$	360

Under FASB ASC Topic 740, the Company established two reserves for uncertain tax positions based upon management’s judgment as to the sustainability of these positions.

In 2014, the Company changed its tax method of accounting for qualifying utility system repairs effective with the tax year ended December 31, 2014 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. In December 2015, the Company was notified by the IRS that its Federal tax filing for 2014 would be reviewed with respect to the tax accounting method change, along with the effects of the net operating loss generated in 2014 and carryback to the 2012 and 2013 tax years. This review, which began in the first quarter of 2016 and was completed in the second quarter of 2016, resulted in no change to the tax liability. 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 specifically agreed to by the tax authorities. Therefore, as required by FASB ASC 740, the Company reserved an additional liability related to a portion of the repair deduction for 2018 and 2019.

Additionally, the Company reserved a liability related to the difference in the tax depreciation utilizing the half-year convention rather than the mid-quarter convention.

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The following table provides the changes in the Company's uncertain tax position:

	For the years ended December 31,
In thousands	2019			2018
Balance at beginning of year	$	283		$	145
Additions based on tax positions related to the current year		37			130
Additions based on tax positions related to prior years		24			13
Reductions for tax positions of prior years		—			—
Settlements		—			—
Federal tax rate change		—			(5	)
Lapses in statutes of limitations		(73	)		—
Balance at end of year	$	271		$	283