Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

Income Taxes

4.Income Taxes

Certain assets and liabilities are reported differently for income tax purposes than they are for financial statements purposes.  The tax effect of these differences is recorded as deferred taxes.  We calculate deferred taxes using the currently enacted income tax rates.

APS has recorded regulatory assets and regulatory liabilities related to income taxes on its Balance Sheets in accordance with accounting guidance for regulated operations.  The regulatory assets are for certain temporary differences, primarily the allowance for equity funds used during construction and pension and other postretirement benefits.  The regulatory liabilities primarily relate to deferred taxes resulting from investment tax credits (“ITC”) and the change in income tax rates.

In accordance with regulatory requirements, APS investment tax credits are deferred and are amortized over the life of the related property with such amortization applied as a credit to reduce current income tax expense in the statement of income.

The $69 million long-term income tax receivable on the Consolidated Balance Sheets represents the anticipated refunds related to an APS tax accounting method change approved by the IRS in the third quarter of 2009.  This amount is classified as long-term, as cash refunds are not expected to be received in the next twelve months.

During the first quarter of 2010, the Company reached a settlement with the IRS with regard to the examination of tax returns for the years ended December 31, 2005 through 2007.  As a result of this settlement, net uncertain tax positions decreased $62 million, including approximately $3 million which decreased our effective tax rate.  Additionally, the settlement resulted in the recognition of net interest benefits of approximately $4 million through the effective tax rate.

The following is a tabular reconciliation of the total amounts of unrecognized tax benefits, excluding interest and penalties, at the beginning and end of the year that are included in accrued taxes and unrecognized tax benefits (dollars in thousands):

	2011			2010			2009
Total unrecognized tax benefits, January 1	$	127,595		$	201,216		$	63,318
Additions for tax positions of the currentyear	10,915			7,551			44,094
Additions for tax positions of prior years	—			—			98,942
Reductions for tax positions of prior years for:
Changes in judgment	(1,555		)	(11,017		)	—
Settlements with taxing authorities	(124		)	(62,199		)	(4,089		)
Lapses of applicable statute of limitations	(826		)	(7,956		)	(1,049		)
Total unrecognized tax benefits,December 31	$	136,005		$	127,595		$	201,216

Included in the balances of unrecognized tax benefits at December 31, 2011, 2010 and 2009 were approximately $8 million, $7 million and $16 million, respectively, of tax positions that, if recognized, would decrease our effective tax rate.

As of the balance sheet date, the tax year ended December 31, 2008 and all subsequent tax years remain subject to examination by the IRS.  With few exceptions, we are no longer subject to state income tax examinations by tax authorities for years prior to 2006.  We do not anticipate that there will be any significant increases or decreases in our unrecognized tax benefits within the next twelve months.

We reflect interest and penalties, if any, on unrecognized tax benefits in the Consolidated Statements of Income as income tax expense.  The amount of interest recognized in the Consolidated Statement of Income related to unrecognized tax benefits was a pre-tax expense of $3 million for 2011, a pre-tax benefit of $2 million for 2010 and a pre-tax expense of $2 million for 2009.

The total amount of accrued liabilities for interest recognized in the Consolidated Balance Sheets related to unrecognized tax benefits was $9 million as of December 31, 2011, $6 million as of December 31, 2010 and $8 million as of December 31, 2009.  To the extent that matters are settled favorably, this amount could reverse and decrease our effective tax rate.  Additionally, as of December 31, 2011, we have recognized $4 million of interest income to be received on the overpayment of income taxes for certain adjustments that we have filed, or will file, with the IRS.

The components of income tax expense are as follows (dollars in thousands):

	Year Ended December 31,
	2011			2010			2009
Current:
Federal	$	(310	)	$	(108,827	)	$	(38,502	)
State	15,140			25,545			(38,080		)
Total current	14,830			(83,282		)	(76,582		)
Deferred:
Federal	159,566			260,236			62,874
State	16,626			10,911			42,618
Discontinued operations	—			(10,736		)	—
Total deferred	176,192			260,411			105,492
Total income tax expense	191,022			177,129			28,910
Less: income tax expense (benefit) ondiscontinued operations	7,418			16,260			(109,641		)
Income tax expense — continuing operations	$	183,604		$	160,869		$	138,551

The following chart compares pretax income from continuing operations at the 35% federal income tax rate to income tax expense — continuing operations (dollars in thousands):

	Year Ended December 31,
	2011			2010			2009
Federal income tax expense at 35%statutory rate	$	188,733		$	177,002		$	138,110
Increases (reductions) in tax expenseresulting from:
State income tax net of federal income tax benefit	19,594			17,485			15,068
Credits and favorable adjustmentsrelated to prior years resolved incurrent year	—			(17,300		)	—
Medicare Subsidy Part-D	823			1,311			(2,095		)
Allowance for equity funds used duringconstruction (see Note 1)	(6,881		)	(6,563		)	(4,265		)
Palo Verde VIE noncontrolling interest (see Note 20)	(9,636		)	(7,057		)	(6,723		)
Other	(9,029		)	(4,009		)	(1,544		)
Income tax expense — continuing operations	$	183,604		$	160,869		$	138,551

The following table shows the net deferred income tax liability recognized on the Consolidated Balance Sheets (dollars in thousands):

	December 31,
	2011			2010
Current asset	$	130,571		$	124,897
Long-term liability	(1,925,388		)	(1,863,861		)
Deferred income taxes — net	$	(1,794,817	)	$	(1,738,964	)

On February 17, 2011, Arizona enacted legislation (H.B. 2001) that included a four year phase-in of corporate income tax rate reductions beginning in 2014.  As a result of these tax rate reductions, Pinnacle West has revised the tax rate applicable to reversing temporary items in Arizona.  In accordance with accounting for regulated companies, the benefit of this rate reduction is substantially offset by a regulatory liability. In 2011, APS increased regulatory liabilities by a total of $62 million, with a corresponding decrease in accumulated deferred income tax liabilities to reflect the impact of this change in tax law.

The components of the net deferred income tax liability were as follows (dollars in thousands):

	December 31,
	2011			2010
DEFERRED TAX ASSETS
Risk management activities	$	117,765		$	124,731
Regulatory liabilities:
Asset retirement obligation and removalcosts	236,739			222,448
Deferred fuel and purchased power	—			23,089
Renewable energy standard	19,722			18,749
Unamortized investment tax credits	31,460			642
Other	33,155			27,718
Pension and other postretirement liabilities	501,202			321,182
Real estate investments and assets held for sale	—			19,855
Renewable energy incentives	57,901			37,327
Credit and loss carryforwards	171,915			42,971
Other	73,759			68,684
Total deferred tax assets	1,243,618			907,396
DEFERRED TAX LIABILITIES
Plant-related	(2,446,908		)	(2,210,976		)
Risk management activities	(30,171		)	(30,125		)
Regulatory assets:
Allowance for equity funds used during construction	(33,347		)	(28,276		)
Deferred fuel and purchased power	(10,884		)	—
Deferred fuel and purchased power —mark-to-market	(30,559		)	(30,276		)
Pension and other postretirementbenefits	(408,716		)	(264,313		)
Other	(73,087		)	(77,078		)
Other	(4,763		)	(5,316		)
Total deferred tax liabilities	(3,038,435		)	(2,646,360		)
Deferred income taxes — net	$	(1,794,817	)	$	(1,738,964	)

As of December 31, 2011, the deferred tax assets for credit and loss carryforwards relate to federal general business credits ($67 million) and federal net operating losses ($92 million), both of which first begin to expire in 2029, and other federal and state loss carryforwards ($13 million) which first begin to expire in 2014.