TAXES

Income 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. Details of income taxes for the three years ended December 31, 2011 are shown below:



PROVISION FOR INCOME TAXES	FirstEnergy			FES			OE			CEI			TE			JCP&L		Met-Ed			Penelec
	(In millions)
2011
Currently payable (receivable)-
Federal	$	(243	)	$	(219	)	$	13		$	17		$	(15	)	$	19	$	26		$	(36	)
State	19			9			(12		)	(7		)	(6		)	7		7			(6		)
	(224		)	(210		)	1			10			(21		)	26		33			(42		)
Deferred, net-
Federal	785			206			65			15			35			71		14			75
State	24			(3		)	13			10			1			20		(10		)	(3		)
	809			203			78			25			36			91		4			72
Investment tax credit amortization	(11		)	(4		)	(1		)	(1		)	—			—		—			—
Total provision for income taxes	$	574		$	(11	)	$	78		$	34		$	15		$	117	$	37		30

2010
Currently payable (receivable)-
Federal	$	(23	)	$	(23	)	$	37		$	58		$	(8	)	$	80	$	1		$	(81	)
State	35			(2		)	(2		)	1			(2		)	36		12			(12		)
	12			(25		)	35			59			(10		)	116		13			(93		)
Deferred, net-
Federal	432			142			41			(19		)	25			30		37			122
State	27			12			3			(4		)	1			1		(2		)	18
	459			154			44			(23		)	26			31		35			140
Investment tax credit amortization	(9		)	(4		)	(1		)	(1		)	—			—		—			(1		)
Total provision for income taxes	$	462		$	125		$	78		$	35		$	16		$	147	$	48		$	46

2009
Currently payable (receivable)-
Federal	$	(183	)	$	87		$	21		$	40		$	6		$	40	$	(34	)	$	(21	)
State	44			8			4			2			—			26		(4		)	4
	(139		)	95			25			42			6			66		(38		)	(17		)
Deferred, net-
Federal	296			169			36			(62		)	(3		)	38		60			55
State	36			21			3			1			2			1		7			2
	332			190			39			(61		)	(1		)	39		67			57
Investment tax credit amortization	(9		)	(4		)	(2		)	(1		)	—			—		—			(1		)
Total provision for income taxes	$	184		$	281		$	62		$	(20	)	$	5		$	105	$	29		$	39

In 2011, an unregulated subsidiary of FirstEnergy elected to be taxed as a limited liability company, which improved its future taxable income and resulted in reversing a portion of its valuation allowance previously established for state income tax benefits. The reversal of the valuation allowance reduced income tax expense by $27 million.

As a result of the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act signed into law in March 2010, beginning in 2013 the tax deduction currently available to FirstEnergy will be reduced to the extent that drug costs are reimbursed under the Medicare Part D retiree subsidy program. As retiree healthcare liabilities and related tax impacts under prior law were already reflected in FirstEnergy’s consolidated financial statements, the change resulted in a charge to FirstEnergy’s earnings in 2010 of approximately $13 million and a reduction in accumulated deferred tax assets associated with these subsidies. This change reflects the anticipated increase in income taxes that will occur as a result of the change in tax law.

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, 2011.



