Taxes on Income

Registrant provides deferred income taxes for temporary differences under the accounting guidance for income taxes for certain transactions which are recognized for income tax purposes in a period different from that in which they are reported in the financial statements. The most significant items are the tax effects of differences in asset basis (including accelerated depreciation and capitalization methods), certain regulatory balancing accounts and advances for, and contributions in aid of construction. The accounting guidance for income taxes also requires that rate-regulated enterprises record deferred income taxes for temporary differences given flow-through treatment at the direction of a regulatory commission. The resulting deferred tax assets and liabilities are recorded at the expected cash flow to be reflected in future rates. Given that the CPUC has consistently permitted the recovery of flowed-through tax effects, GSWC has established regulatory liabilities and assets offsetting such deferred tax assets and liabilities (Note 2). Deferred investment tax credits (“ITC”) are amortized ratably to deferred tax expense over the lives of the property giving rise to the credits.

GSWC is included in AWR’s consolidated federal income tax and combined California state franchise tax returns. California unitary apportionment provides a benefit or detriment to AWR’s state taxes, depending on a combination of the profitability of AWR’s non-California activities as well as the proportion of its California sales to total sales. Consistent with the method adopted for regulatory purposes, GSWC’s tax expense is computed as if GSWC were autonomous and files separate returns. Given that all of GSWC’s activities are conducted within California, GSWC’s state tax expense does not reflect apportionment of its income.

As a regulated utility, GSWC treats certain temporary differences as flow-through adjustments in computing its income tax provision consistent with the income tax approach approved by the CPUC for ratemaking purposes. Flow-through adjustments increase or decrease tax expense in one period, with an offsetting decrease or increase occurring in another period. Giving effect to these temporary differences as flow-through adjustments typically results in a greater variance between the effective tax rate (“ETR”) and the statutory federal income tax rate in any given period than would otherwise exist if GSWC were not required to account for its income taxes as a regulated enterprise. The GSWC ETRs deviate from the statutory rate primarily due to state taxes and differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements (principally plant-, rate-case- and compensation-related items). The ETR at the AWR consolidated level also fluctuates as a result of ASUS's state income taxes, which vary among the jurisdictions in which it operates, and certain permanent differences.

Changes in Tax Law

During the fourth quarter of 2014, the Company reflected a change in its tax method of accounting for certain repair and maintenance expenditures pursuant to regulations issued by the U.S. Treasury Department in September 2013. The Company will file an application for an automatic change in tax accounting method with the Internal Revenue Service ("IRS") for the 2014 tax year to implement the new method effective January 1, 2014. The tax accounting method change will also include a cumulative adjustment for 2013 and prior years, and will permit the expensing of certain utility asset replacement costs that were previously being capitalized and depreciated for book and tax purposes. As a result of the change, the Company will deduct a significant amount of linear asset costs, which consist primarily of water mains and connections.

During the fourth quarter of 2014, the Company completed its analysis of the cumulative adjustment for 2013 and prior years, and recorded a deferred income tax liability of $22.5 million for federal and state repair-and-maintenance deductions of $47 million and $107 million, respectively. In addition, the 2014 deduction for both federal and state purposes was $20.3 million, creating an $8.3 million deferred income tax liability. Although this change reduced AWR’s current taxes payable, it did not reduce its total 2014 income tax expense or ETR. Furthermore, as a result of the repair-and-maintenance deductions, AWR and GSWC generated state net operating losses (“NOLs”) and, as of December 31, 2014, such NOL carry-forwards total $3.6 million and $9.3 million, respectively, which will expire in 2034. The Company believes that it is more likely than not that the benefit from the state income tax NOL carryforwards will be realized and therefore requires no valuation allowance.

In December 2014, the Tax Increase Prevention Act of 2014 extended 50% bonus depreciation for qualifying property through 2014. Although this change in law reduced AWR’s current taxes payable, it did not reduce its total income tax expense or ETR.

The significant components of the deferred tax assets and liabilities as reflected in the balance sheets at December 31, 2014 and 2013 are:



	AWR						GSWC
	December 31,						December 31,
(dollars in thousands)	2014			2013			2014			2013
Deferred tax assets:
Regulatory-liability-related: ITC	$	1,001		$	1,049		$	1,001		$	1,049
Regulatory-liability-related: California Corp Franchise Tax	4,328			4,337			4,328			4,337
Other non-property-related	2,395			4,125			2,136			3,292
Contributions and advances	8,335			8,655			8,335			8,655
	$	16,059		$	18,166		$	15,800		$	17,333
Deferred tax liabilities:
Fixed assets	$	(163,232	)	$	(131,534	)	$	(164,724	)	$	(131,548	)
Regulatory-asset-related: depreciation and other	(22,941		)	(21,575		)	(22,941		)	(21,575		)
California Corp Franchise Tax	(4,069		)	(2,120		)	(4,831		)	(1,749		)
Other property-related	(59		)	(155		)	(59		)	(155		)
Balancing and memorandum accounts	(4,071		)	(6,663		)	(4,071		)	(6,663		)
Deferred charges	(5,461		)	(6,064		)	(5,461		)	(6,064		)
	(199,833		)	(168,111		)	(202,087		)	(167,754		)
Accumulated deferred income taxes - net	$	(183,774	)	$	(149,945	)	$	(186,287	)	$	(150,421	)

