Income Taxes (APSC)

12 Months Ended

Dec. 31, 2013

4. Income Taxes

Certain assets and liabilities are reported differently for income tax purposes than they are for financial statement purposes. The tax effect of these differences is recorded as deferred taxes. We calculate deferred taxes using 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 ITCs 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 $70 million long-term income tax receivable on the Consolidated Balance Sheets as of December 31, 2012 represented the anticipated refund related to an APS tax accounting method change approved by the IRS in the third quarter of 2009. On July 9, 2013, IRS guidance was released which provided clarification regarding the timing and amount of this cash receipt. As a result of this guidance, uncertain tax positions decreased $67 million during the third quarter. This decrease in uncertain tax positions resulted in a corresponding increase to the total anticipated refund due from the IRS and an offsetting increase in long-term deferred tax liabilities. Additionally, as a result of this IRS guidance, the resulting $137 million anticipated refund was reclassified to current income tax receivable.

During the year ended December 31, 2013, the IRS finalized the examination of tax returns for the years ended December 31, 2008 and 2009, and the $137 million anticipated refund was reduced by approximately $4 million to reflect the outcome of this examination. On December 17, 2013, the Joint Committee on Taxation approved the anticipated refund. Cash related to this refund was received in the first quarter of 2014.

On September 13, 2013, the U.S. Treasury Department released final income tax regulations on the deduction and capitalization of expenditures related to tangible property. These final regulations apply to tax years beginning on or after January 1, 2014. Several of the provisions within the regulations will require a tax accounting method change to be filed with the IRS, resulting in a cumulative effect adjustment. To account for the adoption of these regulations, plant-related long-term deferred tax liabilities decreased by $84 million, with the offsetting decrease to current deferred income tax assets. Prior to the issuance of these regulations, this $84 million would have been repaid over 20 years through lower tax depreciation deductions.

Net income associated with the Palo Verde sale leaseback VIEs is not subject to tax (see Note 19). As a result, there is no income tax expense associated with the VIEs recorded on the Consolidated Statements of Income.

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):

	2013			2012			2011
Total unrecognized tax benefits, January 1	$	133,422		$	136,005		$	127,595
Additions for tax positions of the current year	3,516			5,167			10,915
Additions for tax positions of prior years	13,158			—			—
Reductions for tax positions of prior years for:
Changes in judgment	(108,099		)	(7,729		)	(1,555		)
Settlements with taxing authorities	—			—			(124		)
Lapses of applicable statute of limitations	—			(21		)	(826		)
Total unrecognized tax benefits, December 31	$	41,997		$	133,422		$	136,005

Included in the balances of unrecognized tax benefits at December 31, 2013, 2012 and 2011 were approximately $10 million, $10 million and $8 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, 2010 and all subsequent tax years remain subject to examination by the IRS. With a few exceptions, we are no longer subject to state income tax examinations by tax authorities for years before 2010.

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 Statements of Income related to unrecognized tax benefits was a pre-tax benefit of $4 million for 2013, a pre-tax expense of $4 million for 2012, and a pre-tax expense of $3 million for 2011.

The total amount of accrued liabilities for interest recognized in the Consolidated Balance Sheets related to unrecognized tax benefits was less than $1 million as of December 31, 2013, $13 million as of December 31, 2012 and $9 million as of December 31, 2011. To the extent that matters are settled favorably, this amount could reverse and decrease our effective tax rate. Additionally, as of December 31, 2013, we have recognized $5 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,
	2013			2012			2011
Current:
Federal	$	(81,784	)	$	(3,493	)	$	(310	)
State	10,537			8,395			15,140
Total current	(71,247		)	4,902			14,830
Deferred:
Federal	279,973			200,322			159,566
State	21,865			28,280			16,626
Total deferred	301,838			228,602			176,192
Total income tax expense	230,591			233,504			191,022
Less: income tax expense (benefit) on discontinued operations	—			(3,813		)	7,418
Income tax expense — continuing operations	$	230,591		$	237,317		$	183,604

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,
	2013			2012			2011

Federal income tax expense at 35% statutory rate	$	234,695		$	229,709		$	188,733
Increases (reductions) in tax expense resulting from:
State income tax net of federal income tax benefit	21,387			23,819			19,594
Credits and favorable adjustments related to prior years resolved in current year	(3,356		)	—			—
Medicare Subsidy Part-D	823			483			823
Allowance for equity funds used during construction (see Note 1)	(6,997		)	(6,158		)	(6,881		)
Palo Verde VIE noncontrolling interest (see Note 19)	(11,862		)	(11,065		)	(9,636		)
Other	(4,099		)	529			(9,029		)
Income tax expense — continuing operations	$	230,591		$	237,317		$	183,604

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

	December 31,
	2013			2012
Current asset	$	91,152		$	152,191
Long-term liability	(2,351,882		)	(2,151,371		)
Deferred income taxes — net	$	(2,260,730	)	$	(1,999,180	)

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. As of December 31, 2013 APS has recorded a regulatory liability of $75 million, with a corresponding decrease in accumulated deferred income tax liabilities, to reflect the impact of this change in tax law.

