NOTE 17 - INCOME TAXES

The income tax expense (benefit) as of December 31 consisted of the following (dollars in thousands):

	2011			2010			2009
Federal:
Current	$	(5,057	)	$	(5,268	)	$	250
Deferred		7,985			15,645			9,003
Investment tax credits, net		(255	)		(255	)		(320	)
Valuation allowance		19			797			99
		2,692			10,919			9,032
State:
Current		(1,152	)		(392	)		790
Deferred		2,266			3,924			1,134
Valuation allowance		5			211			(283	)
		1,119			3,743			1,641
Total federal and state income taxes	$	3,811		$	14,662		$	10,673

Federal and state income taxes charged to:
Operating expenses	$	5,167		$	7,545		$	5,033
Other income		(1,356	)		7,117			5,640
	$	3,811		$	14,662		$	10,673

The reconciliation between income taxes computed by applying the U.S. federal statutory rate and the reported income tax expense (benefit) from continuing operations as of December 31 follows (dollars in thousands):

	2011			2010			2009
Income before income tax	$	9,515		$	35,616		$	31,423
Federal statutory rate		35.0	%		35.0	%		35.0	%
Federal statutory tax expense		3,330			12,466			10,998
Increase (benefit) in taxes resulting from:
Dividend received deduction		(441	)		(435	)		(584	)
State income taxes net of federal tax benefit		992			2,339			773
Investment credit amortization		(255	)		(255	)		(320	)
Renewable Electricity Credit		0			0			(233	)
AFUDC equity depreciation		114			112			109
Life insurance		(67	)		(221	)		(451	)
Medicare Part D		85			653			(402	)
Domestic production activities deduction		0			(113	)		0
Valuation allowance		19			797			99
VY Investment		0			(811	)		0
ASC 740 (FIN 48)		(263	)		168			205
Return to accrual true-up		279			48			103
Other		18			(86	)		376
Total income tax expense (benefit)	$	3,811		$	14,662		$	10,673

Effective combined federal and state income tax rate		40.1	%		41.2	%		34.0	%

Capitalized Repairs Project: The Capitalized Repairs Project initially included the review of 1999 through 2009 property, plant and equipment additions included in Utility Plant on the Consolidated Balance Sheets. The review was performed to identify capitalized additions, which now result in accelerated income tax deductions. During 2011, the Internal Revenue Service notified us that the Congressional Joint Committee on Taxation allowed our 2009 Capital Repairs deduction in full. Accordingly, during 2011, we received $10.4 million in federal refunds and reduced 2010 and 2011 federal and state tax expense with the remaining 2009 net operating loss carryforward. In 2011, as a result of our 2010 tax year Capitalized Repairs deduction, we recorded an additional $3.4 million to prepayments and deferred income tax liabilities on the Consolidated Balance Sheets. Also during 2011, we recorded $2.6 million to prepayments and deferred income tax liabilities on the Consolidated Balance Sheets, based upon our estimate of the 2011 tax year Capitalized Repairs deduction. As discussed in more detail below, we did not consider the establishment of an unrecorded tax benefit necessary for our 2010 and 2011 Capitalized Repairs deductions. During 2010, as a result of our 2009 tax year Capitalized Repairs deduction, excluding the impact of the related unrecorded tax benefit, we recorded $13.6 million to prepayments and $14.2 million to deferred income tax liabilities on the Consolidated Balance Sheets.

Casualty Loss Refund Claim Settlement: Our Casualty Loss refund claims for the tax years 2003 through 2006, which were previously denied during the IRS audit of these years, were reviewed and settled by IRS Appeals during 2010. Our settlement allowed 100 percent of the Casualty Loss refund claims for the tax years 2003 through 2005, which totaled $1.9 million plus $0.4 million interest, and allowed none of the 2006 tax year refund claim. In 2010, the remaining Casualty Loss refund unrecognized tax benefit of $1 million was removed from the balance of unrecognized tax benefits.

Uncertain Tax Positions: We follow FASB's guidance and methodology for estimating and reporting amounts associated with uncertain tax positions.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits follows (dollars in thousands):

	2011			2010			2009
Balance at January 1	$	3,688		$	987		$	1,662
Reductions from lapse of the statute of limitations								(556	)
Reductions due to the passage of time/other					(56	)		(119	)
Settlements		(3,497	)		(931	)
Gross amount of increase as a result of prior year tax positions		81
Gross amount of increase as a result of current year tax positions					3,688
Balance at December 31	$	272		$	3,688		$	987

Included in the balance of unrecognized tax benefits at December 31, 2011, are $0.2 million of tax benefits that, if recognized, would affect the effective tax rate. The $3.5 million decrease in unrecognized tax benefits during 2011 is due to the IRS settlement of our 2009 tax year Capitalized Repairs deduction, which was allowed in full. This decrease in unrecognized tax benefits resulted in an increase in the effective tax rate due to a limitation on Vermont net operating loss carryforwards. Based upon our analysis of the audit risks associated with our 2010 and 2011 Capitalized Repairs deductions, we concluded that an additional unrecognized tax benefit was not warranted.

During 2010, unrecognized tax benefits were increased by $2.6 million which, due to the impact of deferred tax accounting, resulted in $0.3 million that would affect the effective tax rate if recognized. The $2.6 million increase in unrecognized tax benefits is the net of a $3.6 million increase in unrecognized tax benefits established for our Capitalized Repairs deduction and a $1 million decrease in unrecognized tax benefits due to the settlement of our Casualty Loss claims.

