INCOME TAXES

Judgment and the use of estimates are required in developing the provision for income taxes and reporting of tax-related assets and liabilities. The interpretation of tax laws involves uncertainty, since tax authorities may interpret the laws differently. Dominion and Virginia Power are routinely audited by federal and state tax authorities. Ultimate resolution of income tax matters may result in favorable or unfavorable impacts to net income and cash flows, and adjustments to tax-related assets and liabilities could be material.

In 2010, U.S. federal legislation was enacted that allows taxpayers to fully deduct qualifying capital expenditures incurred after September 8, 2010, through the end of 2011, when placed in service before 2013, and otherwise provides an extension of the fifty percent bonus depreciation allowance for qualifying capital expenditures through 2012.

In December 2011, the IRS issued temporary regulations that provide guidance to taxpayers on the treatment of amounts paid to acquire, produce or improve tangible property and of dispositions of such property. The temporary regulations generally are effective for expenditures made on or after January 1, 2012. Any changes for tax treatment elected by Dominion or required by the regulations will be effective prospectively; however, implementation will require a calculation of the cumulative effect of the changes on prior years, and it is expected that such amount will have to be included in the determination of Dominion's taxable income in 2012, or possibly over a four-year period beginning in 2012. The IRS is expected to issue additional procedural guidance regarding 2012 tax return filing requirements and how the requirements may be implemented for electric generation operations and gas transmission and distribution systems.

Dominion believes the evaluation and implementation of the temporary regulations will require an extensive effort and may permit, or require, changes to how Dominion determines whether expenditures incurred related to plant and equipment should be deducted as repairs or capitalized and depreciated on its tax returns. Since changes will be concerned with the timing for deducting expenditures for tax purposes, the impact of implementation will be reflected in the amount of income taxes payable or receivable, cash flows from operations and deferred taxes. Except to the extent the implementation impacts deferred taxes and, therefore, the rate base used to establish customer rates for regulated utilities, results of operations should not be materially affected. Pending the issuance of additional procedural guidance from the IRS and progress of completion of the evaluation process, Dominion cannot estimate the impact of implementing the temporary regulations.

Continuing Operations

Details of income tax expense for continuing operations including noncontrolling interests were as follows:



	Dominion⁽¹⁾									Virginia Power⁽²⁾
Year Ended December 31,	2011			2010			2009			2011			2010			2009
(millions)
Current:
Federal	$	(11	)	$	891		$	952		$	(35	)	$	(78	)	$	465
State	—			308			129			79			10			91
Total current	(11		)	1,199			1,081			44			(68		)	556
Deferred:
Federal	695			764			(424		)	484			537			(339		)
State	63			96			(59		)	13			74			(69		)
Total deferred	758			860			(483		)	497			611			(408		)
Amortization of deferred investment tax credits	(2		)	(2		)	(2		)	(1		)	(1		)	(1		)
Total income tax expense	$	745		$	2,057		$	596		$	540		$	542		$	147


(1)	In 2011, Dominion's federal income tax expense includes a $346 million benefit related to its current year operating loss that is expected to be used in future years, and state income tax expense reflects changes in the amount of income apportioned among states, higher tax credits, claims for refunds and previously unrecognized tax benefits due to the expiration of statues of limitations.

(2)

In 2011, Virginia Power's federal income tax expense includes a $54 million benefit related to a portion of its current year operating loss that is expected to be used in future years. Also, in 2011 and 2010, Virginia Power's federal income tax expense reflects the amounts of current year operating losses realized through its participation in a tax sharing agreement with Dominion and its subsidiaries.

For continuing operations including noncontrolling interests, the statutory U.S. federal income tax rate reconciles to Dominion's and Virginia Power's effective income tax rate as follows:



	Dominion						Virginia Power
Year Ended December 31,	2011		2010		2009		2011		2010		2009
U.S. statutory rate	35.0	%	35.0	%	35.0	%	35.0	%	35.0	%	35.0	%
Increases (reductions) resulting from:
State taxes, net of federal benefit	1.6		5.0		2.4		4.4		3.8		2.8
Valuation allowances	0.2		0.1		(0.4	)	—		—		—
Investment and production tax credits	(0.6	)	(0.3	)	(1.5	)	—		—		(0.2	)
Amortization of investment tax credits	(0.1	)	—		(0.1	)	(0.1	)	(0.1	)	(0.2	)
AFUDC - equity	(0.6	)	(0.4	)	(1.0	)	(0.8	)	(1.1	)	(3.4	)
Employee stock ownership plan deduction	(0.7	)	(0.3	)	(0.8	)	—		—		—
Pension and other benefits	(0.1	)	—		(0.6	)	—		—		(0.6	)
Domestic production activities deduction	—		(0.4	)	(2.9	)	—		(0.3	)	(4.5	)
Goodwill-sale of U.S. Appalachian E&P business	—		0.9		—		—		—		—
Legislative change	—		1.1		0.4		—		1.1		—
Other, net	(0.4	)	0.1		1.3		1.2		0.5		0.4
Effective tax rate	34.3		40.8		31.8		39.7	%	38.9	%	29.3	%

