Income Taxes (EME, Midwest Generation)

EME

Income Tax Expense (Benefit)

The provision (benefit) for income taxes is composed of the following:



	Years Ended December 31,
(in millions)	2013			2012			2011
Continuing Operations
Current
Federal	$	—		$	—		$	48
State	—			—			(44		)
Total current	—			—			4
Deferred
Federal	$	(33	)	$	26		$	(389	)
State	(60		)	134			(56		)
Total deferred	(93		)	160			(445		)
Provision (benefit) for income taxes from continuing operations	(93		)	160			(441		)
Discontinued operations	6			(73		)	(411		)
Total	$	(87	)	$	87		$	(852	)

The components of income (loss) before income taxes applicable to continuing operations and discontinued operations are as follows:



	Years Ended December 31,
(in millions)	2013			2012			2011
Continuing operations	$	(735	)	$	(637	)	$	(888	)
Discontinued operations	7			(185		)	(1,043		)
Total	$	(728	)	$	(822	)	$	(1,931	)

Deferred Tax Assets and Liabilities

The components of net accumulated deferred income tax asset (liability) were:



	December 31,
(in millions)	2013			2012
Deferred tax assets
Accrued charges and liabilities	$	232		$	234
Net operating loss carryforwards	1,202			841
Production tax and other credit carryforwards	332			254
Derivative instruments	15			49
Other	5			6
Total	1,786			1,384
Valuation allowance	(752		)	(444		)
Net deferred tax assets	1,034			940
Deferred tax liabilities
Property, plant and equipment - basis differences	$	1,069		$	989
Deferred investment tax credit	4			4
State taxes	19			28
Total	1,092			1,021
Deferred tax liabilities, net	$	(58	)	$	(81	)
Classification of net accumulated deferred income taxes
Included in deferred taxes and tax credits, net	$	58		$	81

Valuation Allowance

Historically, EME participated in tax-allocation agreements with EIX in which EME would be eligible to receive payments from EIX for tax losses and credits generated by EME. During 2012, EIX modified the tax-allocation agreements to terminate EME's participation on December 31, 2013. Termination does not relieve any party of any obligations with respect to any tax year beginning prior to the year of termination. As a result, as of December 31, 2013 and 2012, EME recorded a valuation allowance on its net deferred tax assets of $752 million and $444 million, respectively. The net increase during 2013 of $308 million was due to the accumulation of unpaid tax benefits related to net operating losses and production tax credits and $167 million related to an asset impairment charge on the Will County Station recorded during the third quarter of 2013. In 2012, $438 million of the valuation allowance was recorded to net loss on the consolidated statements of operations and $6 million was reflected in accumulated other comprehensive loss. Upon the effectiveness of the Settlement Agreement, EME would expect to reverse the valuation allowance it has recorded. For additional information, see Note 16—Restructuring—Plan of Reorganization.

At December 31, 2013 amounts included in other long-term assets, payables to affiliates, and other long-term liabilities associated with the tax-allocation agreements were $31 million, $15 million and $6 million, respectively. At December 31, 2012, amounts included in other long-term assets, payables to affiliates and other long-term liabilities associated with the tax-allocation agreements were $18 million, $33 million and $21 million, respectively.

Net Operating Loss and Federal Tax Credit Carryforwards

At December 31, 2013, EME had $3,226 million of federal net operating loss carryforwards which expire between 2031 and 2033 and $2,106 million of state net operating loss carryforwards which expire between 2022 and 2033, if unused. Additionally, there were $332 million of federal tax credit carryforwards of which $317 million expire between 2029 and 2033, if unused, and the remainder have no expiration date. Included in net operating loss carryforwards were excess tax benefits that had not been generated by EME. Accordingly, EME recorded a $27 million non-cash income tax benefit offset by an equal valuation allowance during the fourth quarter of 2013.

In addition, at December 31, 2012, EME recorded a non-cash distribution to its parent of $222 million related to tax benefits for which, under the tax-allocation agreements as applied, EME has not yet, and may never be, entitled to be paid. During 2013, in connection with EIX's finalization of their 2012 consolidated tax returns, EME recorded a net non-cash contribution from EIX of $25 million related to tax benefits which EME had previously believed would be utilized in the EIX consolidated tax return on a statutory basis but would not be paid under the tax-allocation agreements. In addition, EME received a net tax-allocation payment from EIX of approximately $12 million as a partial payment for tax benefits previously recorded as non-cash distributions. At December 31, 2013, EME has not yet, and may never be, entitled to be paid for the $185 million remaining as a non-cash distribution to its parent. In addition, EME has not yet, and may never be, paid for the approximately $1,435 million of tax benefits generated by EME which have not yet been utilized in the EIX consolidated tax return. Under the Settlement Agreement, EIX will pay the Reorganization Trust amounts equal to 50% of the EME Tax Attributes. For additional information, see Note 16—Restructuring—Plan of Reorganization.

Capistrano Wind Holdings and Capistrano Wind, LLC, which still participate in tax-allocation agreements with EIX, have generated $126 million of tax benefits, $27 million of which has been used by the EIX consolidated tax group, for all of which either payment has been received or payment is expected to be received under the tax-allocation agreements.

