TAXES

FirstEnergy records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts recognized for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to temporary tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. Deferred tax assets are recognized based on income tax rates expected to be in effect when they are settled.



PROVISION FOR INCOME TAXES	FirstEnergy			FES
	(In millions)
2013
Currently payable (receivable)-
Federal	$	(118	)	$	(300	)
State	70			(3		)
	(48		)	(303		)
Deferred, net-
Federal	305			317
State	(54		)	(4		)
	251			313
Investment tax credit amortization	(8		)	(4		)
Total provision for income taxes	$	195		$	6

2012
Currently payable (receivable)-
Federal	$	(130	)	$	(128	)
State	28			17
	(102		)	(111		)
Deferred, net-
Federal	580			209
State	78			9
	658			218
Investment tax credit amortization	(11		)	(4		)
Total provision for income taxes	$	545		$	103

2011
Currently payable (receivable)-
Federal	$	(251	)	$	(224	)
State	19			9
	(232		)	(215		)
Deferred, net-
Federal	785			205
State	24			(2		)
	809			203
Investment tax credit amortization	(11		)	(4		)
Total provision for income taxes	$	566		$	(16	)

As discussed in Note 11, on July 8, 2013, officers of FirstEnergy and AE Supply committed to deactivating two coal-fired generating plants. As a result of the decision, FirstEnergy determined that it is more likely than not that certain state and local NOL carryforwards will not be realized through future operations or through the reversal of existing temporary differences. As a result, FirstEnergy recorded a valuation reserve of approximately $20 million against carryforwards in 2013.

On July 9, 2013, Pennsylvania House Bill 465 (HB 465) was enacted, adopting new market-based sourcing rules for certain items of income as well as increasing the Pennsylvania NOL deduction credit for tax years beginning after December 31, 2013 and 2014 to the greater of 25% or $4 million of taxable income and 30% or $5 million of taxable income, respectively. Based on income projections, Pennsylvania NOL valuation reserves were reduced by approximately $8 million in 2013.

During 2013, FirstEnergy made changes to state apportionment factors in certain jurisdictions based on sales sourcing rules for electricity, which reduced deferred tax liabilities by approximately $9 million. Furthermore, based on an assessment of business operations, FirstEnergy determined that income from certain subsidiaries should not be apportioned to certain tax jurisdictions due to the absence of business nexus. This assessment resulted in a reduction to deferred tax liabilities of approximately $22 million.

In 2012, a $50 million valuation allowance was established for two unregulated subsidiaries of FirstEnergy based on current judgment as to the realization of certain state deferred tax assets, as impacted by changes in the business and the applicability of certain state law limitations on the long-term utilization of NOL carryforwards. The results of operations in 2012 for those companies decreased accumulated deferred income tax liabilities by approximately $50 million.

In December 2012, two subsidiaries of FES, FG and NG, completed a conversion from corporations to limited liability companies (LLCs). For income tax purposes, these LLCs are treated as divisions (i.e., disregarded entities) of their parent company, FES. The LLC conversions, in combination with anticipated future taxable income, will contribute to the realization of certain state deferred tax assets. In 2011, an unregulated subsidiary of FirstEnergy converted to an LLC which, based on anticipated future taxable income, resulted in the partial reversal of a valuation allowance, reducing income tax expense in 2011 by $27 million.

During 2012, certain FirstEnergy operating companies adopted a new federal tax accounting method (effective for the 2011 consolidated federal tax return) for the deductibility of expenses for repairs to transmission and distribution assets, pursuant to IRS safe harbor guidance. In accordance with the IRS guidance, a cumulative adjustment was made on the 2011 consolidated federal tax return, increasing tax deductions and decreasing taxable income by approximately $417 million. The increased federal tax deductions created a corresponding state tax benefit that reduced FirstEnergy's effective tax rate by approximately $12 million in 2012. The IRS has agreed that the new method of accounting is compliant with the IRS guidance.

FES and the Utilities are party to an intercompany income tax allocation agreement with FirstEnergy and its other subsidiaries that provides for the allocation of consolidated tax liabilities. Net tax benefits attributable to FirstEnergy, excluding any tax benefits derived from interest expense associated with acquisition indebtedness from the merger with GPU, are reallocated to the subsidiaries of FirstEnergy that have taxable income. That allocation is accounted for as a capital contribution to the company receiving the tax benefit.