	FirstEnergy			FES			OE			CEI			TE			JCP&L			Met-Ed			Penelec
	(In millions)
2011
Book income (loss) before provision for income taxes	$	1,459		$	(70	)	$	206		$	104		$	49		$	261		$	105		$	93
Federal income tax expense at statutory rate	$	511		$	(25	)	$	72		$	36		$	17		$	91		$	37		$	33
Increases (reductions) in taxes resulting from-
Amortization of investment tax credits	(11		)	(4		)	(1		)	(1		)	—			—			—			—
State income taxes, net of federal tax benefit	28			4			1			2			(3		)	18			(2		)	(6		)
State unitary tax adjustments	33			—			—			—			—			—			—			—
Manufacturing deduction	16			13			3			1			—			—			—			—
Medicare Part D	36			4			6			3			1			6			5			6
Effectively settled tax items	(11		)	(2		)	(3		)	(3		)	(3		)	—			—			—
State valuation allowance	(19		)	2			—			—			—			—			—			(4		)
Other, net	(9		)	(3		)	—			(4		)	3			2			(3		)	1
Total provision for income taxes	$	574		$	(11	)	$	78		$	34		$	15		$	117		$	37		$	30
2010
Book income before provision for income taxes	$	1,204		$	356		$	233		$	111		$	52		$	330		$	108		$	110
Federal income tax expense at statutory rate	$	421		$	125		$	82		$	39		$	18		$	116		$	38		$	39
Increases (reductions) in taxes resulting from-
Amortization of investment tax credits	(9		)	(4		)	(1		)	(1		)	—			—			—			(1		)
State income taxes, net of federal tax benefit	40			7			1			(2		)	(1		)	24			7			4
Manufacturing deduction	—			2			(2		)	—			—			—			—			—
Medicare Part D	17			1			2			1			—			4			2			3
Effectively settled tax items	(34		)	(2		)	(9		)	(4		)	(3		)	—			—			—
State valuation allowance	—			2			—			—			—			—			—			(1		)
Other, net	27			(6		)	5			2			2			3			1			2
Total provision for income taxes	$	462		$	125		$	78		$	35		$	16		$	147		$	48		$	46
2009
Book income (loss) before provision for income taxes	$	1,056		$	779		$	181		$	(50	)	$	24		$	263		$	82		$	89
Federal income tax expense at statutory rate	$	370		$	273		$	63		$	(18	)	$	8		$	92		$	29		$	31
Increases (reductions) in taxes resulting from-
Amortization of investment tax credits	(9		)	(4		)	(2		)	(1		)	—			—			—			(1		)
State income taxes, net of federal tax benefit	52			19			5			2			1			18			2			4
Manufacturing deduction	(13		)	(11		)	(2		)	1			(1		)	—			—			—
Medicare Part D	14			7			(1		)	—			—			2			1			2
Effectively settled tax items	(217		)	—			—			—			—			—			—			—
State valuation allowance	(1		)	3			—			—			—			—			—			(2		)
Other, net	(12		)	(6		)	(1		)	(4		)	(3		)	(7		)	(3		)	5
Total provision for income taxes	$	184		$	281		$	62		$	(20	)	$	5		$	105		$	29		$	39

Accumulated deferred income taxes as of December 31, 2011 and 2010 are as follows:



	FirstEnergy			FES			OE			CEI			TE			JCP&L			Met-Ed			Penelec
	(In millions)
December 31, 2011
Property basis differences	$	6,738		$	770		$	673		$	527		$	206		$	792		$	457		$	577
Regulatory transition charge	105			—			30			73			5			49			2			—
Customer receivables for future income taxes	125			—			—			—			—			12			55			58
Deferred MISO/PJM transmission costs	51			—			—			—			—			—			34			17
Other regulatory assets — RCP	165			—			82			55			28			—			—			—
Deferred sale and leaseback gain	(450		)	(398		)	(31		)	—			—			(10		)	(12		)	—
Nonutility generation costs	36			—			—			—			—			(2		)	31			7
Unamortized investment tax credits	(72		)	(19		)	(3		)	(4		)	(2		)	(2		)	(4		)	(4		)
Unrealized losses on derivative hedges	(21		)	5			—			—			—			(1		)	—			—
Pensions and OPEB	(752		)	(85		)	(76		)	(36		)	(18		)	(75		)	(24		)	(114		)
Lease market valuation liability	(179		)	(65		)	—			—			(68		)	—			—			—
Oyster Creek securitization (Note 12)	93			—			—			—			—			93			—			—
Nuclear decommissioning activities	123			108			15			—			17			(7		)	7			(17		)
Mark-to-market adjustments	(7		)	(7		)	—			—			—			—			—			—
Deferred gain for asset sales — affiliated companies	—			—			31			20			7			—			—			—
Equity investments	132			—			—			—			—			—			—			—
Loss carryforwards and AMT credits	(612		)	(34		)	—			—			—			—			(6		)	(30		)
Loss carryforward valuation reserve	34			12			—			—			—			—			—			7
All other	161			(1		)	66			28			(5		)	10			—			(2		)
Net deferred income tax liability	$	5,670		$	286		$	787		$	663		$	170		$	859		$	540		$	499

