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.

On January 2, 2013, U.S. federal legislation was enacted that provides an extension of the 50 percent bonus depreciation allowance for qualifying capital expenditures incurred through 2013.

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, including whether expenditures should be deducted as repairs or capitalized and depreciated on tax returns. Upon issuance, the temporary regulations were generally to be effective for expenditures made on or after January 1, 2012. However, in December 2012, in response to public comments received, the IRS amended the temporary regulations to postpone the effective date until January 1, 2014.

Changes in tax treatment elected by Dominion or required by the regulations will impact income taxes payable, 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 are not expected to be materially affected.

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,	2012			2011			2010			2012			2011			2010
(millions)
Current:
Federal	$	(117	)	$	3		$	894		$	70		$	(35	)	$	(78	)
State	80			9			309			81			79			10
Total current expense (benefit)	(37		)	12			1,203			151			44			(68		)
Deferred:
Federal	214			694			818			482			484			537
State	(30		)	50			93			21			13			74
Total deferred expense	184			744			911			503			497			611
Amortization of deferred investment tax credits	(1		)	(2		)	(2		)	(1		)	(1		)	(1		)
Total income tax expense	$	146		$	754		$	2,112		$	653		$	540		$	542

(1)

In 2012, Dominion's current federal income tax benefit includes a benefit related to the carryback of its current year operating loss, and deferred state income tax benefit reflects the impact of Brayton Point, Kincaid and Kewaunee impairment charges. In 2011, Dominion's federal income tax expense includes a 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 statutes of limitations.


(2)	In 2011, Virginia Power's federal income tax expense includes a 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,	2012		2011		2010		2012		2011		2010
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	8.1		1.8		5.1		3.9		4.4		3.8
Valuation allowances	(1.5	)	—		(0.2	)	—		—		—
Production tax credits	(2.4	)	(0.6	)	(0.3	)	—		—		—
Amortization of investment tax credits	(0.3	)	(0.1	)	—		(0.1	)	(0.1	)	(0.1	)
AFUDC - equity	(4.1	)	(0.6	)	(0.4	)	(0.9	)	(0.8	)	(1.1	)
Employee stock ownership plan deduction	(3.1	)	(0.7	)	(0.3	)	—		—		—
Goodwill	0.4		—		0.9		—		—		—
Legislative change	—		—		1.1		—		—		1.1
Other, net	(2.8	)	(0.6	)	(0.2	)	0.4		1.2		0.2
Effective tax rate	29.3	%	34.2	%	40.7	%	38.3	%	39.7	%	38.9	%

Dominion's effective tax rate in 2012 reflects the amplified effect of permanent differences due to lower pre-tax income, as well as the state tax impact of Brayton Point, Kincaid and Kewaunee impairment charges. The rate also reflects a $20 million reduction of a valuation allowance related to state operating loss carryforwards attributable to Fairless and a $14 million increase in valuation allowance related to Brayton Point state credit carryforwards. After considering the results of Fairless' operations in recent years and a forecast of future operating results reflecting Dominion's planned purchase of the facility, Dominion has concluded that it is more likely than not that the tax benefit of the operating losses will be realized. Significant assumptions include future commodity prices, in particular, those for electric energy produced by Fairless and those for natural gas, as compared to other fuels used for the generation of electricity, which will significantly influence the extent to which Fairless is dispatched by PJM. Also, in connection with its intention to sell Brayton Point, Dominion evaluated state tax credits previously recognized for the power station and recorded a $14 million increase in valuation allowance related to credit carryforwards and a $14 million deferred tax liability, representing recapture of credits claimed in prior years that would result upon completion of a sale. Dominion will continue to evaluate the likelihood of realizing these tax benefits on a quarterly basis.

