Income Taxes

9 Months Ended

Sep. 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 September 30,										Nine Months Ended September 30,
	2012					2011					2012					2011
	(millions of dollars)
Income tax at Federal statutory rate	$	72		35.0	%	$	47		35.0	%	$	134		35.0	%	$	133		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		9		4.4			9		6.7			19		5.0			19		5.0
Asset removal costs		(1	)	(0.5	)		(2	)	(1.5	)		(8	)	(2.1	)		(4	)	(1.1	)
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			5		3.7			(10	)	(2.6	)		(11	)	(2.9	)
Cross-border energy lease investments		15		7.3			(5	)	(3.7	)		13		3.4			15		3.9
Other, net		(2	)	(0.8	)		1		0.5			(6	)	(1.7	)		(9	)	(2.3	)
Consolidated income tax expense related to continuing operations	$	93		45.4	%	$	55		40.7	%	$	142		37.0	%	$	143		37.6	%

Three Months Ended September 30, 2012 and 2011

PHI’s consolidated effective income tax rates for the three months ended September 30, 2012 and 2011 were 45.4% and 40.7%, respectively. The increase in the effective rate for the three months ended September 30, 2012 primarily reflects the reversal of income tax benefits associated with cross-border energy lease investments in the third quarter of 2012, partially offset by changes in estimates and interest related to uncertain and effectively settled tax positions recorded in 2011.

As discussed further in Note (8), “Leasing Activities,” during the third quarter of 2012, PHI terminated early its interest in certain cross-border energy leases. As a result of the early terminations, PHI reversed $16 million of previously recognized income tax benefits which will not be realized due to the early termination.

Nine Months Ended September 30, 2012 and 2011

PHI’s consolidated effective income tax rates for the nine months ended September 30, 2012 and 2011 were 37.0% and 37.6%, respectively. The effective income tax rates for the nine months ended September 30, 2012 and 2011 reflect the reversal of income tax benefits associated with the early termination of cross-border energy leases in the third quarter of 2012 and in the second quarter of 2011 of $16 million and $22 million, respectively, as discussed in Note (8), “Leasing Activities.”

In addition, the effective income tax rate for the nine months ended September 30, 2012 includes income tax benefits of $10 million related to uncertain and effectively settled tax positions, primarily due to the effective settlement with the Internal Revenue Service (IRS) in the first quarter of 2012 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. During the nine months ended September 30, 2011, PHI recorded tax benefits of $11 million related to uncertain and effectively settled tax positions, primarily resulting from the settlement with the IRS on interest due on its 1996 through 2002 tax years.

The rate for the nine months ended September 30, 2012 also reflects an increase in deductible asset removal costs for Pepco in 2012 related to a higher level of asset retirements.

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 September 30,										Nine Months Ended September 30,
	2012					2011					2012					2011
	(millions of dollars)
Income tax at Federal statutory rate	$	30		35.0	%	$	21		35.0	%	$	49		35.0	%	$	42		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		5		5.9			4		6.1			8		5.8			6		5.3
Asset removal costs		(1	)	(1.2	)		(2	)	(3.0	)		(8	)	(5.8	)		(4	)	(3.7	)
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			1		1.3			(11	)	(7.9	)		(4	)	(2.7	)
Permanent differences related to deferred compensation funding		—		—			—		(0.3	)		(1	)	(0.7	)		(2	)	(1.4	)
State tax benefit related to prior years’ asset dispositions		—		—			—		—			—		—			(4	)	(3.5	)
Tax credits		—		—			—		—			(1	)	(0.7	)		—		—
Other, net		1		1.5			(1	)	(1.4	)		2		1.6			(2	)	(2.3	)
Income tax expense	$	35		41.2	%	$	23		37.7	%	$	38		27.3	%	$	32		26.7	%

Three Months Ended September 30, 2012 and 2011

Pepco’s effective income tax rates for the three months ended September 30, 2012 and 2011 were 41.2% and 37.7%, respectively. The increase in the effective income tax rate primarily resulted from a decrease in asset removal costs as a result of fewer asset retirements in the third quarter of 2012 and a decrease in benefits associated with changes in estimates and interest related to uncertain and effectively settled tax positions.

Nine Months Ended September 30, 2012 and 2011

Pepco’s effective income tax rates for the nine months ended September 30, 2012 and 2011 were 27.3% and 26.7%, respectively. The effective income tax rates primarily reflect tax benefits recorded in each period related to asset removal costs and changes in estimates and interest related to uncertain and effectively settled tax positions and a tax benefit recorded in 2011 for state tax refunds associated with prior years’ asset dispositions.