December 31, 2010
Property basis differences	$	3,910		$	650		$	625		$	496		$	206		$	728		$	407		$	504
Regulatory transition charge	235			12			37			89			3			95			(1		)	—
Customer receivables for future income taxes	113			—			—			—			—			13			48			52
Deferred MISO/PJM transmission costs	85			—			—			—			—			—			62			23
Other regulatory assets — RCP	166			—			82			56			28			—			—			—
Deferred sale and leaseback gain	(469		)	(412		)	(35		)	—			—			(10		)	(12		)	—
Nonutility generation costs	51			—			—			—			—			—			55			(4		)
Unamortized investment tax credits	(44		)	(20		)	(4		)	(4		)	(2		)	(2		)	(5		)	(4		)
Unrealized losses on derivative hedges	(29		)	—			—			—			—			—			—			—
Pensions and OPEB	(686		)	(96		)	(58		)	(32		)	(28		)	(74		)	(13		)	(80		)
Lease market valuation liability	(197		)	(82		)	—			—			(81		)	—			—			—
Oyster Creek securitization (Note 12)	109			—			—			—			—			109			—			—
Nuclear decommissioning activities	47			79			7			(1		)	15			(8		)	2			(47		)
Mark-to-market adjustments	(42		)	(42		)	—			—			—			—			—			—
Deferred gain for asset sales — affiliated companies	—			—			34			22			7			—			—			—
Loss carryforwards	(41		)	(10		)	—			—			—			—			—			(23		)
Loss carryforward valuation reserve	26			9			—			—			—			—			—			11
All other	(74		)	(21		)	49			21			(7		)	(58		)	(17		)	6
Net deferred income tax liability	$	3,160		$	67		$	737		$	647		$	141		$	793		$	526		$	438

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 a result of the merger with AE in 2011, FirstEnergy's unrecognized income tax benefits increased by $97 million. FirstEnergy also reached a settlement with the IRS on a research and development claim and recognized approximately $30 million of income tax benefits, including $5 million that favorably affected FirstEnergy's effective tax rate in 2011. The IRS issued guidance in 2011 providing a safe harbor method of tax accounting for electric transmission and distribution property (see discussion below) to determine the tax treatment of repair costs for electric transmission and distribution assets. FirstEnergy is evaluating the method change for this temporary tax item and, if elected, is not expected to be material to the financial position or effective tax rates of FirstEnergy and the Utilities.

After reaching settlements on appeal in 2010 related primarily to the capitalization of certain costs for the tax years 2004-2008 and an unrelated federal tax matter related to prior year gains and losses recognized from the disposition of assets, as well as receiving final approval from the Joint Committee on Taxation for several items that were under appeal for tax years 2001-2003, FirstEnergy recognized approximately $78 million of net tax benefits in 2010, including $21 million$0 millionthat favorably affected FirstEnergy’s effective tax rate. The remaining portion of the tax benefit increased FirstEnergy’s accumulated deferred income taxes.

Upon reaching a settlement on several items under appeal for the tax years 2001-2003, as well as other items that effectively settled in 2009, FirstEnergy recognized approximately $100 million of net tax benefits, including $161 million that favorably affected FirstEnergy’s 2009 effective tax rate. The offsetting $61 million primarily related to tax items where the uncertainty was removed and the tax refund was received.

As of December 31, 2011, it is reasonably possible that approximately $44 million of unrecognized tax benefits may be resolved during 2012, of which up to approximately $10 million, if recognized, would affect FirstEnergy’s effective tax rate. The potential decrease in the amount of unrecognized tax benefits is primarily associated with issues related to the capitalization of certain costs and various state tax items.

