Income Taxes

12 Months Ended

Dec. 31, 2014

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.

During the year ended December 31, 2013, IRS guidance was released which provided clarification regarding an APS tax accounting method change approved by the IRS in the third quarter of 2009. As a result of this guidance, uncertain tax positions decreased $67 million. Additionally, the IRS finalized the examination of tax returns for the years ended December 31, 2008 and 2009, which further reduced uncertain tax positions by approximately $41 million. These reductions in uncertain tax positions were materially offset by an increase in deferred tax liabilities.

Included in the current income tax receivable on the Consolidated Balance Sheets as of December 31, 2013 was $133 million that represented an anticipated IRS refund related to the finalized examinations of tax years ended December 31, 2008 and 2009. 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 require a tax accounting method change to be filed with the IRS prior to September 15, 2015, resulting in a tax-effected cumulative effect adjustment of approximately $82 million. The anticipated impact of these final regulations has been accounted for in the Consolidated Balance Sheets as of December 31, 2013 and 2014.

Net income associated with the Palo Verde sale leaseback VIEs is not subject to tax (see Note 18). 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):



	2014			2013			2012
Total unrecognized tax benefits, January 1	$	41,997		$	133,422		$	136,005
Additions for tax positions of the current year	4,309			3,516			5,167
Additions for tax positions of prior years	751			13,158			—
Reductions for tax positions of prior years for:
Changes in judgment	(2,282		)	(108,099		)	(7,729		)
Settlements with taxing authorities	—			—			—
Lapses of applicable statute of limitations	—			—			(21		)
Total unrecognized tax benefits, December 31	$	44,775		$	41,997		$	133,422

Included in the balances of unrecognized tax benefits at December 31, 2014, 2013 and 2012 were approximately $11 million, $10 million and $10 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, 2011 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 2008.

In January 2014, we prospectively adopted guidance requiring unrecognized tax benefits to be presented as a reduction to any available deferred income tax asset for a net operating loss, a similar tax loss, or a tax credit carryforward. As a result of this guidance, $26 million of unrecognized tax benefits were recorded as a reduction to net current deferred income tax assets on the Consolidated Balance Sheets as of December 31, 2014.

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 expense of $1 million for 2014, a pre-tax benefit of $4 million for 2013, and a pre-tax expense of $4 million for 2012.

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, 2014 and December 31, 2013 and $13 million as of December 31, 2012. To the extent that matters are settled favorably, this amount could reverse and decrease our effective tax rate. Additionally, as of December 31, 2014, we have recognized less than $1 million of interest expense to be paid on the underpayment 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,
	2014		2013			2012
Current:
Federal	$	25,054	$	(81,784	)	$	(3,493	)
State	10,382		10,537			8,395
Total current	35,436		(71,247		)	4,902
Deferred:
Federal	167,365		279,973			200,322
State	17,904		21,865			28,280
Total deferred	185,269		301,838			228,602
Total income tax expense	220,705		230,591			233,504
Less: income tax benefit on discontinued operations	—		—			(3,813		)
Income tax expense — continuing operations	$	220,705	$	230,591		$	237,317

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,
	2014			2013			2012
Federal income tax expense at 35% statutory rate	$	225,540		$	234,695		$	229,709
Increases (reductions) in tax expense resulting from:
State income tax net of federal income tax benefit	18,149			21,387			23,819
Credits and favorable adjustments related to prior years resolved in current year	—			(3,356		)	—
Medicare Subsidy Part-D	830			823			483
Allowance for equity funds used during construction (see Note 1)	(8,523		)	(6,997		)	(6,158		)
Palo Verde VIE noncontrolling interest (see Note 18)	(9,135		)	(11,862		)	(11,065		)
Investment tax credit amortization	(4,928		)	(3,548		)	(2,030		)
Other	(1,228		)	(551		)	2,559
Income tax expense — continuing operations	$	220,705		$	230,591		$	237,317

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



	December 31,
	2014			2013
Current asset	$	122,232		$	91,152
Long-term liability	(2,582,636		)	(2,351,882		)
Deferred income taxes — net	$	(2,460,404	)	$	(2,260,730	)

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, 2014, APS has recorded a regulatory liability of $74 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, 2014, 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,
	2014			2013
DEFERRED TAX ASSETS
Risk management activities	$	57,505		$	44,920
Regulatory liabilities:
Asset retirement obligation and removal costs	229,772			235,959
Unamortized investment tax credits	96,232			82,116
Other postretirement benefits	90,496			—
Other	60,409			42,609
Pension liabilities	205,227			140,773
Other postretirement liabilities	—			57,869
Renewable energy incentives	65,169			65,434
Credit and loss carryforwards	68,347			133,070
Other	138,729			148,492
Total deferred tax assets	1,011,886			951,242
DEFERRED TAX LIABILITIES
Plant-related	(2,958,369		)	(2,903,730		)
Risk management activities	(12,171		)	(16,191		)
Other postretirement assets	(59,170		)	—
Regulatory assets:
Allowance for equity funds used during construction	(48,286		)	(43,058		)
Deferred fuel and purchased power	(2,498		)	(8,282		)
Deferred fuel and purchased power — mark-to-market	(38,187		)	(13,343		)
Pension and other postretirement benefits	(191,747		)	(129,250		)
Retired power plant costs (see Note 3)	(57,255		)	(8,199		)
Other	(99,123		)	(85,003		)
Other	(5,484		)	(4,916		)
Total deferred tax liabilities	(3,472,290		)	(3,211,972		)
Deferred income taxes — net	$	(2,460,404	)	$	(2,260,730	)

As of December 31, 2014, the deferred tax assets for credit and loss carryforwards relate primarily to federal general business credits of approximately $90 million, which first begin to expire in 2031, and other federal and state loss carryforwards of $4 million, which first begin to expire in 2019. The credit and loss carryforwards amount above has been reduced by $26 million of unrecognized tax benefits as a result of the guidance adopted in January 2014, as disclosed above.

