Income Taxes

On December 22, 2017, the TCJA was enacted. The TCJA includes significant changes to the IRC, including amendments which significantly changed the taxation of business entities and includes specific provisions related to regulated public utilities. The more significant changes that impact the Company included in the TCJA are reductions in the corporate federal income tax rate from 35% to 21%, elimination of the corporate alternative minimum tax provision, additional limitations on deductions of executive compensation, and limitations on the utilization of NOLs arising after December 31, 2017, to 80% of taxable income with no carryback but with an indefinite carryforward. The specific provisions related to regulated public utilities in the TCJA generally provide for the continued deductibility of interest expense, the elimination of bonus depreciation for property acquired and placed into service after September 27, 2017, and the continuance of rate normalization requirements for accelerated depreciation benefits and changes to deferred tax balances as a result of the change in the corporate federal income tax rate.

The results for the twelve months ended December 31, 2017 contain provisional estimates of the impact of the TCJA. These amounts are considered provisional because they use estimates for which tax returns have not yet been filed and because estimated amounts may be impacted by future regulatory and accounting guidance if and when issued. The Company will adjust these provisional amounts as further information becomes available and as we refine our calculations. As permitted by recent guidance issued by the Securities and Exchange Commission, these adjustments will occur during a reasonable “measurement period” not to exceed twelve months from the date of enactment.

Provisional reductions in accumulated deferred federal income taxes ("ADFIT") due to the reduction in the corporate income tax rate to 21% under the provisions of the TCJA will result in amounts previously collected from utility customers for these deferred taxes to be refundable to such customers, generally through reductions in future rates. The TCJA includes provisions that stipulate how these excess deferred taxes are to be returned to customers for certain accelerated tax depreciation benefits. Potential refunds of other deferred taxes will be determined by the Company’s regulators. The December 31, 2017 balance sheet reflects the impact of the TCJA which reduced ADFIT by $298.9 million, reduced regulatory assets by $23.6 million and increased regulatory liabilities by $275.3 million. The changes in deferred taxes were recorded at the amount of the reduced future cash flow expected to be included in rates, as required in ASC 740. These adjustments had no impact on the Company’s cash flows for the year ended December 31, 2017.

In February 2018, the FASB issued ASU 2018-02, as a result of concerns raised by stakeholders due to the TCJA. ASU 2018-02 addresses concerns that the tax reduction due to the change in the corporate tax rate from 35% to 21% would be “stranded” in AOCI. ASU 2018-02 allows companies to reclassify stranded taxes from AOCI to retained earnings. The Company is currently in the process of evaluating the impact of ASU 2018-02 and its impact on regulated utilities. At December 31, 2017, the Company has $7.2 million in stranded taxes in AOCI.

The provisional tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2017 and 2016 are presented below (in thousands):



	December 31,
	2017			2016
Deferred tax assets:
Benefit of tax loss carryforwards	$	24,035		$	60,749
Alternative minimum tax credit carryforward	16,620			16,620
Pensions and benefits	32,606			57,756
Asset retirement obligation	19,530			26,929
Regulatory liabilities related to income taxes	63,794			—
Deferred fuel	1,405			—
Total gross deferred tax assets	157,990			162,054
Deferred tax liabilities:
Plant, principally due to depreciation and basis differences	(426,077		)	(668,303		)
Decommissioning	(34,520		)	(43,463		)
Deferred fuel	—			(3,962		)
Other	(2,416		)	(1,392		)
Total gross deferred tax liabilities	(463,013		)	(717,120		)
Net accumulated deferred income taxes	$	(305,023	)	$	(555,066	)

Based on the average annual earnings before taxes for the prior three years, and excluding the effects of unusual or infrequent items, the Company believes that the deferred tax assets will be fully realized.

