7. Income Taxes

COLI - In 2007, Xcel Energy Inc., PSCo and the U.S. government settled an ongoing dispute regarding PSCo's right to deduct interest expense on policy loans related to its COLI program that insured lives of certain PSCo employees. These COLI policies were owned and managed by PSRI. Xcel Energy Inc. and PSCo paid the U.S. government a total of $64.4 million in settlement of the U.S. government's claims for tax, penalty and interest for tax years 1993 through 2007. Xcel Energy Inc. and PSCo surrendered the policies to its insurer on Oct. 31, 2007, without recognizing a taxable gain. As a result of the settlement, the lawsuit filed by Xcel Energy Inc. and PSCo in the U.S. District Court was dismissed and the Tax Court proceedings were dismissed in December 2010 and January 2011.

As part of the Tax Court proceedings, during 2010, an agreement in principle of Xcel Energy Inc.'s and PSCo's statements of account was reached, dating back to tax year 1993. Upon completion of this review, PSRI recorded a net non-recurring tax and interest charge of approximately $9.4 million. Upon final cash settlement in 2011, Xcel Energy received $0.7 million and recognized a further reduction of expense of $0.3 million. A closing agreement covering tax years 2003 through 2007 was finalized with the IRS in January 2012.

In 2010, Xcel Energy Inc., PSCo and PSRI entered into a settlement agreement with Provident related to all claims asserted by Xcel Energy Inc., PSCo and PSRI against Provident in a lawsuit associated with the discontinued COLI program. Under the terms of the settlement, Xcel Energy Inc., PSCo and PSRI were paid $25 million by Provident and Reassure America Life Insurance Company in 2010. The $25 million proceeds were not subject to income taxes.

Medicare Part D Subsidy Reimbursements - In March 2010, the Patient Protection and Affordable Care Act was signed into law. The law includes provisions to generate tax revenue to help offset the cost of the new legislation. One of these provisions reduces the deductibility of retiree health care costs to the extent of federal subsidies received by plan sponsors that provide retiree prescription drug benefits equivalent to Medicare Part D coverage, beginning in 2013. Based on this provision, PSCo became subject to additional taxes and was required to reverse previously recorded tax benefits in the period of enactment. As a result, PSCo expensed approximately $9.9 million of previously recognized tax benefits relating to Medicare Part D subsidies during the first quarter of 2010. PSCo does not expect the $9.9 million of additional tax expense to recur in future periods.

Federal Audit - PSCo is a member of the Xcel Energy affiliated group that files a consolidated federal income tax return. The statute of limitations applicable to Xcel Energy's 2007 federal income tax return expired in September 2011. The statute of limitations applicable to Xcel Energy's 2008 federal income tax return expires in September 2012. The IRS commenced an examination of tax years 2008 and 2009 in the third quarter of 2010. In December 2011, Xcel Energy finalized the Revenue Agent Report and signed the Waiver of Assessment for tax years 2008 and 2009. The total assessment for these tax years was $1.4 million, including tax and interest.

State Audits - PSCo is a member of the Xcel Energy affiliated group that files consolidated state income tax returns. As of Dec. 31, 2011, PSCo's earliest open tax year that is subject to examination by state taxing authorities under applicable statutes of limitations is 2006. As of Dec. 31, 2011, there were no state income tax audits in progress.

Unrecognized Tax Benefits -The unrecognized tax benefit balance includes permanent tax positions, which if recognized would affect the annual ETR. In addition, the unrecognized tax benefit balance includes temporary tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. A change in the period of deductibility would not affect the ETR but would accelerate the payment of cash to the taxing authority to an earlier period.

A reconciliation of the amount of unrecognized tax benefit is as follows:

(Millions of Dollars)	Dec. 31, 2011		Dec. 31, 2010
Unrecognized tax benefit - Permanent tax positions	$	0.5	$	1.3
Unrecognized tax benefit - Temporary tax positions		10.9		10.3
Unrecognized tax benefit balance	$	11.4	$	11.6

A reconciliation of the beginning and ending amount of unrecognized tax benefit is as follows:

(Millions of Dollars)	2011			2010			2009
Balance at Jan. 1	$	11.6		$	7.2		$	10.3
Additions based on tax positions related to the current year		3.4			4.1			3.7
Reductions based on tax positions related to the current year		(0.8	)		(0.2	)		(0.3	)
Additions for tax positions of prior years		5.8			1.6			2.2
Reductions for tax positions of prior years		(0.9	)		(1.1	)		(0.5	)
Settlements with taxing authorities		(7.7	)		-			(8.2	)
Balance at Dec. 31	$	11.4		$	11.6		$	7.2

The unrecognized tax benefit amounts were reduced by the tax benefits associated with NOL and tax credit carryforwards. The amounts of tax benefits associated with NOL and tax credit carryfowards are as follows:

(Millions of Dollars)		Dec. 31, 2011				Dec. 31, 2010
NOL and tax credit carryforwards		$	(3.7	)		$	(7.2	)

The decrease in the unrecognized tax benefit balance of $0.2 million in 2011 was due to the resolution of certain federal audit matters, partially offset by an increase due to the addition of uncertain tax positions related to current and prior years' activity. PSCo's amount of unrecognized tax benefits could change in the next 12 months as the IRS and state audits resume. At this time, due to the uncertain nature of the audit process, it is not reasonably possible to estimate an overall range of possible change. However, PSCo does not anticipate total unrecognized tax benefits will significantly change within the next 12 months.