The following tables provide a reconciliation of federal income tax expense at the federal statutory rate to the total provision for income taxes for the three years ended December 31, 2013:



	FirstEnergy			FES
	(In millions)
2013
Book income before provision for income taxes	$	570		$	52
Federal income tax expense at statutory rate	$	199		$	18
Increases (reductions) in taxes resulting from-
Amortization of investment tax credits	(8		)	(4		)
State income taxes, net of federal tax benefit	10			(5		)
FirstEnergy effectively settled tax items	(2		)	—
ESOP Dividend	(9		)	(2		)
Nondeductible compensation	3			—
Other permanent items	1			—
AFUDC equity and other flow-through	(7		)	—
Other, net	8			(1		)
Total provision for income taxes	$	195		$	6

2012
Book income before provision for income taxes	$	1,299		$	276
Federal income tax expense at statutory rate	$	455		$	97
Increases (reductions) in taxes resulting from-
Amortization of investment tax credits	(11		)	(4		)
State income taxes, net of federal tax benefit	69			17
Medicare Part D	32			1
Effectively settled tax items	(20		)	(11		)
State valuation allowance	60			—
State apportionment remeasurement	(50		)	—
Other, net	10			3
Total provision for income taxes	$	545		$	103

2011
Book income before provision for income taxes	$	1,438		$	(83	)
Federal income tax expense (benefit) at statutory rate	$	503		$	(29	)
Increases (reductions) in taxes resulting from-
Amortization of investment tax credits	(11		)	(4		)
State income taxes, net of federal tax benefit	28			5
State unitary tax adjustments	33			—
Manufacturing deduction	16			13
Medicare Part D	36			4
Effectively settled tax items	(11		)	(2		)
State valuation allowance	(19		)	2
Other, net	(9		)	(5		)
Total provision for income taxes (benefits)	$	566		$	(16	)

Accumulated deferred income taxes as of December 31, 2013 and 2012 are as follows:



	FirstEnergy			FES
	(In millions)
December 31, 2013
Property basis differences	$	8,078		$	1,428
Regulatory transition charge	(26		)	—
Customer receivables for future income taxes	(2		)	—
Deferred MISO/PJM transmission costs	27			—
Other regulatory assets — RCP	69			—
Deferred sale and leaseback gain	(411		)	(370		)
Non-utility generation costs	(1		)	—
Unamortized investment tax credits	(62		)	(16		)
Unrealized losses on derivative hedges	(20		)	(1		)
Pensions and OPEB	(938		)	(77		)
Lease market valuation liability	(59		)	55
Oyster Creek securitization (Note 12)	57			—
Nuclear decommissioning activities	44			31
Mark-to-market adjustments	31			30
Deferred gain for asset sales — affiliated companies	781			—
Loss carryforwards and AMT credits	(1,599		)	(369		)
Loss carryforward valuation reserve	142			18
Storm damage	179			—
Market transition charge	81			—
All other	231			(13		)
Net deferred income tax liability	$	6,602		$	716

December 31, 2012
Property basis differences	$	7,868		$	1,060
Regulatory transition charge	79			—
Customer receivables for future income taxes	130			—
Deferred MISO/PJM transmission costs	125			—
Other regulatory assets — RCP	161			—
Deferred sale and leaseback gain	(431		)	(384		)
Non-utility generation costs	5			—
Unamortized investment tax credits	(67		)	(17		)
Unrealized losses on derivative hedges	(21		)	2
Pensions and OPEB	(1,102		)	(105		)
Lease market valuation liability	(81		)	33
Oyster Creek securitization (Note 12)	75			—
Nuclear decommissioning activities	127			111
Mark-to-market adjustments	30			30
Loss carryforwards and ATM credits	(1,199		)	(221		)
Loss carryforward valuation reserve	102			16
Storm damage	192			—
Market transition charge	65			—
All other	239			(22		)
Net deferred income tax liability	$	6,297		$	503

FirstEnergy accounts for uncertainty in income taxes recognized in its financial statements. Accounting guidance prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of tax positions taken or expected to be taken on a company's tax return. As of December 31, 2013 and 2012, FirstEnergy's total unrecognized income tax benefits were approximately $48 million and $43 million, respectively. All $48 million of unrecognized income tax benefits as of December 31, 2013, would impact the effective tax rate if ultimately recognized in future years. As of December 31, 2013, it is reasonably possible that approximately $35 million of unrecognized tax benefits may be resolved during 2014 as a result of the statute of limitations expiring, all of which would affect FirstEnergy's effective tax rate.

During 2013, the AE companies reduced reserves for unrecognized tax benefits related to various tax positions, with a total reduction to the effective tax rate of approximately $5 million.

During 2013, FirstEnergy settled a claim with the IRS for approximately $1.0 billion of additional accelerated (bonus) depreciation deductions for certain generation property for the 2010 taxable year, which resulted in a carryback refund of approximately $110 million, an increase in the NOL carryfoward of approximately $65 million, with a corresponding increase to accumulated deferred income taxes for this temporary tax item and an overall decrease to FirstEnergy's effective tax rate of approximately $2 million for adjustments to interest resulting from the settlement.

During 2012, FirstEnergy reached a settlement with state authorities related to state apportionment factors in Pennsylvania on an intercompany asset sale, which reduced FirstEnergy's effective tax rate by $3 million. During 2012, based on further IRS guidance related to the tax accounting for costs to repair and maintain fixed assets, the AE companies reduced their amount of unrecognized tax benefits by $21 million, with a corresponding adjustment to accumulated deferred income taxes for this temporary tax item, with no resulting impact to the effective tax rate.