Dominion's and Virginia Power's effective tax rates in 2010 reflect reductions of deferred tax assets of $57 million and $17 million, respectively, resulting from the enactment of the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act of 2010, which eliminated the employer's deduction, beginning in 2013, for that portion of its retiree prescription drug coverage cost that is being reimbursed by the Medicare Part D subsidy. In addition, Dominion's effective tax rate in 2010 includes higher state income taxes and the impact of goodwill written off that is not deductible for tax purposes associated with the sale of the Appalachian E&P operations.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

The Companies' deferred income taxes consist of the following:



	Dominion						Virginia Power
At December 31,	2011			2010			2011			2010
(millions)
Deferred income taxes:
Total deferred income tax assets	$	2,229		$	1,642		$	503		$	402
Total deferred income tax liabilities	7,424			6,233			3,759			3,139
Total net deferred income tax liabilities	$	5,195		$	4,591		$	3,256		$	2,737
Total deferred income taxes:
Plant and equipment, primarily depreciation method and basis differences	$	4,008		$	3,027		$	2,758		$	2,109
Nuclear decommissioning	913			749			374			343
Deferred state income taxes	493			446			243			228
Federal benefit of deferred state income taxes	(173		)	(156		)	(85		)	(80		)
Deferred fuel, purchased energy and gas costs	161			120			144			111
Pension benefits	396			521			8			26
Other postretirement benefits	(167		)	(186		)	(13		)	(14		)
Loss and credit carryforwards	(577		)	(181		)	(55		)	—
Reserve for rate proceedings	(54		)	(56		)	(54		)	(56		)
Partnership basis differences	274			265			—			—
Valuation allowances	96			68			—			—
Other	(175		)	(26		)	(64		)	70
Total net deferred income tax liabilities	$	5,195		$	4,591		$	3,256		$	2,737

At December 31, 2011, Dominion had the following deductible loss and credit carryforwards:


•	Federal loss carryforwards of $1.0 billion that expire if unutilized during the period 2021 through 2031;


•	Federal production tax credits of $13 million that expire if unutilized through 2031;


•	State loss carryforwards of $1.1 billion that expire if unutilized during the period 2014 through 2031. A valuation allowance on $866 million of these carryforwards has been established;


•	State minimum tax credits of $101 million that do not expire;


•	State investment tax credits of $6 million that expire if unutilized through 2014; and


•	State investment tax credits of $3 million that do not expire.

At December 31, 2011, Virginia Power had the following deductible loss and credit carryforwards:


•	Federal loss carryforwards of $157 million that expire if unutilized through 2031; and


•	State minimum tax credits of $1 million that do not expire.

Positions taken by an entity in its income tax returns that are recognized in the financial statements must satisfy a more-likely-than-not recognition threshold, assuming that the position will be examined by tax authorities with full knowledge of all relevant information. The amount of tax return positions that are not recognized in the financial statements is disclosed as unrecognized tax benefits. These unrecognized tax benefits may impact the financial statements by increasing income taxes payable, reducing tax refunds receivable or changing deferred taxes. Also, when uncertainty about the deductibility of an amount is limited to the timing of such deductibility, an increase in taxes payable (or reduction in tax refunds receivable) is accompanied by a decrease in deferred tax liabilities.

A reconciliation of changes in the Companies' unrecognized tax benefits follows:



	Dominion									Virginia Power
	2011			2010			2009			2011			2010			2009
(millions)
Balance at January 1	$	307		$	291		$	404		$	117		$	121		$	180
Increases-prior period positions	127			34			51			22			4			11
Decreases-prior period positions	(107		)	(59		)	(142		)	(46		)	(28		)	(71		)
Increases-current period positions	64			61			43			47			25			22
Decreases-current period positions	(21		)	—			—			(21		)	—			—
Prior period positions becoming otherwise deductible in current period	(12		)	(16		)	(36		)	(5		)	(5		)	(9		)
Settlements with tax authorities	—			—			(13		)	—			—			(9		)
Expiration of statutes of limitations	(11		)	(4		)	(16		)	—			—			(3		)
Balance at December 31	$	347		$	307		$	291		$	114		$	117		$	121