The current and deferred components of income tax expense are as follows:



	AWR
	Year Ended December 31,
(dollars in thousands)	2014		2013		2012
Current
Federal	$	5,595	$	13,741	$	15,585
State	137		5,930		5,273
Total current tax expense	$	5,732	$	19,671	$	20,858
Deferred
Federal	$	24,815	$	14,769	$	13,088
State	7,501		1,343		1,999
Total deferred tax expense	32,316		16,112		15,087
Total income tax expense	$	38,048	$	35,783	$	35,945



	GSWC
	Year Ended December 31,
(dollars in thousands)	2014			2013		2012
Current
Federal	$	408		$	10,768	$	7,957
State	(2,754		)	6,315		3,830
Total current tax expense	$	(2,346	)	$	17,083	$	11,787
Deferred
Federal	$	24,373		$	14,691	$	12,670
State	9,979			1,360		2,043
Total deferred tax expense	34,352			16,051		14,713
Total income tax expense	$	32,006		$	33,134	$	26,500

The reconciliations of the effective tax rates to the federal statutory rate are as follows:



	AWR
	Year Ended December 31,
(dollars in thousands, except percent)	2014			2013			2012
Federal taxes on pretax income at statutory rate	$	34,687		$	34,464		$	31,533
Increase (decrease) in taxes resulting from:
State income tax, net of federal benefit	4,781			5,111			4,957
Flow-through on fixed assets	651			646			636
Flow-through on pension costs	(507		)	612			10
Flow-through on removal costs	(1,571		)	(2,141		)	(943		)
Domestic production activities deduction	(643		)	(2,944		)	(553		)
Investment tax credit	(91		)	(91		)	(91		)
Other – net	741			126			396
Total income tax expense from operations	$	38,048		$	35,783		$	35,945
Pretax income from operations	$	99,106		$	98,469		$	90,093
Effective income tax rate	38.4		%	36.3		%	39.9		%



	GSWC
	Year Ended December 31,
(dollars in thousands, except percent)	2014			2013			2012
Federal taxes on pretax income at statutory rate	$	27,952		$	28,622		$	23,002
Increase (decrease) in taxes resulting from:
State income tax, net of federal benefit	4,693			5,372			4,048
Flow-through on fixed assets	651			646			636
Flow-through on pension costs	(507		)	612			10
Flow-through on removal costs	(1,571		)	(2,141		)	(943		)
Domestic production activities deduction	(55		)	(1,316		)	(553		)
Investment tax credit	(91		)	(91		)	(91		)
Other – net	934			1,430			391
Total income tax expense from operations	$	32,006		$	33,134		$	26,500
Pretax income from operations	$	79,863		$	81,776		$	65,720
Effective income tax rate	40.1		%	40.5		%	40.3		%

AWR and GSWC had no unrecognized tax benefits at December 31, 2014, 2013 and 2012.

Registrant’s policy is to classify interest on income tax over/underpayments in interest income/expense and penalties in “other operating expenses.”

At December 31, 2014, AWR and GSWC included $504,000 and $472,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. AWR and GSWC recognized $19,000 and $14,000, respectively, of interest income from taxing authorities during the year ended December 31, 2014. At December 31, 2013, AWR and GSWC included $757,000 and $704,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. AWR and GSWC recognized $99,000 and $21,000 respectively, of interest income from taxing authorities during the year ended December 31, 2013. At December 31, 2012, AWR and GSWC included $2,838,000 and $2,775,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. AWR and GSWC recognized $473,000 and $461,000, respectively, of interest income from taxing authorities during the year ended December 31, 2012.

At December 31, 2014, 2013 and 2012, Registrant had no significant accruals for income-tax-related penalties and did not recognize any significant income-tax-related penalties during the years ended December 31, 2014, 2013 and 2012.

Registrant files federal and various state income tax returns. During 2014, the Internal Revenue Service (“IRS”) completed its examination of 2007 and 2008 refund claims and issued refunds for both. AWR’s federal 2010 refund claim came under exam in 2014, and its 2011-2013 tax years remain subject to examination by the IRS. AWR has filed protective refund claims with the applicable state taxing authority for the 2002 through 2008 tax years in connection with the matters on the federal claims for these years and other state tax matters. During 2012, the California Franchise Tax Board commenced examining these claims. The 2009-2013 tax years remain subject to examination by state taxing authorities.