During the fourth quarter of 2012, FirstEnergy reached a settlement with the IRS on deductions for prior year costs to repair generation assets, permitting the reduction of unrecognized tax benefits by approximately $34 million, with a corresponding adjustment to accumulated deferred income taxes for this temporary tax item, and an overall decrease to FirstEnergy's effective tax rate of approximately $10 million for adjustments to potential interest expense resulting from the settlement. Also during the fourth quarter of 2012, the AE companies reduced reserves for unrecognized tax benefits related to various tax positions, including the IRS's agreement on AE's deduction of merger-related expenses, with a total reduction to the effective tax rate of approximately $7 million.

The following table summarizes the changes in unrecognized tax positions for the years ended 2013, 2012 and 2011:



	FirstEnergy			FES
	(In millions)
Balance, January 1, 2011	$	45		$	41
Increase due to merger with AE	97			—
Prior years increases	10			8
Prior years decreases	(35		)	(4		)
Balance, December 31, 2011	$	117		$	45
Current year increases	2			—
Current year decreases	(7		)	—
Prior years increases	6			6
Prior years decreases	(37		)	(13		)
Decrease for settlements	(38		)	(35		)
Balance, December 31, 2012	$	43		$	3
Prior years increases	10			—
Prior years decreases	(5		)	—
Balance, December 31, 2013	$	48		$	3

FirstEnergy recognizes interest expense or income related to uncertain tax positions. That amount is computed by applying the applicable statutory interest rate to the difference between the tax position recognized and the amount previously taken or expected to be taken on the federal income tax return. FirstEnergy includes net interest and penalties in the provision for income taxes. FirstEnergy's reversal of accrued interest associated with unrecognized tax benefits was immaterial to FirstEnergy's effective tax rate in 2013 and reduced the 2012 effective tax rate by approximately $4 million. The interest associated with the 2011 settlement of a claim favorably affected FirstEnergy's effective tax rate by $7 million in 2011.

The following table summarizes the net interest expense (income) for the three years ended December 31, 2013 and the cumulative net interest payable as of December 31, 2013 and 2012:



	Net Interest Expense (Income) For the Years Ended December 31,								Net Interest Payable As of December 31,
	2013		2012			2011			2013		2012
	(In millions)								(In millions)
FirstEnergy	$	1	$	(4	)	$	(5	)	$	9	$	8
FES	—		(4		)	1			1		1

FirstEnergy has tax returns that are under review at the audit or appeals level by the IRS (2011-2013) and state tax authorities. FirstEnergy's tax returns for all state jurisdictions are open from 2009-2012. The IRS completed its audit of the 2011 tax year in December 2013 and is in the process of preparing the final audit report. Tax years 2012-2013 are under review by the IRS. In August 2013 the IRS completed its audit of AE for tax years 2009 and 2010 and the final federal tax return for the period January-February 2011. For the remainder of the 2011 taxable year and future years, the AE companies are part of the FirstEnergy federal consolidated group. State tax returns for tax years 2010 through 2012 remain subject to review in Pennsylvania, West Virginia, Maryland and Virginia for certain subsidiaries of AE.

FirstEnergy has recorded as deferred income tax assets the effect of NOLs and tax credits that will more likely than not be realized through future operations and through the reversal of existing temporary differences. As of December 31, 2013, the deferred income tax assets, before any valuation allowances, consisted of $1.1 billion of federal NOL carryforwards that expire from 2025 to 2033, federal AMT credits of $25 million that have an indefinite carryforward period, and $418 million of state and local NOL carryforwards that begin to expire in 2014.

The table below summarizes pre-tax NOL carryforwards for state and local income tax purposes of approximately $9.8 billion for FirstEnergy, of which approximately $6.3 billion is expected to be utilized based on current estimates and assumptions. The ultimate utilization of these NOLs may be impacted by statutory limitations on the use of NOLs imposed by state and local tax jurisdictions, changes in statutory tax rates, and changes in business which, among other things, impact both future profitability and the manner in which future taxable income is apportioned to various state and local tax jurisdictions.



Expiration Period	FirstEnergy				FES
	(In millions)
	State		Local		State		Local
2014-2018	$	14	$	2,289	$	8	$	1,243
2019-2023	2,513		—		23		—
2024-2028	2,051		—		60		—
2029-2033	2,891		—		752		—
	$	7,469	$	2,289	$	843	$	1,243

General Taxes



	FirstEnergy		FES
	(In millions)
2013
KWH excise	$	219	$	—
State gross receipts	240		77
Real and personal property	368		40
Social security and unemployment	110		19
Other	41		2
Total general taxes	$	978	$	138
2012
KWH excise	$	230	$	—
State gross receipts	251		77
Real and personal property	328		35
Social security and unemployment	126		20
Other	49		4
Total general taxes	$	984	$	136
2011
KWH excise	$	244	$	—
State gross receipts	264		62
Real and personal property	298		42
Social security and unemployment	109		14
Other	62		6
Total general taxes	$	977	$	124