In 2009, FirstEnergy, on behalf of the Utilities, filed a change in accounting method related to the costs to repair and maintain electric utility network (transmission and distribution) assets. In 2010, approximately $325 million of costs were included as a repair deduction on FirstEnergy’s 2009 consolidated federal income tax return, which reduced taxable income and increased the amount of tax refunds that were applied to FirstEnergy’s 2010 estimated federal tax payments. Due to the flow through of the Pennsylvania state income tax benefit for this change in accounting, FirstEnergy’s effective tax rate was reduced by $6 million in 2010. In connection with completing FirstEnergy’s 2009 consolidated tax return, FES recognized an $8 million adjustment that increased its income tax expense in 2010.

In 2008, FirstEnergy, on behalf of FGCO and NGC, filed a change in accounting method related to the costs to repair and maintain electric generation stations. During the second quarter of 2009, the IRS approved the change in accounting method and $281 million of costs were included as a repair deduction on FirstEnergy’s 2008 consolidated federal income tax return. Since the IRS did not complete its review over this change in accounting method by the extended filing date of FirstEnergy’s federal tax return, FirstEnergy increased the amount of unrecognized tax benefits by $34 million in the third quarter of 2009, with a corresponding adjustment to accumulated deferred income taxes for this temporary tax item. There was no impact on FirstEnergy’s effective tax rate for 2009.

The following table summarizes the changes in unrecognized tax positions for the years ended 2011, 2010 and 2009.



	FirstEnergy			FES			OE			CEI			TE			JCP&L			Met-Ed			Penelec
	(In millions)
Balance, January 1, 2009	$	219		$	5		$	(30	)	$	(26	)	$	(4	)	$	42		$	28		$	24
Current year increases	41			34			4			3			—			—			—			—
Prior years increases	46			2			103			52			10			—			—			—
Prior years decreases	(100		)	—			—			—			—			(28		)	(15		)	(13		)
Decrease for settlement	(15		)	—			—			—			—			—			—			—
Balance, December 31, 2009	$	191		$	41		$	77		$	29		$	6		$	14		$	13		$	11
Current year increases	10			6			2			(1		)	—			—			2			1
Prior years increases	2			—			—			—			—			—			—			—
Prior years decreases	(81		)	(4		)	(19		)	(15		)	(6		)	(21		)	(2		)	(5		)
Decrease for settlement	(77		)	(2		)	(58		)	(14		)	—			7			(11		)	(6		)
Balance, December 31, 2010	$	45		$	41		$	2		$	(1	)	$	—		$	—		$	2		$	1
Increase due to merger with AE	97			—			—			—			—			—			—			—
Prior years increases	10			8			—			1			—			—			—			—
Prior years decreases	(35		)	(4		)	(2		)	—			—			—			(2		)	(1		)
Balance, December 31, 2011	$	117		$	45		$	—		$	—		$	—		$	—		$	—		$	—

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. As a result of the merger with AE in 2011, the amount of accrued interest increased by $6 million. The interest associated with the 2011 settlement of the claim favorably affected FirstEnergy's effective tax rate by $7 million in 2011. The reversal of accrued interest associated with the recognized tax benefits favorably affected FirstEnergy’s effective tax rate by $12 million in 2010. The reversal of accrued interest associated with the $161 million in recognized tax benefits favorably affected FirstEnergy’s effective tax rate in 2009 by $56 million.

