Income Taxes

12 Months Ended

Dec. 31, 2017

Income Taxes.

a. MGE Energy and MGE Income Taxes.

MGE Energy files a consolidated federal income tax return that includes the operations of all subsidiary companies. The subsidiaries calculate their respective federal income tax provisions as if they were separate taxable entities.

On a consolidated and separate company basis, the income tax provision consists of the following provision (benefit) components for the years ended December 31:

		MGE Energy						MGE
(In thousands)		2017		2016		2015		2017		2016		2015
Current payable:
Federal	$	21,125	$	16,908	$	16,837	$	21,512	$	17,521	$	19,295
State		5,129		3,287		2,774		5,316		3,497		3,443
Net-deferred:
Federal		(8,346)		17,571		15,951		(11,195)		16,391		13,538
State		4,264		4,850		5,976		3,435		4,485		5,305
Amortized investment tax credits		(78)		(103)		(175)		(78)		(103)		(175)
Total income tax provision	$	22,094	$	42,513	$	41,363	$	18,990	$	41,791	$	41,406

The consolidated income tax provision differs from the amount computed by applying the statutory federal income tax rate to income before income taxes, as follows:

	MGE Energy			MGE
	2017	2016	2015	2017	2016	2015
Statutory federal income tax rate	35.0 %	35.0 %	35.0 %	35.0 %	35.0 %	35.0 %
State income taxes, net of federal benefit	5.1 %	5.1 %	5.2 %	5.1 %	5.1 %	5.2 %
Amortized investment tax credits	-%	(0.1)%	(0.2)%	-%	(0.1)%	(0.2)%
Credit for electricity from wind energy	(1.6)%	(1.6)%	(1.8)%	(1.7)%	(1.7)%	(1.8)%
Domestic manufacturing deduction	(1.4)%	(1.3)%	(1.4)%	(1.5)%	(1.3)%	(1.4)%
AFUDC equity, net	(0.2)%	(0.2)%	(0.1)%	(0.2)%	(0.2)%	(0.1)%
Federal income tax rate reduction	(18.1)%	-%	-%	(19.3)%	-%	-%
Other, net, individually insignificant	(0.3)%	(0.9)%	-%	(0.4)%	(0.9)%	-%
Effective income tax rate	18.5 %	36.0 %	36.7 %	17.0 %	35.9 %	36.7 %

The significant components of deferred tax liabilities (assets) that appear on the consolidated balance sheets as of December 31 are as follows:

		MGE Energy				MGE
(In thousands)		2017		2016		2017		2016
Property-related	$	238,437	$	344,721	$	238,544	$	344,630
Investment in ATC^(a)		48,324		71,898		-		-
Bond transactions		832		1,324		832		1,324
Pension and other postretirement benefits		42,919		63,516		42,919		63,516
Derivatives		11,525		20,304		11,525		20,304
Tax deductible prepayments		6,169		8,404		6,169		8,404
Other		9,389		16,606		9,222		16,571
Gross deferred income tax liabilities		357,595		526,773		309,211		454,749
Investment in ATC^(a)		(24,781)		(31,212)		-		-
Accrued expenses		(15,135)		(22,410)		(15,135)		(22,410)
Pension and other postretirement benefits		(32,196)		(48,860)		(32,196)		(48,860)
Deferred tax regulatory account		(36,124)		(903)		(36,124)		(903)
Derivatives		(11,525)		(20,304)		(11,525)		(20,304)
Other		(12,790)		(19,340)		(12,831)		(19,224)
Gross deferred income tax assets		(132,551)		(143,029)		(107,811)		(111,701)
Less valuation allowance		86		69		86		69
Net deferred income tax assets		(132,465)		(142,960)		(107,725)		(111,632)
Deferred income taxes	$	225,130	$	383,813	$	201,486	$	343,117

(a) As of December 1, 2016, MGE transferred its ownership interest in ATC to MGE Energy, resulting in a deferred intercompany gain and a corresponding step-up in tax basis.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the Tax Act). The Tax Act makes broad and complex changes to the U.S. tax code, including a reduction in the U.S. federal corporate tax rate from 35 percent to 21 percent.

The SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting for certain income tax effects. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting is complete. To the extent that a company's accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue accounting for certain income tax effects on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

The Tax Act reduces the corporate tax rate to 21 percent, effective January 1, 2018. Consequently, MGE Energy has recorded a provisional decrease related to deferred tax assets (DTAs) and deferred tax liabilities (DTLs) of $2.1 million and $179.0 million, respectively, with a corresponding net adjustment to deferred income tax expense of $21.7 million generated by nonregulated activities, investment in ATC of $20.4 million, regulatory assets of $4.3 million, and regulatory liabilities of $130.5 million for the year ended December 31, 2017. MGE has recorded a provisional increase related to DTAs and decrease related to DTLs of $1.4 million and $155.1 million, respectively, with a corresponding net adjustment to deferred income tax expense of $21.7 million, regulatory assets of $4.3 million, and regulatory liabilities of $130.5 million for the year ended December 31, 2017. Given that changes in income taxes are generally passed through in customer rates for the regulated utility, a regulatory liability was recorded. The amount and timing of the cash impacts will depend on the period over which certain income tax benefits are provided to customers, which will be subject to review by the PSCW. A portion of the regulatory liability will be returned to customers based on a mandated timeframe dictated by applicable tax laws. While we are able to make a reasonable estimate of the impact of the reduction in corporate rate, it may be affected by other analyses related to the Tax Act. Any subsequent adjustment to these amounts will be recorded in the quarter of 2018 when the analysis is complete.

Our state valuation allowance reduces MGE Energy's and MGE's deferred tax assets for state carryforward losses to estimated realizable value due to the uncertainty of future income estimates in various state tax jurisdictions. For tax purposes, as of December 31, 2017, both MGE Energy and MGE had approximately $1.4 million of state tax net operating loss deductions subject to a valuation allowance that expire between 2020 and 2023 if unused.

b. Accounting for Uncertainty in Income Taxes - MGE Energy and MGE.

MGE Energy and MGE account for the difference between the tax benefit amount taken on prior year tax returns, or expected to be taken on a current year tax return, and the tax benefit amount recognized in the financial statements as an unrecognized tax benefit.

A tabular reconciliation of unrecognized tax benefits and interest from January 1, 2015, to December 31, 2017, is as follows:

(In thousands)
Unrecognized Tax Benefits:		2017		2016		2015
Unrecognized tax benefits, January 1,	$	2,487	$	2,528	$	2,365
Additions based on tax positions related to the current year		552		452		488
Additions based on tax positions related to the prior years		19		39		520
Reductions based on tax positions related to the prior years		(1,134)		(532)		(845)
Unrecognized tax benefits, December 31,	$	1,924	$	2,487	$	2,528

(In thousands)
Interest on Unrecognized Tax Benefits:		2017		2016		2015
Accrued interest on unrecognized tax benefits, January 1,	$	388	$	311	$	92
Reduction in interest expense on uncertain tax positions		(312)		(27)		(102)
Interest expense on uncertain tax positions		89		104		321
Accrued interest on unrecognized tax benefits, December 31,	$	165	$	388	$	311

Unrecognized tax benefits are classified with "Other deferred liabilities" on the consolidated balance sheets. The interest component is offset by a regulatory asset.

At December 31, 2017, 2016, and 2015, MGE Energy and MGE had unrecognized tax benefits primarily related to temporary tax differences associated with the change in income tax method of accounting for electric generation and electric and gas distribution repairs. In addition, at December 31, 2017 and 2016, MGE Energy and MGE had unrecognized tax benefits relating to permanent differences and tax credits of less than $0.1 million. There were no unrecognized tax benefits at December 31, 2015, related to federal permanent differences and tax credits.

The unrecognized tax benefits at December 31, 2017, are not expected to significantly increase or decrease within the next twelve months. In addition, statutes of limitations will expire for MGE Energy and MGE tax returns. The impact of the statutes of limitations expiring is not anticipated to be material. The following table shows tax years that remain subject to examination by major jurisdiction:

	Taxpayer	Open Years
	MGE Energy and consolidated subsidiaries in federal return	2014 through 2017
	MGE Energy Wisconsin combined reporting corporation return	2013 through 2017