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,	2012			2011			2012			2011
(millions)
Deferred income taxes:
Total deferred income tax assets	$	2,505		$	2,229		$	466		$	503
Total deferred income tax liabilities	7,716			7,424			4,238			3,759
Total net deferred income tax liabilities	$	5,211		$	5,195		$	3,772		$	3,256
Total deferred income taxes:
Plant and equipment, primarily depreciation method and basis differences	$	4,601		$	4,008		$	3,394		$	2,758
Nuclear decommissioning	994			913			407			374
Deferred state income taxes	474			493			265			243
Federal benefit of deferred state income taxes	(166		)	(173		)	(93		)	(85		)
Deferred fuel, purchased energy and gas costs	3			161			(16		)	144
Pension benefits	231			396			(17		)	8
Other postretirement benefits	(171		)	(167		)	(7		)	(13		)
Loss and credit carryforwards	(656		)	(577		)	(77		)	(55		)
Reserve for rate proceedings	—			(54		)	—			(54		)
Partnership basis differences	174			274			—			—
Valuation allowances	93			96			—			—
Other	(366		)	(175		)	(84		)	(64		)
Total net deferred income tax liabilities	$	5,211		$	5,195		$	3,772		$	3,256

At December 31, 2012, Dominion had the following deductible loss and credit carryforwards:


•	Federal loss carryforwards of $1.1 billion that expire if unutilized during the period 2021 through 2031;


•	Federal production tax credits of $26 million that expire if unutilized through 2032;


•	State loss carryforwards of $1.4 billion that expire if unutilized during the period 2014 through 2032. A valuation allowance on $857 million of these carryforwards has been established;


•	State minimum tax credits of $96 million that do not expire; and


•	State investment tax credits of $28 million that expire if unutilized through 2016. A valuation allowance on $21 million of these credits has been established for credits that are not expected to be utilized.

At December 31, 2012, Virginia Power had federal loss carryforwards of $220 million that expire if unutilized through 2031.

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
	2012			2011			2010			2012			2011			2010
(millions)
Balance at January 1	$	347		$	307		$	291		$	114		$	117		$	121
Increases-prior period positions	28			127			34			4			22			4
Decreases-prior period positions	(106		)	(119		)	(75		)	(80		)	(51		)	(33		)
Increases-current period positions	43			64			61			24			47			25
Decreases-current period positions	—			(21		)	—			—			(21		)	—
Settlements with tax authorities	(4		)	—			—			(4		)	—			—
Expiration of statutes of limitation	(15		)	(11		)	(4		)	(1		)	—			—
Balance at December 31	$	293		$	347		$	307		$	57		$	114		$	117

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 $167 million, $184 million and $133 million at December 31, 2012, 2011 and 2010, respectively. For Dominion, the change in these unrecognized tax benefits increased income tax expense by $1 million, $51 million and $38 million in 2012, 2011 and 2010, respectively. For Virginia Power, these unrecognized tax benefits were $13 million, $20 million and $14 million at December 31, 2012, 2011 and 2010, respectively. For Virginia Power, the change in these unrecognized tax benefits increased income tax expense by $1 million, $6 million and by less than $1 million in 2012, 2011 and 2010, respectively.

For Dominion and its subsidiaries, the U.S. federal statute of limitations has expired for years prior to 2008. For prior years, Dominion had 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 2007. The IRS position had provided 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 U.S. 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 and, in May 2012, the U.S. Court of Appeals for the Federal Circuit ruled in favor of Dominion. The resolution of this matter did not have a material impact on the Companies' 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 were not affected.

In April 2012, the IRS issued its Revenue Agent Report for Dominion's consolidated tax returns for tax years 2006 and 2007, reflecting the resolution of all issues, except the capitalized interest on idle property issue that was in litigation at that time but later resolved as discussed above.

The IRS examination of tax years 2008, 2009 and 2010 began in the first quarter of 2012 and was later expanded to include examination of the 2011 tax year. The audit is expected to be concluded in late 2013.

It is reasonably possible that settlements with and payments to tax authorities in 2013 and, the expiration of statutes of limitations, could reduce unrecognized tax benefits for Dominion and Virginia Power by up to $65 million and $35 million, respectively. 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 $10 million, and Virginia Power's earnings would not be affected.

Otherwise, with regard to 2012 and prior years, Dominion and Virginia Power cannot estimate the range of reasonably possible changes to unrecognized tax benefits that may occur in 2013.

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	2009
Connecticut	2009
Massachusetts	2008
Virginia⁽¹⁾	2009
West Virginia	2009


(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

Dominion's effective tax rate for 2012 reflects the dispositions of State Line and Salem Harbor.

Dominion's effective tax rate for 2011 reflects an expectation that State Line's deferred tax assets, including 2011 operating losses, will not be realized in State Line's separately filed state tax returns.

Dominion's effective tax rate for 2010 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.