The following table summarizes the net interest expense (income) for the three years ended December 31, 2011 and the cumulative net interest payable (receivable) as of December 31, 2011 and 2010:



	Net Interest Expense (Income) For the Years Ended December 31,									Net Interest Payable As of December 31,
	2011			2010			2009			2011		2010
	(In millions)									(In millions)
FirstEnergy	$	(5	)	$	(10	)	$	(49	)	$	11	$	3
FES	1			1			(1		)	4		2
OE	(2		)	(3		)	4			1		1
CEI	(2		)	(2		)	3			—		—
TE	(1		)	(1		)	—			—		—
JCP&L	—			(2		)	(4		)	—		—
Met-Ed	—			—			(2		)	—		—
Penelec	—			—			(1		)	—		—

FirstEnergy has tax returns that are under review at the audit or appeals level by the IRS (2008-2010) and state tax authorities. FirstEnergy's tax returns for all state jurisdictions are open from 2008-2010, as well as 2005-2007 for New Jersey. The IRS completed its audits of tax year 2008 in July 2010 and tax year 2009 in April 2011, with both tax years having one item under appeal. Tax years 2010-2011 are under review by the IRS. Allegheny is currently under audit by the IRS for tax years 2007 and 2008. Allegheny has filed its 2010 and 2009 federal returns and such filings are subject to review. State tax returns for tax years 2008 through 2010 remain subject to review in Pennsylvania, West Virginia, Maryland and Virginia for certain subsidiaries of AE. Management believes that adequate reserves have been recognized and final settlement of these audits is not expected to have a material adverse effect on FirstEnergy's financial condition, results of operations, cash flow or liquidity.

FirstEnergy has recorded as deferred income tax assets the effect of net operating losses and tax credits that will more likely than not be realized through future operations and through the reversal of existing temporary differences. In 2011, the tax benefit of operating loss carryforwards included in deferred income tax expense was $344 million. As of December 31, 2011, the deferred income tax assets, before any valuation allowances, consisted of $286 million of federal net operating loss carryforwards that expire from 2024 to 2031, federal AMT credits of $25 million that have an indefinite carryforward period and $301 million of state and local net operating loss carryforwards that begin to expire in 2012.

FirstEnergy has pre-tax net operating loss carryforwards for state and local income tax purposes of approximately $12.9 billion, of which $11.8 billion is expected to be utilized. The associated deferred tax assets, net of valuation reserves, are $267 million. These losses expire as follows:



Expiration Period	FirstEnergy		FES		Penelec
	(In millions)
2012-2016	$	885	$	644	$	—
2017-2021	901		33		119
2022-2026	8,402		4		94
2027-2031	2,675		408		257
	$	12,863	$	1,089	$	470

General Taxes

Details of general taxes for the years ended 2011, 2010 and 2009, are shown below:



	FirstEnergy		FES		OE		CEI		TE		JCP&L		Met-Ed			Penelec
	(In millions)
2011
KWH excise	$	244	$	—	$	90	$	66	$	27	$	50	$	—		$	—
State gross receipts	264		62		17		2		1		—		64			55
Real and personal property	299		42		73		80		23		6		2			2
Social security and unemployment	109		14		9		6		3		11		5			6
Other	62		6		1		—		—		—		3			3
Total general taxes	$	978	$	124	$	190	$	154	$	54	$	67	$	74		$	66
2010
KWH excise	$	245	$	5	$	92	$	68	$	27	$	51	$	—		$	—
State gross receipts	185		17		15		—		—		—		85			68
Real and personal property	243		53		67		70		23		5		—			(1		)
Social security and unemployment	86		14		8		5		2		9		4			5
Other	17		5		1		—		—		—		(1		)	1
Total general taxes	$	776	$	94	$	183	$	143	$	52	$	65	$	88		$	73
2009
KWH excise⁽¹⁾	$	224	$	1	$	84	$	66	$	24	$	49	$	—		$	—
State gross receipts	171		14		15		—		—		—		78			63
Real and personal property	253		53		64		74		21		5		2			2
Social security and unemployment	90		14		8		5		3		9		5			6
Other	15		5		—		—		—		—		3			3
Total general taxes	$	753	$	87	$	171	$	145	$	48	$	63	$	88		$	74


⁽¹⁾	KWH excise tax for OE and TE include $7 million and $3 million credit adjustments, respectively, recognized in 2009 related to prior periods.