INCOME TAX EXPENSE



Income Tax Expense
Year Ended December 31	2016			2015			2014
Millions
Current Tax Expense (a)
Federal	—			—			$1.1
State	$0.4			$0.2			2.9
Total Current Tax Expense		$0.4			$0.2			$4.0
Deferred Tax Expense
Federal		$12.0			$19.4			$25.3
State	8.1			6.5			8.2
Investment Tax Credit Amortization	(0.7		)	(0.8		)	(0.8		)
Total Deferred Tax Expense		$19.4			$25.1			$32.7
Total Income Tax Expense		$19.8			$25.3			$36.7

(a)

For the years ended December 31, 2016, 2015 and 2014, the federal and state current tax expense was minimal due to NOLs which resulted from the bonus depreciation provisions of the Protecting Americans from Tax Hikes Act of 2015, the Tax Increase Prevention Act of 2014 and the American Taxpayer Relief Act of 2012. The federal and state NOLs will be carried forward to offset future taxable income. The year ended December 31, 2014, includes the resolution of an Internal Revenue Service examination for tax years 2005 through 2009 and the impacts of initiatives implemented on the 2013 federal and state tax returns to utilize tax carryforwards that may have expired.

NOTE 13. INCOME TAX EXPENSE (Continued)



Reconciliation of Taxes from Federal Statutory
Rate to Total Income Tax Expense
Year Ended December 31	2016			2015			2014
Millions
Income Before Non-Controlling Interest and Income Taxes		$175.6			$166.8			$162.2
Statutory Federal Income Tax Rate	35		%	35		%	35		%
Income Taxes Computed at 35 percent Statutory Federal Rate		$61.5			$58.4			$56.8
Increase (Decrease) in Tax Due to:
State Income Taxes – Net of Federal Income Tax Benefit	5.6			4.4			7.2
Regulatory Differences for Utility Plant	(0.1		)	(0.6		)	(3.5		)
Production Tax Credits	(41.5		)	(37.0		)	(23.7		)
Change in Fair Value of Contingent Consideration	(3.8		)	—			—
Other	(1.9		)	0.1			(0.1		)
Total Income Tax Expense		$19.8			$25.3			$36.7

The effective tax rate was 11.3 percent for 2016 (15.2 percent for 2015; 22.6 percent for 2014). The 2016, 2015, and 2014 effective rates were primarily impacted by production tax credits. The 2016 effective rate was also impacted by a decrease in the liability related to U.S. Water Services’ contingent consideration (see Note 9. Fair Value), and the 2014 effective rate was also impacted by the deduction for AFUDC–Equity (included in Regulatory Differences for Utility Plant in the preceding table).



Deferred Tax Assets and Liabilities
As of December 31	2016			2015
Millions
Deferred Tax Assets
Employee Benefits and Compensation		$104.6			$105.4
Property Related	117.8			126.6
NOL Carryforwards	185.6			186.4
Tax Credit Carryforwards	227.4			164.8
Power Sales Agreements	59.3			73.0
Other	46.9			21.8
Gross Deferred Tax Assets	741.6			678.0
Deferred Tax Asset Valuation Allowance	(43.0		)	(31.6		)
Total Deferred Tax Assets		$698.6			$646.4
Deferred Tax Liabilities
Property Related		$1,094.7			$1,053.0
Regulatory Asset for Benefit Obligations	91.9			89.4
Unamortized Investment Tax Credits	33.3			26.0
Partnership Basis Differences	50.9			47.8
Other	11.9			10.0
Total Deferred Tax Liabilities		$1,282.7			$1,226.2
Net Deferred Income Taxes (a)		$584.1			$579.8


(a)	Recorded as a net long-term Deferred Income Tax liability on the Consolidated Balance Sheet.

NOTE 13. INCOME TAX EXPENSE (Continued)



NOL and Tax Credit Carryforwards
As of December 31	2016	2015
Millions
Federal NOL Carryforwards (a)	$485.3		$493.0
Federal Tax Credit Carryforwards	$163.7	$113.6
State NOL Carryforwards (a)	$294.4	$228.6
State Tax Credit Carryforwards (b)	$21.0	$20.0


(a)	Pre-tax amounts.


(b)	Net of a $42.7 million valuation allowance as of December 31, 2016 ($31.2 million as of December 31, 2015).

The federal NOL and tax credit carryforward periods expire between 2030 and 2036. We expect to fully utilize the federal NOL and federal tax credit carryforwards; therefore no federal valuation allowance has been recognized as of December 31, 2016. The state NOL and tax credit carryforward periods expire between 2024 and 2045. We have established a valuation allowance against certain state NOL and tax credits that we do not expect to utilize before their expiration.



Gross Unrecognized Income Tax Benefits	2016			2015			2014
Millions
Balance at January 1		$2.4			$2.0			$1.2
Additions for Tax Positions Related to the Current Year	0.1			0.5			—
Additions for Tax Positions Related to Prior Years	0.2			0.7			1.0
Reductions for Tax Positions Related to Prior Years	(0.3		)	(0.7		)	—
Lapse of Statute	(0.4		)	(0.1		)	(0.2		)
Balance as of December 31		$2.0			$2.4			$2.0

Unrecognized tax benefits are the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured pursuant to the “more-likely-than-not” criteria. The unrecognized tax benefit balance includes permanent tax positions which, if recognized would affect the annual effective income tax rate. In addition, the unrecognized tax benefit balance includes temporary tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. A change in the period of deductibility would not affect the effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period. The gross unrecognized tax benefits as of December 31, 2016, included $0.6 million of net unrecognized tax benefits which, if recognized, would affect the annual effective income tax rate.

As of December 31, 2016, we had no accrued interest (none as of December 31, 2015; none as of December 31, 2014) related to unrecognized tax benefits included on the Consolidated Balance Sheet due to our NOL carryforwards. We classify interest related to unrecognized tax benefits as interest expense and tax-related penalties in operating expenses on the Consolidated Statement of Income. Interest expense related to unrecognized tax benefits on the Consolidated Statement of Income was immaterial in 2016 (immaterial in 2015, and in 2014). There were no penalties recognized in 2016, 2015 or 2014. The unrecognized tax benefit amounts have been presented as reductions to the tax benefits associated with NOL and tax credit carryforwards on the Consolidated Balance Sheet.

No material changes to unrecognized tax benefits are expected during the next 12 months.

ALLETE and its subsidiaries file a consolidated federal income tax return as well as combined and separate state income tax returns in various jurisdictions. ALLETE has no open federal or state audits, and is no longer subject to federal examination for years before 2013 or state examination for years before 2012.