In the first quarter of 2012, Pepco recorded income tax benefits of $10 million related to uncertain and effectively settled tax positions primarily due to the effective settlement with the Internal Revenue Service (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, PHI reached a settlement with the 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.

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.

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 September 30,										Nine Months Ended September 30,
	2012					2011					2012					2011
	(millions of dollars)
Income tax at Federal statutory rate	$	12		35.0	%	$	7		35.0	%	$	32		35.0	%	$	31		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		2		6.1			1		5.2			5		5.6			5		5.3
Adjustments to prior year taxes		(2	)	(6.1	)		(1	)	(4.8	)		(2	)	(2.2	)		(1	)	(1.1	)
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			2		9.5			—		—			(3	)	(3.1	)
Depreciation		(1	)	(3.0	)		—		(0.5	)		(1	)	(1.1	)		—		—
Other, net		—		1.3			1		3.2			—		0.5			—		0.3
Income tax expense	$	11		33.3	%	$	10		47.6	%	$	34		37.8	%	$	32		36.4	%

Three Months Ended September 30, 2012 and 2011

DPL’s effective income tax rates for the three months ended September 30, 2012 and 2011 were 33.3% and 47.6%, respectively. The decrease in the effective income tax rate primarily resulted from adjustments to prior year taxes, tax benefits related to depreciation and changes in estimates and interest related to uncertain and effectively settled tax positions as discussed below.

In the third quarters of 2012 and 2011, DPL recorded reductions of $2 million and $1 million related to certain non-recurring adjustments to prior year taxes. Further, in the third quarter of 2012, DPL also recorded additional tax benefits related to depreciation on property, plant and equipment purchased prior to 1975.

In addition, in the third quarter of 2011, DPL recalculated interest on its uncertain tax positions for open tax years using different assumptions related to the application of its deposit made with the Internal Revenue Service (IRS) in 2006 which results in an additional tax expense in the third quarter of 2011 of $1 million (after-tax).

Nine Months Ended September 30, 2012 and 2011

DPL’s effective income tax rates for the nine months ended September 30, 2012 and 2011 were 37.8% and 36.4%, respectively. The increase in the effective income tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions.

During the second quarter of 2011, PHI reached a settlement with the 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. This benefit is partially offset by the adjustments recorded in the third quarter of 2011 related to DPL’s settlement with the state taxing authorities resulting in $1 million (after-tax) of additional tax expense, and tax expense of $1 million (after-tax) associated with the recalculation of interest on uncertain tax positions for open tax years using different assumptions related to the application of its deposit made with the IRS in 2006.

The increase in the effective income tax rate was partially offset by the adjustments to prior year taxes and tax benefits related to depreciation 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 September 30,									Nine Months Ended September 30,
	2012				2011					2012					2011
	(millions of dollars)
Income tax at Federal statutory rate	$	11	35.0	%	$	12		35.0	%	$	20		35.0	%	$	27		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		2	6.1			2		4.4			3		5.3			5		5.9
Change in estimates and interest related to uncertain and effectively settled tax positions		—	—			4		10.5			—		—			4		5.1
Deferred tax adjustment		—	—			—		—			—		—			1		1.7
Other, net		—	(1.7	)		(1	)	0.1			(2	)	(3.5	)		(1	)	(0.9	)
Consolidated income tax expense	$	13	39.4	%	$	17		50.0	%	$	21		36.8	%	$	36		46.8	%

Three Months ended September 30, 2012 and 2011

ACE’s consolidated effective income tax rates for the three months ended September 30, 2012 and 2011 were 39.4% and 50.0%, respectively. The decrease in the effective income tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions.

During the third quarter of 2011 the company recalculated interest on its uncertain tax positions for open tax years using different assumptions related to the application of its deposit made with the Internal Revenue Service in 2006. This resulted in an additional tax expense of $3 million (after-tax).

Nine Months ended September 30, 2012 and 2011

ACE’s consolidated effective income tax rates for the nine months ended September 30, 2012 and 2011 were 36.8% and 46.8%, respectively. The decrease in the effective income tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions and a deferred tax adjustment.

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 November 2010 audit settlement for 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 has recorded an additional $1 million (after-tax) of interest due to the IRS. This additional interest expense was recorded in the second quarter of 2011. This is further impacted by the adjustment recorded in the third quarter of 2011 related to the recalculation of interest on its uncertain tax positions for open tax years using different assumptions related to the application of its deposit made with the Internal Revenue Service in 2006.

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.