Income Taxes

6 Months Ended

Jun. 30, 2011

Income Taxes [Abstract]

INCOME TAXES

8. INCOME TAXES

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 Allegheny in the first quarter of 2011, FirstEnergy’s unrecognized tax benefits increased by $97 million. During the second quarter of 2011, FirstEnergy 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 for the second quarter and first six months of 2011. There were no other material changes to FirstEnergy’s unrecognized income tax benefits during the first six months of 2011. After reaching a tentative agreement with the IRS on a tax item at appeals related to the capitalization of certain costs for tax years 2005-2008, as well as reaching a settlement on an unrelated state tax matter in the second quarter of 2010, FirstEnergy recognized approximately $70 million of net income tax benefits, including $13 million that favorably affected FirstEnergy’s effective tax rate for the second quarter of 2010. The remaining portion of the income tax benefit recognized in the first six months of 2010 increased FirstEnergy’s accumulated deferred income taxes for the settled temporary tax item.

As of June 30, 2011, it is reasonably possible that approximately $46 million of unrecognized income tax benefits may be resolved within the next twelve months, of which approximately $4 million, if recognized, would affect FirstEnergy’s effective tax rate. The potential decrease in the amount of unrecognized income tax benefits is primarily associated with issues related to the capitalization of certain costs and various state tax items.

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 tax return. FirstEnergy includes net interest and penalties in the provision for income taxes. The interest associated with the settlement of the claim noted above favorably affected FirstEnergy’s effective tax rate by $6 million in the first half of 2011. During the first six months of 2011, there were no material changes to the amount of accrued interest, except for a $6 million increase in accrued interest as a result of the merger with Allegheny. The reversal of accrued interest associated with the recognized income tax benefits noted above favorably affected FirstEnergy’s effective tax rate by $11 million in the first six months of 2010. The net amount of interest accrued as of June 30, 2011 was $10 million, compared with $3 million as of December 31, 2010.

As a result of the non-deductible portion of merger transaction costs, FirstEnergy’s effective tax rate was unfavorably impacted by $28 million in the first six months of 2011.

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 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 the first quarter of 2010 of approximately $13 million and a reduction in accumulated deferred tax assets associated with these subsidies. That charge reflected the anticipated increase in income taxes that will occur as a result of the change in tax law.

Allegheny is currently under audit by the IRS for tax years 2007 and 2008. The 2009 federal return was filed and is subject to review. State tax returns for tax years 2006 through 2009 remain subject to review in Pennsylvania, West Virginia, Maryland and Virginia for certain subsidiaries of AE. FirstEnergy has tax returns that are under review at the audit or appeals level by the IRS (2008-2010) and state tax authorities. Tax returns for all state jurisdictions are open from 2006-2009. The IRS began auditing the year 2008 in February 2008 and the audit was completed in July 2010 with one item under appeal. The 2009 tax year audit began in February 2009 and the 2010 tax year audit began in February 2010. 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 or results of operations.