There were no unrecognized tax benefits that would affect the effective tax rate if recognized at December 31, 2009.

We recognize interest related to unrecognized tax benefits as interest expense and penalties are recorded as other deductions. For the year ended December 31, 2011, interest expense recognized on the Consolidated Statements of Income was less than $0.1 million. There was no interest expense in 2010 and a $0.1 million reversal of previously recorded interest expense in 2009. At December 31, 2011 there was less than $0.1 million of interest accrued on the Consolidated Balance Sheets. There was no accrued interest related to unrecognized tax benefits at December 31, 2010.

The 2004 through 2006 tax years, although audited by the IRS, and the 2007 through 2009 tax years remain open to examination. The 2008 tax year is currently under examination by the IRS. For state tax purposes the 2007 through 2009 tax years remain open to examination by the states of New York, New Hampshire, Maine, Connecticut and Vermont.

Valuation Allowance: FASB's guidance for income taxes prohibits the recognition of all or a portion of deferred income tax benefits if it is more likely than not that the deferred tax asset will not be realized. During 2010, based upon FASB income tax guidance, we recorded a $1 million deferred tax asset representing the excess of tax basis over book value for our investment in VYNPC. We also recorded an equal valuation allowance as it is more likely than not that this deferred tax asset will not be realized. There was no tax impact for this transaction.

Health Care Legislation: On March 23, 2010, the PPACA was signed into law. The PPACA is a comprehensive health care reform bill that includes revenue-raising provisions for nearly $400 billion over 10 years through tax increases on high-income individuals, excise taxes on high-cost group health plans, and new fees on selected health-care-related industries. In addition, on March 25, 2010, the Health Care and Education Affordability Reconciliation Act of 2010 was passed into law, which modifies certain provisions of the PPACA.

Together, the legislation repeals the current rule permitting a tax deduction for prescription drug coverage expense under our postretirement medical plan that is actuarially equivalent to that provided under Medicare Part D. This provision is effective for taxable years beginning after December 31, 2012. As required, in 2010 we recorded an increase of $2.1 million in regulatory assets and an increase of $2.8 million in deferred income taxes liabilities on the Consolidated Balance Sheets, resulting in an increase of $0.7 million in income tax expense on the Consolidated Statements of Income, related to postretirement medical expenditures that will not be deductible in the future. This legislative change is considered an exogenous event and is included in the exogenous effects deferral. See Note 9 – Retail Rates and Regulatory Accounting for additional information.

Tax Bonus Depreciation: The Small Business Jobs Act of 2010, which became law on September 27, 2010, extended 50 percent bonus depreciation to 2010. In addition, as a result of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which became law on December 17, 2010, the 50 percent bonus depreciation was extended through 2012, and a 100 percent expensing was allowed for property placed in service after September 8, 2010 through 2011. The combined impact of the additional bonus depreciation allowed as a result of these Acts was $4.2 million in 2011 and $6.7 million in 2010. The amounts were recorded to prepayments and deferred income tax liabilities on the Consolidated Balance Sheet. These legislative changes are considered exogenous events and are included in the exogenous effects deferral. See Note 9 - Retail Rates and Regulatory Accounting for additional information.

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 are presented below (dollars in thousands):

	2011			2010
Deferred tax assets - current
Reserves for uncollectible accounts	$	1,339		$	1,073
Deferred compensation and pension		189			906
Environmental costs accrual		(42	)		11
Loss contingency accrual		485			485
Active medical accrual		303			270
Self insurance reserve		500			472
PCAM		124			2,086
Smart Grid		90			388
ASC 815 Derivatives		2,004			0
Federal and State NOL carryforward		2,086			0
Termination fee		7,902			0
Other accruals		398			407
Total deferred tax assets - current		15,378			6,098
Deferred tax liabilities - current
Property tax accruals		475			397
Prepaid insurance		160			150
Derivative instruments		2			11
Millstone decommissioning costs		326			197
ESAM		2,366			842
Other accruals		187			0
Total deferred tax liabilities - current		3,516			1,597
Net deferred tax assets - current	$	11,862		$	4,501

Deferred tax assets - long term
Accruals and other reserves not currently deductible	$	1,252		$	1,473
Millstone decommissioning costs		2,411			2,327
Contributions in aid of construction		1,534			1,720
Loss contingency accrual		1,454			1,939
Deferred compensation		1,485			480
Investments		1,032			1,008
Pension and postretirement medical liability		13,477			10,926
Gross deferred tax assets - long term		22,645			19,873
Less valuation allowance		(1,032	)		(1,008	)
Total deferred tax assets - long-term		21,613			18,865
Deferred tax liabilities - long term
Property, plant and equipment		75,960			67,388
Benefits - regulatory asset		15,116			11,330
Investments		25,916			19,226
Other		4,935			3,327
Total deferred tax liabilities - long term		121,927			101,271

Net deferred tax liabilities - long term		100,314			82,406
Net deferred tax liabilities	$	88,452		$	77,905

A summary of the liabilities and assets combining current and long-term:

	2011		2010
Total deferred tax liabilities - current and long-term	$	125,443	$	102,868
Less total deferred tax assets - current and long-term		36,991		24,963
Net deferred tax liabilities	$	88,452	$	77,905

At December 31, 2011, Federal operating loss carryforwards totaled $4.1 million and will expire on September 15, 2031. In addition, State operating loss carryforwards totaled $7.6 million and will expire on October 15, 2021. The tax effected balances of these operating loss carryforwards are recorded as current deferred income tax assets on the Consolidated Statements of Income.