6. Income Taxes

Medicare Part D Subsidy Reimbursements - In March 2010, the Patient Protection and Affordable Care Act was signed into law. The law includes provisions to generate tax revenue to help offset the cost of the new legislation. One of these provisions reduces the deductibility of retiree health care costs to the extent of federal subsidies received by plan sponsors that provide retiree prescription drug benefits equivalent to Medicare Part D coverage, beginning in 2013. Based on this provision, SPS became subject to additional taxes and was required to reverse previously recorded tax benefits in the period of enactment. SPS expensed approximately $1.9 million of previously recognized tax benefits relating to Medicare Part D subsidies during the first quarter of 2011. SPS does not expect the $1.9 million of additional tax expense to recur in future periods.

Federal Audit - SPS is a member of the Xcel Energy affiliated group that files a consolidated federal income tax return. The statute of limitations applicable to Xcel Energy's 2007 federal income tax return expired in September 2011. The statute of limitations applicable to Xcel Energy's 2008 federal income tax return expires in September 2012. The IRS commenced an examination of tax years 2008 and 2009 in the third quarter of 2010. In December 2011, Xcel Energy finalized the Revenue Agent Report and signed the Waiver of Assessment for tax years 2008 and 2009. The total assessment for these tax years was $1.4 million, including tax and interest.

State Audits - SPS is a member of the Xcel Energy affiliated group that files consolidated state income tax returns. As of Dec. 31, 2011, SPS' earliest open tax year that is subject to examination by state taxing authorities under applicable statutes of limitations is 2007. As of Dec. 31, 2011, there were no state income tax audits in progress.

Unrecognized Tax Benefits -The unrecognized tax benefit balance includes permanent tax positions, which if recognized would affect the annual ETR. In addition, the unrecognized tax benefit balance includes temporary tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. A change in the period of deductibility would not affect the ETR but would accelerate the payment of cash to the taxing authority to an earlier period.

A reconciliation of the amount of unrecognized tax benefit is as follows:

(Millions of Dollars)	Dec. 31, 2011		Dec. 31, 2010
Unrecognized tax benefit - Permanent tax positions	$	0.2	$	0.2
Unrecognized tax benefit - Temporary tax positions		4.6		4.1
Unrecognized tax benefit balance	$	4.8	$	4.3

A reconciliation of the beginning and ending amount of unrecognized tax benefit is as follows:

(Millions of Dollars)	2011			2010			2009
Balance at Jan. 1	$	4.3		$	2.9		$	3.5
Additions based on tax positions related to the current year		1.5			1.3			1.4
Reductions based on tax positions related to the current year		(0.2	)		-			-
Additions for tax positions of prior years		2.5			0.2			0.8
Reductions for tax positions of prior years		(0.3	)		(0.1	)		(0.1	)
Settlements with taxing authorities		(3.0	)		-			(2.7	)
Balance at Dec. 31	$	4.8		$	4.3		$	2.9

The unrecognized tax benefit amounts were reduced by the tax benefits associated with NOL and tax credit carryforwards. The amounts of tax benefits associated with NOL and tax credit carryfowards are as follows:

(Millions of Dollars)		Dec. 31, 2011				Dec. 31, 2010
NOL and tax credit carryforwards		$	(2.0	)		$	(0.1	)

The increase in the unrecognized tax benefit balance of $0.5 million in 2011 was due to the addition of uncertain tax positions related to current and prior years' activity, partially offset by a decrease due to the resolution of certain federal audit matters. SPS' amount of unrecognized tax benefits could change in the next 12 months as the IRS and state audits resume. At this time, due to the uncertain nature of the audit process, it is not reasonably possible to estimate an overall range of possible change. However, SPS does not anticipate total unrecognized tax benefits will significantly change within the next 12 months.

