(10) INCOME TAXES

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


	Three Months Ended September 30,										Nine Months Ended September 30,
	2014					2013					2014					2013
	*(millions of dollars)*
Income tax at federal statutory rate	$	40		35.0	%	$	61		35.0	%	$	116		35.0	%	$	116		35.0	%
Increases (decreases) resulting from:
State income taxes, net of federal effect		6		5.3	%		11		6.3	%		21		6.3	%		21		6.3	%
Asset removal costs		(4	)	(3.5	)%		(5	)	(2.9	)%		(9	)	(2.7	)%		(11	)	(3.3	)%
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			1		0.6	%		—		—			55		16.6	%
Energy efficiency-related tax deductions		(4	)	(3.5	)%		—		—			(4	)	(1.2	)%		—		—
Establishment of valuation allowances related to deferred tax assets		—		—			—		—			—		—			101		30.4	%
Merger-related costs		—		—			—		—			7		2.1	%		—		—
Other, net		(4	)	(3.2	)%		(3	)	(1.9	)%		(6	)	(1.9	)%		(2	)	(0.7	)%

Consolidated income tax expense related to continuing operations	$	34		30.1	%	$	65		37.1	%	$	125		37.6	%	$	280		84.3	%

In the third quarter of 2014, PHI recorded a tax benefit of $4 million related to certain energy efficiency tax deductions associated with Pepco Energy Services’ energy savings performance contracting services.

In connection with entering into the Merger Agreement (as further described in Note (1), “Organization”), PHI incurred certain merger-related costs in the second and third quarters of 2014 which are not tax deductible.

In the first quarter of 2013, PHI recorded interest expense related to uncertain and effectively settled tax positions of $51 million primarily representing the anticipated additional interest expense on estimated federal and state income tax obligations that was allocated to PHI’s continuing operations resulting from a change in assessment of tax benefits associated with the former cross-border energy lease investments of PCI in the first quarter of 2013.

Also, in the first quarter of 2013, PHI established valuation allowances of $101 million related to deferred tax assets. Between 1990 and 1999, PCI, through various subsidiaries, entered into certain transactions involving investments in aircraft and aircraft equipment, railcars and other assets. In connection with these transactions, PCI recorded deferred tax assets in prior years of $101 million in the aggregate. Following events that took place during the first quarter of 2013, which included (i) court decisions in favor of the IRS with respect to other taxpayers’ cross-border lease and other structured transactions (as discussed in Note (18), “Discontinued Operations – Cross-Border Energy Lease Investments”), (ii) the change in PHI’s tax position with respect to the tax benefits associated with its cross-border energy leases, and (iii) PHI’s decision in March 2013 to begin to pursue the early termination of its remaining cross-border energy lease investments (which represented a substantial portion of the remaining assets within PCI) without the intent to reinvest these proceeds in income-producing assets, management evaluated the likelihood that PCI would be able to realize the $101 million of deferred tax assets in the future. Based on this evaluation, PCI established valuation allowances against these deferred tax assets totaling $101 million in the first quarter of 2013. Further, during the fourth quarter of 2013, in light of additional court decisions in favor of the IRS involving other taxpayers, and after consideration of all relevant factors, management determined that it would abandon the further pursuit of these deferred tax assets, and these assets totaling $101 million were charged off against the previously established valuation allowances.

Final IRS Regulations on Repair of Tangible Property

In August 2011, the IRS issued Revenue Procedure 2011-43 providing a safe harbor method of tax accounting for repair costs associated with electric transmission and distribution property. In September 2012, with the filing of its 2011 tax return, PHI adopted the safe harbor for the 2011 tax year. In September 2013, the IRS published final regulations regarding the tax treatment of costs incurred to acquire, produce or improve tangible property. In February 2014, the IRS issued revenue procedures that describe how taxpayers should implement the final regulations. The final repair regulations and the related revenue procedures did not modify the guidance set forth in Revenue Procedure 2011-43 that the Unit of Property for electric transmission and distribution network assets is determined by the taxpayer’s particular facts and circumstances. The final regulations did not have a material impact on PHI’s consolidated financial statements.

Income Taxes

(9) INCOME TAXES

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


	Three Months Ended September 30,										Nine Months Ended September 30,
	2014					2013					2014					2013
	*(millions of dollars)*

Income tax at federal statutory rate	$	37		35.0	%	$	37		35.0	%	$	79		35.0	%	$	66		35.0	%
Increases (decreases) resulting from:
State income taxes, net of federal effect		6		5.7	%		6		5.7	%		13		5.7	%		11		5.9	%
Asset removal costs		(4	)	(3.8	)%		(5	)	(4.7	)%		(9	)	(4.0	)%		(11	)	(5.9	)%
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			—		—			—		—			(4	)	(2.1	)%

Other, net		(1	)	(0.7	)%		2		1.7	%		(1	)	(0.6	)%		—		0.1	%


Income tax expense	$	38		36.2	%	$	40		37.7	%	$	82		36.1	%	$	62		33.0	%

In the first quarter of 2013, Pepco recorded changes in estimates and interest related to uncertain and effectively settled tax positions. On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Consolidated Edison Company of New York, Inc. & Subsidiaries v. United States (to which Pepco is not a party) that disallowed tax benefits associated with Consolidated Edison’s cross-border lease transaction. As a result of the court’s ruling in this case, PHI determined in the first quarter of 2013 that it could no longer support its current assessment with respect to the likely outcome of tax positions associated with its cross-border energy lease investments held by its wholly-owned subsidiary Potomac Capital Investment Corporation, and PHI recorded an after-tax charge of $377 million in the first quarter of 2013. Included in the $377 million charge was an after-tax interest charge of $54 million and this amount was allocated to each member of PHI’s consolidated group as if each member was a separate taxpayer, resulting in Pepco recording a $5 million interest benefit in the first quarter of 2013.