ARIZONA PUBLIC SERVICE COMPANY

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 $135 million current income tax receivable on APS’s Consolidated Balance Sheets as of December 31, 2013 represented an anticipated IRS refund related to the finalized examinations of tax years ended December 31, 2008 and 2009. 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 require a tax accounting method change to be filed with the IRS prior to September 15, 2015 resulting in a tax-effected cumulative effect adjustment of approximately $82 million. The anticipated impact of these final regulations has been accounted for in APS's Consolidated Balance Sheets as of December 31, 2013 and 2014.

Net income associated with the Palo Verde sale leaseback VIEs is not subject to tax (see Note 18). As a result, there is no income tax expense associated with the VIEs recorded on APS’s Consolidated Statements of Income.



	2014			2013			2012
Total unrecognized tax benefits, January 1	$	41,997		$	133,241		$	135,824
Additions for tax positions of the current year	4,309			3,516			5,167
Additions for tax positions of prior years	751			13,158			—
Reductions for tax positions of prior years for:
Changes in judgment	(2,282		)	(107,918		)	(7,729		)
Settlements with taxing authorities	—			—			—
Lapses of applicable statute of limitations	—			—			(21		)
Total unrecognized tax benefits, December 31	$	44,775		$	41,997		$	133,241

Included in the balance of unrecognized tax benefits at December 31, 2014, 2013 and 2012 were approximately $11 million, $10 million and $10 million, respectively, of tax positions that, if recognized, would decrease our effective tax rate.

In January 2014, we prospectively adopted guidance requiring unrecognized tax benefits to be presented as a reduction to any available deferred income tax asset for a net operating loss, a similar tax loss, or a tax credit carryforward. The adoption of this guidance did not have any impact on APS's Consolidated Balance Sheets as of December 31, 2014.

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 expense of $1 million for 2014, a pre-tax benefit of $4 million for 2013 and a pre-tax expense of $4 million for 2012.

The total amount of accrued liabilities for interest recognized in the Consolidated Balance Sheets related to unrecognized tax benefits was $1 million as of December 31, 2014, less than $1 million as of December 31, 2013 and $13 million as of December 31, 2012. To the extent that matters are settled favorably, this amount could be reversed and decrease our effective tax rate. Additionally, as of December 31, 2014, we have recognized less than $1 million of interest expense to be paid on the underpayment 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,
	2014		2013			2012
Current:
Federal	$	40,115	$	(97,531	)	$	(11,650	)
State	15,598		11,983			12,308
Total current	55,713		(85,548		)	658
Deferred:
Federal	165,027		305,389			216,367
State	16,620		25,254			27,371
Total deferred	181,647		330,643			243,738
Total income tax expense	$	237,360	$	245,095		$	244,396

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,
	2014			2013			2012
Federal income tax expense at 35% statutory rate	$	239,638		$	246,384		$	235,027
Increases (reductions) in tax expense resulting from:
State income tax net of federal income tax benefit	21,148			23,970			25,379
Credits and favorable adjustments related to prior years resolved in current year	—			(3,231		)	—
Medicare Subsidy Part-D	830			823			483
Allowance for equity funds used during construction (see Note 1)	(8,523		)	(6,997		)	(6,158		)
Palo Verde VIE noncontrolling interest (see Note 18)	(9,135		)	(11,862		)	(11,065		)
Investment tax credit amortization	(4,928		)	(3,548		)	(2,030		)
Other	(1,670		)	(444		)	2,760
Income tax expense	$	237,360		$	245,095		$	244,396

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



	December 31,
	2014			2013
Current asset (liability)	$	55,253		$	(2,033	)
Long-term liability	(2,571,365		)	(2,347,724		)
Deferred income taxes — net	$	(2,516,112	)	$	(2,349,757	)

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



	December 31,
	2014			2013
DEFERRED TAX ASSETS
Regulatory liabilities:
Asset retirement obligation and removal costs	$	229,772		$	235,959
Unamortized investment tax credits	96,232			82,116
Other postretirement benefits	90,496			—
Other	60,409			42,609
Risk management activities	57,505			44,920
Pension liabilities	194,541			132,263
Other postretirement liabilities	—			53,950
Renewable energy incentives	65,169			65,434
Credit and loss carryforwards	—			38,183
Other	161,379			166,781
Total deferred tax assets	955,503			862,215
DEFERRED TAX LIABILITIES
Plant-related	(2,958,369		)	(2,903,730		)
Risk management activities	(12,171		)	(16,191		)
Other postretirement benefit assets	(58,495		)	—
Regulatory assets:
Allowance for equity funds used during construction	(48,286		)	(43,058		)
Deferred fuel and purchased power	(2,498		)	(8,282		)
Deferred fuel and purchased power — mark-to-market	(38,187		)	(13,343		)
Pension and other postretirement benefits	(191,747		)	(129,250		)
Retired power plant costs (see Note 3)	(57,255		)	(8,199		)
Other	(99,123		)	(85,003		)
Other	(5,484		)	(4,916		)
Total deferred tax liabilities	(3,471,615		)	(3,211,972		)
Deferred income taxes — net	$	(2,516,112	)	$	(2,349,757	)

- 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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