The Company recognized income tax expense for 2017, 2016 and 2015 as follows (in thousands):



	Years Ended December 31,
	2017			2016			2015
Income tax expense:
Federal:
Current	$	2,507		$	2,642		$	2,319
Deferred	46,089			47,909			32,819
Total federal income tax	48,596			50,551			35,138
State:
Current	(897		)	766			1,730
Deferred	1,816			3,285			(1,650		)
Total state income tax	919			4,051			80
Generation (amortization) of accumulated investment tax credits	1,489			(684		)	(323		)
Total income tax expense	$	51,004		$	53,918		$	34,895

As of December 31, 2017, the Company had $16.6 million of AMT credit carryforwards. Based on the TCJA provisions, the Company may claim a refund of 50% of the remaining AMT credits (to the extent the credits exceed the Company's regular tax liability for the year) in 2018, 2019, and 2020. Any AMT credits remaining after 2020 will be refunded in 2021. As of December 31, 2017, the Company had $23.0 million of federal and $1.4 million of state tax loss carryforwards. Under the TCJA, NOLs arising in tax years ending after 2017 cannot be carried back but can be carried forward indefinitely. The use of NOLs generated after 2017 to offset taxable income is limited to 80% of taxable income. Federal NOLs generated prior to 2018 are able to offset 100% of future taxable income to the extent available but have lives of only 20 years.

Income tax provisions differ from amounts computed by applying the statutory federal income tax rate of 35% to book income before federal income tax as follows (in thousands):



	Years Ended December 31,
	2017			2016			2015
Federal income tax expense computed on income at statutory rate	$	52,243		$	52,740		$	40,885
Difference due to:
State taxes, net of federal benefit	597			2,633			52
AEFUDC	450			(475		)	(2,345		)
Permanent tax differences	(2,562		)	(2,369		)	(2,898		)
Other	276			1,389			(799		)
Total income tax expense	$	51,004		$	53,918		$	34,895
Effective income tax rate	34.2		%	35.8		%	29.9		%

The Company files income tax returns in the United States federal jurisdiction and in the states of Texas, New Mexico and Arizona. The Company is no longer subject to tax examination by the taxing authorities in the federal, Arizona and New Mexico jurisdictions for years prior to 2013. In August 2017, the Company reached an agreement with the Texas Comptroller of Public Accounts and settled audits in Texas for tax years 2007 through 2011.

In the third quarter of 2016, the Company changed its accounting for state income taxes from the flow-through method to the normalization method in accordance with the 2016 PUCT Final Order and the NMPRC Final Order. Under the flow-through method, the Company previously recorded deferred state income taxes and regulatory liabilities and assets offsetting such deferred state income taxes at the expected cash flow to be reflected in future rates. Upon implementation of normalization, the Company began amortizing the net regulatory asset for deferred state income taxes to deferred income tax expense over a 15 year period as allowed by the regulators. In the third quarter of 2016, the Company began recording deferred state income tax expense as required by normalization, retroactive to January 2016 as provided in the final orders. The impact of the change was additional income tax expense of $1.9 million and $5.1 million for the years ended December 31, 2017 and 2016, respectively.

The FASB guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company recorded a decrease of $1.2 million (net of an increase of $0.5 million), a decrease of $0.4 million (net of an increase of $0.3 million), and an unrecognized tax position of $0.8 million, in 2017, 2016, and 2015 respectively, related to transmission and distribution costs and other amounts deducted in current and prior year Texas franchise tax returns. The Company recorded an unrecognized tax position of $0.1 million in 2017 and a decrease of $0.3 million in 2016 related to tax credits taken and apportionment factors used in prior year Arizona income tax returns, which have been settled through audit. A reconciliation of the December 31, 2017, 2016 and 2015 amounts of unrecognized tax benefits are as follows (in thousands):



	2017			2016			2015
Balance at January 1	$	5,300		$	6,000		$	5,200
Additions for tax positions related to the current year	200			400			500
Reductions for tax positions related to the current year	—			—			—
Additions for tax positions of prior years	400			100			300
Reductions for tax positions of prior years	(1,700		)	(1,200		)	—
Balance at December 31	$	4,200		$	5,300		$	6,000

If recognized, $1.1 million of the unrecognized tax position at December 31, 2017, would reduce the effective tax rate. The Company recognized an income tax benefit for the decrease in unrecognized tax positions of $1.1 million for the year ended December 31, 2017.

The Company recognizes in tax expense interest and penalties related to tax benefits that have not been recognized. For the year ended December 31, 2017, the Company recognized a benefit of $0.2 million. For the years ended December 31, 2016, and 2015 the Company recognized interest expense of $0.1 million, and $0.2 million, respectively. The Company had approximately $0.7 million and $0.8 million accrued for the payment of interest and penalties at December 31, 2017 and 2016, respectively.