Final IRS Regulations on Repair of Tangible Property

In August 2011, the IRS issued Revenue Procedure 2011-43 providing a safe harbor method of tax accounting for repair costs associated with electric transmission and distribution property. In September 2012, with the filing of its 2011 tax return, PHI adopted the safe harbor for the 2011 tax year. In September 2013, the IRS published final regulations regarding the tax treatment of costs incurred to acquire, produce or improve tangible property. In February 2014, the IRS issued revenue procedures that describe how taxpayers should implement the final regulations. The final repair regulations and the related revenue procedures did not modify the guidance set forth in Revenue Procedure 2011-43 that the Unit of Property for electric transmission and distribution network assets is determined by the taxpayer’s particular facts and circumstances. The final regulations did not have a material impact on Pepco’s financial statements.

Income Taxes

(10) INCOME TAXES

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


	Three Months Ended September 30,										Nine Months Ended September 30,
	2014					2013					2014					2013
	*(millions of dollars)*

Income tax at federal statutory rate	$	13		35.0	%	$	13		35.0	%	$	46		35.0	%	$	35		35.0	%
Increases (decreases) resulting from:

State income taxes, net of federal effect		2		5.6	%		2		5.4	%		7		5.4	%		5		5.0	%
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			—		—			—		—			(1	)	(1.0	)%

Other, net		(2	)	(4.5	)%		(1	)	(2.6	)%		(2	)	(1.2	)%		—		—


Income tax expense	$	13		36.1	%	$	14		37.8	%	$	51		39.2	%	$	39		39.0	%

In the first quarter of 2013, DPL recorded changes in estimates and interest related to uncertain and effectively settled tax positions. On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Consolidated Edison Company of New York, Inc. & Subsidiaries v. United States (to which DPL is not a party) that disallowed tax benefits associated with Consolidated Edison’s cross-border lease transaction. As a result of the court’s ruling in this case, PHI determined in the first quarter of 2013 that it could no longer support its current assessment with respect to the likely outcome of tax positions associated with its cross-border energy lease investments held by its wholly-owned subsidiary Potomac Capital Investment Corporation, and PHI recorded an after-tax charge of $377 million in the first quarter of 2013. Included in the $377 million charge was an after-tax interest charge of $54 million and this amount was allocated to each member of PHI’s consolidated group as if each member was a separate taxpayer, resulting in DPL recording a $1 million interest benefit in the first quarter of 2013.

Final IRS Regulations on Repair of Tangible Property

In August 2011, the IRS issued Revenue Procedure 2011-43 providing a safe harbor method of tax accounting for repair costs associated with electric transmission and distribution property. In September 2012, with the filing of its 2011 tax return, PHI adopted the safe harbor for the 2011 tax year. In September 2013, the IRS published final regulations regarding the tax treatment of costs incurred to acquire, produce or improve tangible property. In February 2014, the IRS issued revenue procedures that describe how taxpayers should implement the final regulations. The final repair regulations and the related revenue procedures did not modify the guidance set forth in Revenue Procedure 2011-43 that the Unit of Property for electric transmission and distribution network assets is determined by the taxpayer’s particular facts and circumstances. The final regulations did not have a material impact on DPL’s financial statements.

Income Taxes

(9) INCOME TAXES

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


	Three Months Ended September 30,										Nine Months Ended September 30,
	2014					2013					2014					2013
	*(millions of dollars)*

Income tax at federal statutory rate	$	13		35.0	%	$	13		35.0	%	$	22		35.0	%	$	19		35.0	%
Increases (decreases) resulting from:

State income taxes, net of federal effect		2		5.4	%		2		5.3	%		4		6.3	%		4		7.3	%
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			—		—			—		—			(9	)	(16.4	)%

Other, net		(1	)	(2.6	)%		(2	)	(6.1	)%		(2	)	(3.2	)%		—		(0.4	)%


Consolidated income tax expense	$	14		37.8	%	$	13		34.2	%	$	24		38.1	%	$	14		25.5	%

In the first quarter of 2013, ACE recorded changes in estimates and interest related to uncertain and effectively settled tax positions. On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Consolidated Edison Company of New York, Inc. & Subsidiaries v. United States (to which ACE is not a party) that disallowed tax benefits associated with Consolidated Edison’s cross-border lease transaction. As a result of the court’s ruling in this case, PHI determined in the first quarter of 2013 that it could no longer support its current assessment with respect to the likely outcome of tax positions associated with its cross-border energy lease investments held by its wholly-owned subsidiary Potomac Capital Investment Corporation, and PHI recorded an after-tax charge of $377 million in the first quarter of 2013. Included in the $377 million charge was an after-tax interest charge of $54 million and this amount was allocated to each member of PHI’s consolidated group as if each member was a separate taxpayer, resulting in ACE recording a $6 million interest benefit in the first quarter of 2013.

Final IRS Regulations on Repair of Tangible Property

In August 2011, the IRS issued Revenue Procedure 2011-43 providing a safe harbor method of tax accounting for repair costs associated with electric transmission and distribution property. In September 2012, with the filing of its 2011 tax return, PHI adopted the safe harbor for the 2011 tax year. In September 2013, the IRS published final regulations regarding the tax treatment of costs incurred to acquire, produce or improve tangible property. In February 2014, the IRS issued revenue procedures that describe how taxpayers should implement the final regulations. The final repair regulations and the related revenue procedures did not modify the guidance set forth in Revenue Procedure 2011-43 that the Unit of Property for electric transmission and distribution network assets is determined by the taxpayer’s particular facts and circumstances. The final regulations did not have a material impact on ACE’s consolidated financial statements.