The payable for interest related to unrecognized tax benefits is partially offset by the interest benefit associated with NOL and tax credit carryforwards. A reconciliation of the beginning and ending amount of the payable for interest related to unrecognized tax benefits is as follows:

(Millions of Dollars)	2011			2010			2009
Payable for interest related to unrecognized tax benefits at Jan. 1	$	(0.2	)	$	(0.1	)	$	(0.3	)
Interest income (expense) related to unrecognized tax benefits		0.1			(0.1	)		0.2
Payable for interest related to unrecognized tax benefits at Dec. 31	$	(0.1	)	$	(0.2	)	$	(0.1	)

No amounts were accrued for penalties related to unrecognized tax benefits as of Dec. 31, 2011, 2010 or 2009.

Other Income Tax Matters - NOL amounts represent the amount of the tax loss that is carried forward and tax credits represent the deferred tax asset. NOL and tax credit carryforwards as of Dec. 31 were as follows:

(Millions of Dollars)	2011		2010
Federal NOL carryforward	$	175.1	$	5.9
Federal tax credit carryforwards		1.3		1.1
State NOL carryforwards		37.3		17.9
Valuation allowance for state NOL carryforwards		-		(1.3	)

The federal carryforward periods expire between 2021 and 2031. The state carryforward periods expire between 2012 and 2030.

Total income tax expense from operations differs from the amount computed by applying the statutory federal income tax rate to income before income tax expense. The following reconciles such differences for the years ending Dec. 31:

	2011			2010			2009
Federal statutory rate		35.0	%		35.0	%		35.0	%
Increases (decreases) in tax from:
State income taxes, net of federal income tax benefit		2.7			1.8			2.7
Resolution of income tax audits and other		0.3			0.1			0.2
Tax credit recognized, net of federal income tax expense		(0.3	)		(0.4	)		(0.4	)
Regulatory differences - utility plant items		(0.1	)		0.2			0.2
Change in unrecognized tax benefits		-			-			(0.2)
Previously recognized Medicare Part D subsidies		-			1.5			-
Other, net		0.4			0.3			(0.1	)
Effective income tax rate		38.0	%		38.5	%		37.4	%

The components of income tax expense for the years ending Dec. 31 were:

(Thousands of Dollars)	2011			2010			2009
Current federal tax (benefit) expense	$	(1,993	)	$	19,850		$	6,922
Current state tax expense		3,287			2,669			4,145
Current change in unrecognized tax (benefit) expense		(1,394	)		1,376			(647	)
Deferred federal tax expense		51,111			26,050			29,234
Deferred state tax expense		3,240			747			870
Deferred change in unrecognized tax expense (benefit)		1,365			(1,340	)		438
Deferred tax credits		(208	)		(145	)		(169	)
Deferred investment tax credits		(275	)		(341	)		(298	)
Total income tax expense	$	55,133		$	48,866		$	40,495

The components of deferred income tax expense for the years ending Dec. 31 were:

(Thousands of Dollars)	2011			2010			2009
Deferred tax expense excluding items below	$	56,181		$	25,318		$	31,740
Amortization and adjustments to deferred income taxes on income tax regulatory assets and liabilities		(575	)		90			726
Tax expense allocated to other comprehensive income		(98	)		(96	)		(2,093	)
Deferred tax expense	$	55,508		$	25,312		$	30,373

The components of the net deferred tax liability (current and noncurrent portions) at Dec. 31 were:

(Thousands of Dollars)	2011		2010
Deferred tax liabilities:
Difference between book and tax bases of property	$	597,122	$	483,998
Employee benefits		56,069		53,505
Other		21,359		20,614
Total deferred tax liabilities	$	674,550	$	558,117

Deferred tax assets:
NOL carryforward	$	65,278	$	4,482
Unbilled revenue - fuel costs		13,138		11,051
Regulatory liabilities		7,501		9,506
Rate refund		2,708		2,248
Deferred fuel costs		2,473		3,668
Bad debts		1,936		1,835
Other		3,182		3,174
Total deferred tax assets	$	96,216	$	35,964
Net deferred tax liability	$	578,334	$	522,153