Income Taxes

6 Months Ended

Jun. 30, 2012

Income Taxes

(11) INCOME TAXES

A reconciliation of PHI’s consolidated effective income tax rate from continuing operations is as follows:

	Three Months Ended June 30,										Six Months Ended June 30,
	2012					2011					2012					2011
	(millions of dollars)
Income tax at Federal statutory rate	$	34		35.0	%	$	52		35.0	%	$	63		35.0	%	$	86		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		5		5.3			6		4.0			10		5.4			11		4.5
Asset removal costs		(4	)	(4.0	)		(2	)	(1.3	)		(7	)	(3.8	)		(3	)	(1.2	)
Change in estimates and interest related to uncertain and effectively settled tax positions		3		2.8			(17	)	(11.4	)		(10	)	(5.8	)		(15	)	(6.1	)
Cross-border energy lease investments		(1	)	(1.1	)		21		14.1			(2	)	(1.2	)		20		8.2
State tax benefit related to prior years’ asset dispositions		—		—			(4	)	(2.7	)		—		—			(4	)	(1.6	)
Other, net		(2	)	(1.9	)		(2	)	(1.5	)		(5	)	(2.2	)		(7	)	(2.9	)
Consolidated income tax expense related to continuing operations	$	35		36.1	%	$	54		36.2	%	$	49		27.4	%	$	88		35.9	%

Three Months Ended June 30, 2012 and 2011

PHI’s consolidated effective tax rates for the three months ended June 30, 2012 and 2011 were 36.1% and 36.2%, respectively. The effective tax rates for the three months ended June 30, 2012 and 2011 were substantially the same, however, the rate for 2011 reflects the reversal of income tax benefits associated with cross-border energy lease investments in the second quarter of 2011, offset by benefits recorded in 2011 in connection with estimates and interest related to uncertain and effectively settled tax positions, as described further below.

As discussed further in Note (8), “Leasing Activities,” during the second quarter of 2011, PHI terminated its interest in certain cross-border energy leases early. As a result of the early terminations, PHI reversed $22 million of previously recognized income tax benefits associated with those leases which will not be realized due to the early termination.

In the second quarter of 2011, PHI reached a settlement with the Internal Revenue Service (IRS) with respect to interest due on its federal tax liabilities related to the tax years 1996 through 2002. In connection with this agreement, PHI reallocated certain amounts that had been on deposit with the IRS since 2006 among liabilities in the settlement years and subsequent years. Primarily related to the settlement and reallocations, PHI recorded an additional tax benefit in the amount of $17 million (after-tax) in the second quarter of 2011.

Also in the second quarter of 2011, PHI received refunds of approximately $5 million and recorded tax benefits of approximately $4 million (after-tax) related to the filing of amended state tax returns. These amended returns reduced state taxable income due to an increase in tax basis reported on certain prior years’ asset dispositions.

Six Months Ended June 30, 2012 and 2011

PHI’s consolidated effective tax rates for the six months ended June 30, 2012 and 2011 were 27.4% and 35.9%, respectively. The lower effective tax rate for the six months ended June 30, 2012 was primarily a result of the reversal of income tax benefits associated with cross-border energy lease investments in the second quarter of 2011, as discussed above. The rate was further decreased by an increase in deductible asset removal costs for Pepco in 2012 related to a higher level of asset retirements. The decrease in the effective tax rate for the six months ended June 30, 2012 was partially offset by lower benefits recorded in 2012 in connection with estimates and interest related to uncertain and effectively settled tax positions as discussed below.

In the first quarter of 2012, PHI recorded income tax benefits related to uncertain and effectively settled tax positions, primarily due to the effective settlement with the IRS with respect to the methodology used historically to calculate deductible mixed service costs and the expiration of the statute of limitations associated with an uncertain tax position in Pepco. In contrast, during the six months ended June 30, 2011, PHI recorded a $17 million benefit, primarily resulting from the settlement with the IRS on interest due on its 1996 through 2002 tax years discussed above, and the $4 million state tax benefit related to prior years’ asset dispositions.