Certain unrecognized tax benefits, or portions thereof, if recognized, would affect the effective tax rate. Changes in these unrecognized tax benefits may result from claims for tax benefits, or portions thereof, that may not be realized, remeasurement of amounts expected to be realized, settlements with tax authorities and expiration of statutes of limitation. For Dominion and its subsidiaries, these unrecognized tax benefits were $184 million, $133 million and $95 million at December 31, 2011, 2010 and 2009, respectively. For Dominion, the change in these unrecognized tax benefits increased income tax expense by $51 million in 2011 and $38 million in 2010 and decreased income tax expense by $26 million in 2009. For Virginia Power, these unrecognized tax benefits were $20 million at December 31, 2011 and $14 million at December 31, 2010 and 2009. For Virginia Power, the change in these unrecognized tax benefits increased income tax expense by $6 million in 2011 and by less than $1 million in 2010 and decreased income tax expense by $7 million in 2009.

A portion of Dominion's and Virginia Power's unrecognized tax benefits balances at December 31, 2011 represents tax positions for which the ultimate deductibility is highly certain; however, there is uncertainty about the timing of such deductibility. When uncertainty about the deductibility of amounts is limited to the timing of such deductibility, any tax liabilities recognized for prior periods would be subject to offset with the availability of refundable amounts from later periods when such deductions could otherwise be taken. Pending resolution of these uncertainties, interest is accrued until the period in which the amounts would become deductible.

For Dominion and its subsidiaries, the U.S. federal statute of limitations has expired for years prior to 2006, except that Dominion has reserved the right to pursue refunds related to the calculation of interest to be capitalized in connection with improvements to in-service plant and equipment for the years 1995 through 2005. The IRS position provides that capitalized interest must also be computed on the adjusted tax basis of in-service assets that are idled while making improvements to them. In response to litigation initiated by Dominion in March 2008, the United States Court of Federal Claims ruled in February 2011, sustaining the IRS position. In July 2011, Dominion filed an appeal with the United States Court of Appeals for the Federal Circuit. Dominion believes the ultimate resolution of this matter will not have a material impact on its cash flows, results of operations or financial condition.

In January 2012, the Appellate Division of the IRS informed Dominion that the Joint Committee had completed its review of the settlement of tax years 2004 and 2005 for Dominion and its consolidated subsidiaries. Since the measurement of unrecognized tax benefits in 2011 considered the results of completed settlement negotiations, Dominion's results of operations in 2012 will not be affected.

In 2011, the IRS completed its fieldwork in the examination of Dominion's consolidated tax returns for tax years 2006 and 2007. Dominion and the IRS have resolved all issues, except Dominion is reserving the right to pursue a refund related to the capitalized interest issue that is currently being litigated.

The IRS examination of tax years 2008, 2009 and 2010 will begin in the first quarter of 2012.

It is reasonably possible that resolution of the litigation related to capitalized interest and settlements with and payments to tax authorities in 2012 could reduce unrecognized tax benefits for Dominion and Virginia Power by $24 million and $15 million, respectively. Dominion's unrecognized tax benefits could also be reduced by up to $18 million, including $8 million for Virginia Power, to recognize prior period amounts becoming otherwise deductible in 2012 and the expiration of statutes of limitations. If such changes were to occur, other than revisions of the accrual for interest on tax underpayments and overpayments, Dominion's earnings could increase by up to $7 million with no material impact on Virginia Power's earnings.

Otherwise, with regard to 2011 and prior years, Dominion and Virginia Power cannot estimate the range of reasonably possible changes to unrecognized tax benefits that may occur in 2012.

For each of the major states in which Dominion operates, the earliest tax year remaining open for examination is as follows:



State	Earliest Open Tax Year
Pennsylvania	2008
Connecticut	2007
Massachusetts	2007
Virginia⁽¹⁾	2008
West Virginia	2008


(1)	Virginia is the only state considered major for Virginia Power's operations.

Dominion and Virginia Power are also obligated to report adjustments resulting from IRS settlements to state tax authorities. In addition, if Dominion utilizes operating losses or tax credits generated in years for which the statute of limitations has expired, such amounts are subject to examination.

Discontinued Operations

Income tax expense in 2010 for Dominion's discontinued operations primarily reflects the impact of goodwill written off in the sale of Peoples that is not deductible for tax purposes and the reversal of deferred taxes for which the benefit was offset by the reversal of income tax-related regulatory assets.