On April 4, 2013, New Mexico enacted legislation (H.B. 641) that included a five-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 New Mexico. In accordance with accounting for regulated companies, the benefit of this rate reduction is substantially offset by a regulatory liability. As of December 31, 2013, APS has recorded a regulatory liability of $2 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,
	2013			2012
DEFERRED TAX ASSETS
Risk management activities	$	44,920		$	72,243
Regulatory liabilities:
Asset retirement obligation and removal costs	235,959			238,669
Unamortized investment tax credits	82,116			53,837
Other	42,609			33,764
Pension and other postretirement liabilities	198,642			408,764
Renewable energy incentives	65,434			66,941
Credit and loss carryforwards	133,070			139,022
Other	148,492			68,844
Total deferred tax assets	951,242			1,082,084
DEFERRED TAX LIABILITIES
Plant-related	(2,903,730		)	(2,584,166		)
Risk management activities	(16,191		)	(23,940		)
Regulatory assets:
Allowance for equity funds used during construction	(43,058		)	(37,899		)
Deferred fuel and purchased power	(8,282		)	(28,858		)
Deferred fuel and purchased power — mark-to-market	(13,343		)	(15,796		)
Pension and other postretirement benefits	(129,250		)	(316,757		)
Other	(93,202		)	(68,170		)
Other	(4,916		)	(5,678		)
Total deferred tax liabilities	(3,211,972		)	(3,081,264		)
Deferred income taxes — net	$	(2,260,730	)	$	(1,999,180	)

As of December 31, 2013, the deferred tax assets for credit and loss carryforwards relate to federal general business credits of $131 million which first begin to expire in 2031, and other federal and state loss carryforwards of $2 million which first begin to expire in 2018.

ARIZONA PUBLIC SERVICE COMPANY

Income Taxes

S-1. Income Taxes

APS is included in Pinnacle West’s consolidated tax return. However, when Pinnacle West allocates income taxes to APS, it is done based upon APS’s taxable income computed on a stand-alone basis, in accordance with the tax sharing agreement.

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 currently enacted tax rates.

In accordance with regulatory requirements, APS ITCs 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 $71 million long-term income tax receivable on APS’s Consolidated Balance Sheets as of December 31, 2012 represented the anticipated refund related to an APS tax accounting method change approved by the IRS in the third quarter of 2009. On July 9, 2013, IRS guidance was released which provided clarification regarding the timing and amount of this cash receipt. As a result of this guidance, uncertain tax positions decreased $67 million during the third quarter. This decrease in uncertain tax positions resulted in a corresponding increase to the total anticipated refund due from the IRS and an offsetting increase in long-term deferred tax liabilities. Additionally, as a result of this IRS guidance, the $138 million anticipated refund was reclassified to current income tax receivable.

During the year ended December 31, 2013, the IRS finalized the examination of tax returns for the years ended December 31, 2008 and 2009, and the $138 million anticipated refund was reduced by approximately $2 million to reflect the outcome of this examination. On December 17, 2013, the Joint Committee on Taxation approved the anticipated refund. Cash related to this refund was received in the first quarter of 2014.

On September 13, 2013, the U.S. Treasury Department released final income tax regulations on the deduction and capitalization of expenditures related to tangible property. These final regulations apply to tax years beginning on or after January 1, 2014. Several of the provisions within the regulations will require a tax accounting method change to be filed with the IRS resulting in a cumulative effect adjustment. To account for the adoption of these regulations plant-related long-term deferred tax liabilities decreased by $84 million, with the offsetting decrease to current deferred income tax assets. Prior to the issuance of these regulations, this $84 million would have been repaid over 20 years through lower tax depreciation deductions.

Net income associated with the Palo Verde sale leaseback VIEs is not subject to tax (see Note 19). As a result, there is no income tax expense associated with the VIEs recorded on APS’s Consolidated Statements of Income.