Potomac Electric Power Co [Member]

Income Taxes

(9) INCOME TAXES

A reconciliation of Pepco’s effective income tax rate is as follows:

	Three Months Ended June 30,										Six Months Ended June 30,
	2012					2011					2012					2011
						(millions of dollars)
Income tax at Federal statutory rate	$	12		35.0	%	$	12		35.0	%	$	19		35.0	%	$	21		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		2		5.6			2		4.7			3		5.7			3		4.6
Asset removal costs		(4	)	(11.5	)		(2	)	(4.4	)		(7	)	(12.8	)		(3	)	(4.2	)
Change in estimates and interest related to uncertain and effectively settled tax positions		(1	)	(3.5	)		(4	)	(12.1	)		(11	)	(20.2	)		(4	)	(6.6	)
Permanent differences related to deferred compensation funding		—		(0.9	)		—		(1.2	)		(1	)	(0.9	)		(2	)	(2.5	)
State tax benefit related to prior years’ asset dispositions		—		—			(4	)	(12.4	)		—		—			(4	)	(7.1	)
Other, net		(1	)	(1.8	)		(2	)	(3.8	)		—		(1.2	)		(2	)	(3.9	)
Income tax expense	$	8		22.9	%	$	2		5.8	%	$	3		5.6	%	$	9		15.3	%

Three Months Ended June 30, 2012 and 2011

Pepco’s effective tax rates for the three months ended June 30, 2012 and 2011 were 22.9% and 5.8%, respectively. The increase in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions and refunds received on amended state tax returns in 2011 related to prior years’ asset dispositions.

In the second quarter of 2011, PHI reached a settlement with the Internal Revenue Service (IRS) with respect to interest due on its federal tax liabilities related to the tax years 1996 through 2002. In connection with this agreement, PHI reallocated certain amounts that have been on deposit with the IRS since 2006 among liabilities in the settlement years and subsequent years. Primarily related to the settlement and reallocations, Pepco recorded an additional tax benefit in the amount of $5 million (after-tax) in the second quarter of 2011.

Also in the second quarter of 2011, Pepco received refunds of approximately $5 million and recorded tax benefits of approximately $4 million (after-tax) related to the filing of amended state tax returns. These amended returns reduced state taxable income due to an increase in tax basis on certain prior years’ asset dispositions.

Six Months Ended June 30, 2012 and 2011

Pepco’s effective tax rates for the six months ended June 30, 2012 and 2011 were 5.6% and 15.3%, respectively. The decrease in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions, partially offset by the state tax benefit recorded in 2011 related to prior years’ asset dispositions. The effective rate was further decreased as a result of the increase in asset removal costs in 2012 primarily related to a higher level of asset retirements.

In the first quarter of 2012, Pepco recorded income tax benefits related to uncertain and effectively settled tax positions primarily due to the effective settlement with the IRS with respect to the methodology used historically to calculate deductible mixed service costs and the expiration of the statute of limitations associated with an uncertain tax position.

In the second quarter of 2011, Pepco recorded a $5 million interest benefit from the reallocation of its deposits and a $4 million tax benefit related to the filing of amended state tax returns, as discussed above.

Further, in March of 2011, Pepco accrued $3 million related to proceeds from life insurance policies on a former executive. This income is not taxable and is included in the permanent differences related to deferred compensation funding.