The payable for interest related to unrecognized tax benefits is partially offset by the interest benefit associated with NOL and tax credit carryforwards. A reconciliation of the beginning and ending amount of the payable for interest related to unrecognized tax benefits is as follows:

(Millions of Dollars)	2011			2010			2009
Payable for interest related to unrecognized tax benefits at Jan. 1	$	(0.1	)	$	(0.1	)	$	(0.4	)
Interest (expense) income related to unrecognized tax benefits		(0.2	)		-			0.3
Payable for interest related to unrecognized tax benefits at Dec. 31	$	(0.3	)	$	(0.1	)	$	(0.1	)

No amounts were accrued for penalties related to unrecognized tax benefits as of Dec. 31, 2011, 2010 or 2009.

Other Income Tax Matters - NOL amounts represent the amount of the tax loss that is carried forward and tax credits represent the deferred tax asset. NOL and tax credit carryforwards as of Dec. 31 were as follows:

(Millions of Dollars)	2011		2010
Federal NOL carryforward	$	391.6	$	150.5
Federal tax credit carryforwards		15.5		14.6
State NOL carryforward		566.8		298.2
State tax credit carryforwards, net of federal detriment		9.4		8.4

The federal carryforward periods expire between 2021 and 2031. The state carryforward periods expire between 2012 and 2031.

Total income tax expense from operations differs from the amount computed by applying the statutory federal income tax rate to income before income tax expense. The following reconciles such differences for the years ending Dec. 31:

	2011			2010			2009
Federal statutory rate		35.0	%		35.0	%		35.0	%
Increases (decreases) in tax from:
State income taxes, net of federal income tax benefit		2.1			1.1			3.3
Resolution of income tax audits and other		0.4			1.2			0.1
Tax credits recognized, net of federal income tax expense		(0.8	)		(0.8	)		(1.0	)
Regulatory differences - utility plant items		(0.2	)		(0.5	)		(2.7	)
Change in unrecognized tax benefits		(0.1	)		-			(0.1	)
Previously recognized Medicare Part D subsidies		(0.1	)		1.6			-
Life insurance policies		-			(1.4	)		-
Other, net		0.2			0.2			(0.1	)
Effective income tax rate		36.5	%		36.4	%		34.5	%

The components of income tax expense for the years ending Dec. 31 were:

(Thousands of Dollars)	2011			2010			2009
Current federal tax expense (benefit)	$	1,889		$	76,228		$	(20,867	)
Current state tax benefit		(796	)		(461	)		(2,327	)
Current change in unrecognized tax expense (benefit)		3,326			1,246			(1,374	)
Deferred federal tax expense		208,481			147,704			172,454
Deferred state tax expense		24,894			11,180			27,508
Deferred change in unrecognized tax (benefit) expense		(4,059	)		(920	)		864
Deferred tax credits		(2,761	)		(3,103	)		(3,478	)
Deferred investment tax credits		(2,613	)		(2,693	)		(2,375	)
Total income tax expense	$	228,361		$	229,181		$	170,405

The components of deferred income tax expense for the years ending Dec. 31 were:

(Thousands of Dollars)	2011			2010			2009
Deferred tax expense excluding items below	$	216,393		$	160,543		$	224,484
Tax benefit (expense) allocated to other comprehensive income and other		12,149			393			(298	)
Amortization and adjustments to deferred income taxes on income tax regulatory assets and liabilities		(1,987	)		(6,075	)		(26,838	)
Deferred tax expense	$	226,555		$	154,861		$	197,348

The components of the net deferred tax liability (current and noncurrent) at Dec. 31 were as follows:

(Thousands of Dollars)	2011		2010
Deferred tax liabilities:
Difference between book and tax bases of property	$	1,823,058	$	1,527,296
Employee benefits		130,544		105,578
Other		113,489		122,856
Total deferred tax liabilities	$	2,067,091	$	1,755,730
Deferred tax assets:
NOL carryforward	$	169,688	$	73,948
Unbilled revenue - fuel costs		61,118		59,182
Tax credit carryforward		24,972		22,983
Deferred investment tax credits		16,985		17,989
Regulatory liabilities		14,693		18,249
Litigation reserve		258		11,433
Other		37,278		26,240
Total deferred tax assets	$	324,992	$	230,024
Net deferred tax liability	$	1,742,099	$	1,525,706