	2013			2012			2011
Total unrecognized tax benefits, January 1	$	133,241		$	135,824		$	126,698
Additions for tax positions of the current year	3,516			5,167			10,915
Additions for tax positions of prior years	13,158			—			—
Reductions for tax positions of prior years for:
Changes in judgment	(107,918		)	(7,729		)	(1,555		)
Settlements with taxing authorities	—			—			(124		)
Lapses of applicable statute of limitations	—			(21		)	(110		)
Total unrecognized tax benefits, December 31	$	41,997		$	133,241		$	135,824

Included in the balance of unrecognized tax benefits at December 31, 2013, 2012 and 2011 were approximately $10 million, $10 million and $8 million, respectively, of tax positions that, if recognized, would decrease our effective tax rate.

We reflect interest and penalties, if any, on unrecognized tax benefits in the Statements of Income as income tax expense. The amount of interest recognized in the Statements of Income related to unrecognized tax benefits was a pre-tax benefit of $4 million for 2013, a pre-tax expense of $4 million for 2012 and a pre-tax expense of $3 million for 2011.

The total amount of accrued liabilities for interest recognized in the Balance Sheets related to unrecognized tax benefits was less than $1 million as of December 31, 2013, $13 million as of December 31, 2012 and $9 million as of December 31, 2011. To the extent that matters are settled favorably, this amount could be reversed and decrease our effective tax rate. Additionally, as of December 31, 2013, we have recognized $5 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 APS’s income tax expense are as follows (dollars in thousands):

	Year Ended December 31,
	2013			2012			2011
Current:
Federal	$	(97,531	)	$	(11,650	)	$	4,633
State	11,983			12,308			19,104
Total current	(85,548		)	658			23,737
Deferred:
Federal	305,389			216,367			154,632
State	25,254			27,371			14,173
Total deferred	330,643			243,738			168,805
Total income tax expense	$	245,095		$	244,396		$	192,542

On the APS Statements of Income, federal and state income taxes are allocated between operating income and other income.

The following chart compares APS’s pretax income at the 35% federal income tax rate to income tax expense (dollars in thousands):

	Year Ended December 31,
	2013			2012			2011

Federal income tax expense at 35% statutory rate	$	246,384		$	235,027		$	194,710
Increases (reductions) in tax expense resulting from:
State income tax net of federal income tax benefit	23,970			25,379			21,139
Credits and favorable adjustments related to prior years resolved in current year	(3,231		)	—			—
Medicare Subsidy Part-D	823			483			823
Allowance for equity funds used during construction (see Note 1)	(6,997		)	(6,158		)	(6,880		)
Palo Verde VIE noncontrolling interest (see Note 19)	(11,862		)	(11,065		)	(9,633		)
Other	(3,992		)	730			(7,617		)
Income tax expense	$	245,095		$	244,396		$	192,542

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

	December 31,
	2013			2012
Current asset (liability)	$	(2,033	)	$	74,420
Long-term liability	(2,347,724		)	(2,133,976		)
Deferred income taxes — net	$	(2,349,757	)	$	(2,059,556	)

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. As of December 31, 2013, APS has recorded a regulatory liability of $75 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,
	2013			2012
DEFERRED TAX ASSETS
Regulatory liabilities:
Asset retirement obligation and removal costs	$	235,959		$	238,669
Unamortized investment tax credits	82,116			53,837
Other	42,609			33,764
Risk management activities	44,920			72,243
Pension and other postretirement liabilities	186,213			392,486
Renewable energy incentives	65,434			66,941
Credit and loss carryforwards	38,183			52,441
Other	166,781			111,327
Total deferred tax assets	862,215			1,021,708
DEFERRED TAX LIABILITIES
Plant-related	(2,903,730		)	(2,584,166		)
Risk management activities	(16,191		)	(23,940		)
Regulatory assets:
Allowance for equity funds used during construction	(43,058		)	(37,899		)
Deferred fuel and purchased power	(8,282		)	(28,858		)
Deferred fuel and purchased power — mark-to-market	(13,343		)	(15,796		)
Pension and other postretirement benefits	(129,250		)	(316,757		)
Other	(93,202		)	(68,170		)
Other	(4,916		)	(5,678		)
Total deferred tax liabilities	(3,211,972		)	(3,081,264		)
Deferred income taxes — net	$	(2,349,757	)	$	(2,059,556	)

As of December 31, 2013, the deferred tax assets for credit and loss carryforwards relate primarily to federal general business credits which first begin to expire in 2031.

- Definition

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

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