Delmarva Power & Light Co/De [Member]

Income Taxes

(10) INCOME TAXES

A reconciliation of DPL’s effective income tax rate is as follows:

	Three Months Ended June 30,									Six Months Ended June 30,
	2012				2011					2012				2011
	(millions of dollars)
Income tax at Federal statutory rate	$	8	35.0	%	$	10		35.0	%	$	20	35.0	%	$	24		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		1	5.1			1		5.2			3	5.4			4		6.0
Change in estimates and interest related to uncertain and effectively settled tax positions		—	—			(5	)	(18.5	)		—	(0.2	)		(5	)	(7.5	)
Deferred tax adjustment		—	—			(1	)	(3.7	)		—	—			(1	)	(1.5	)
Depreciation		—	0.5			1		3.7			—	—			1		1.5
Other, net		—	0.3			(1	)	(3.2	)		—	0.2			(1	)	(0.7	)
Income tax expense	$	9	40.9	%	$	5		18.5	%	$	23	40.4	%	$	22		32.8	%

Three Months Ended June 30, 2012 and 2011

DPL’s effective tax rates for the three months ended June 30, 2012 and 2011 were 40.9% and 18.5%, respectively. The increase in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions as discussed below.

During the second quarter of 2011, PHI reached a settlement with the Internal Revenue Service (IRS) with respect to interest due on its federal tax liabilities related to the tax years 1996 through 2002. In connection with this agreement, PHI reallocated certain amounts that have been on deposit with the IRS since 2006 among liabilities in the settlement years and subsequent years. Primarily related to the settlement and reallocations, DPL recorded an additional $4 million (after-tax) interest benefit in the second quarter of 2011. Also during the second quarter of 2011, DPL completed a reconciliation of its deferred taxes on certain regulatory assets and, as a result, recorded a $1 million decrease to income tax expense as shown in the “Deferred tax adjustment” line above.

Six Months Ended June 30, 2012 and 2011

DPL’s effective tax rates for the six months ended June 30, 2012 and 2011 were 40.4% and 32.8%, respectively. The increase in the effective tax rate resulted from changes in estimates and interest related to uncertain and effectively settled tax positions, primarily related to the additional $4 million interest benefit in 2011 from the reallocation of deposits discussed above.

Atlantic City Electric Co [Member]

Income Taxes

(9) INCOME TAXES

A reconciliation of ACE’s consolidated effective income tax rate is as follows:

	Three Months Ended June 30,								Six Months Ended June 30,
	2012				2011				2012					2011
	(millions of dollars)
Income tax at Federal statutory rate	$	8	35.0	%	$	11	35.0	%	$	8		35.0	%	$	15		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		1	4.2			2	6.6			1		4.0			3		7.0
Change in estimates and interest related to uncertain and effectively settled tax positions		—	0.8			—	1.3			(1	)	(4.0	)		1		1.4
Deferred tax adjustment		—	—			1	3.1			—		(0.4	)		1		2.3
Other, net		—	(0.9	)		—	(2.2	)		—		(1.3	)		(1	)	(1.5	)
Consolidated income tax expense	$	9	39.1	%	$	14	43.8	%	$	8		33.3	%	$	19		44.2	%

Three Months ended June 30, 2012 and 2011

ACE’s consolidated effective tax rates for the three months ended June 30, 2012 and 2011 were 39.1% and 43.8%, respectively. During the second quarter of 2011, PHI reached a settlement with the Internal Revenue Service (IRS) with respect to interest due on its federal tax liabilities related to the tax years 1996 through 2002. In connection with this agreement, PHI reallocated certain amounts that have been on deposit with the IRS since 2006 among liabilities in the settlement years and subsequent years. Primarily related to the settlement and reallocations, ACE recorded an additional $1 million (after-tax) of interest due to the IRS in the second quarter of 2011. Also during the second quarter of 2011, ACE completed a reconciliation of its deferred taxes on certain regulatory assets and, as a result, recorded a $1 million increase to income tax expense as shown in the “Deferred Tax Adjustment” line above.

Six Months ended June 30, 2012 and 2011

ACE’s consolidated effective tax rates for the six months ended June 30, 2012 and 2011 were 33.3% and 44.2%, respectively. The decrease in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions during 2012, primarily due to the effective settlement with the Internal Revenue Service with respect to the methodology used historically to calculate deductible mixed service costs.