Effective Tax Rate

The table below provides a reconciliation of income tax expense (benefit) computed at the federal statutory income tax rate to the income tax provision (benefit):



	Years Ended December 31,
(in millions)	2013			2012			2011
Loss from continuing operations before income taxes	$	(735	)	$	(637	)	$	(888	)
Benefit for income taxes at federal statutory rate of 35%	$	(257	)	$	(223	)	$	(311	)
Increase (decrease) in income tax from
State tax - net of federal benefit	(32		)	11			(56		)
Excess losses over tax allocation losses	(27		)	—			—
Change in valuation allowance	308			438			—
Production tax credits, net	(79		)	(68		)	(66		)
Qualified production deduction	—			—			(6		)
Deferred tax adjustments	1			—			(8		)
Taxes on income allocated to noncontrolling interests	(10		)	(4		)	—
Other	3			6			6
Total provision (benefit) for income taxes from continuing operations	$	(93	)	$	160		$	(441	)
Effective tax rate	13		%	*			50		%


*	Not meaningful.

Estimated state income tax benefits allocated from EIX of $5 million, $3 million and $6 million were recognized for the years ended December 31, 2013, 2012 and 2011, respectively. In the fourth quarter of 2012, EME's state tax benefit was reduced by a change in future state apportionment factors resulting from EME's exit from the EIX consolidated tax group.

Accounting for Uncertainty in Income Taxes

Unrecognized Tax Benefits

The following table provides a reconciliation of unrecognized tax benefits:



(in millions)	2013		2012			2011
Balance at January 1	$	159	$	171		$	153
Tax positions taken during the current year
Increases	—		—			9
Decreases	—		—			—
Tax positions taken during a prior year
Increases	—		—			9
Decreases	—		(12		)	—
Decreases for settlements during the period	—		—			—
Decreases resulting from a lapse in statute of limitations	—		—			—
Balance at December 31	$	159	$	159		$	171

As of December 31, 2013 and 2012, $154 million of the unrecognized tax benefits, if recognized, would impact the effective tax rate. EME believes that it is reasonably possible that unrecognized tax benefits could be reduced by an amount up to $66 million within the next 12 months as a result of settling the audit for tax years 2003 through 2006.

EIX's federal income tax returns and California combined franchise tax returns are currently open for years subsequent to 2002. In addition, specific California refund claims made by EIX for years 1991 through 2002 remain subject to audit.

Accrued Interest and Penalties

The total amount of accrued interest and penalties related to EME's income tax liabilities was $76 million and $65 million as of December 31, 2013 and 2012, respectively.

The net after-tax interest and penalties recognized in income tax expense was $6 million, $8 million and $10 million for 2013, 2012 and 2011, respectively.

Tax Dispute

The Internal Revenue Service examination phase of tax years 2003 through 2006 was completed in the fourth quarter of 2010, which included a proposed adjustment related to EME. The proposed adjustment increases the taxable gain on the 2004 sale of EME's international assets, which if sustained, would result in a federal tax payment of approximately $207 million, including approximately $59 million of interest and $42 million in penalties through December 31, 2013. EME disagrees with the proposed adjustment and filed a protest with the Internal Revenue Service in the first quarter of 2011. During the fourth quarter of 2013, the Internal Revenue Service advised EME that it intends to issue technical advice adverse to EME supporting the proposed adjustment by Internal Revenue Service examination increasing the taxable gain on the 2004 sale of EME's international assets (the technical advice adverse to EME was received in February 2014). The technical advice did not address penalties. EME is continuing to protest the asserted penalty with Internal Revenue Service Appeals. EME anticipates that the Internal Revenue Service will issue a deficiency notice for the tax, interest and possibly penalties related to this issue at the conclusion of the Internal Revenue Service appeals process. After the receipt of such deficiency notice, EME will have 90 days to file a petition in Unites States Tax Court. If a petition is not timely filed, EME anticipates after the expiration of the 90-day period, the Internal Revenue Service will assess the underpayment of tax, interest and penalties, if any, and demand payment. Under the Settlement Agreement, this liability along with the rest of the EME Tax Attributes will be retained by the EIX consolidated tax group. For additional information, see Note 16—Restructuring—Plan of Reorganization.

Tax Election at Homer City

On March 15, 2012, Homer City made an election to be treated as a partnership for federal and state income tax purposes. As a result of this election, Homer City is treated for tax purposes as distributing its assets and liabilities to its partners, both of which are wholly owned subsidiaries of EME, and triggering tax deductions of approximately $1 billion. Such tax deductions were included in EIX's 2011 consolidated tax returns.

Midwest Generation

Income Tax Benefit

The benefit for income taxes is composed of the following:



	Years Ended December 31,
(in millions)	2013			2012			2011
Current
Federal	$	—		$	—		$	2
State	—			—			12
Total current	—			—			14
Deferred
Federal	$	(14	)	$	(76	)	$	(145	)
State	(3		)	14			(41		)
Total deferred	(17		)	(62		)	(186		)
Benefit for income taxes	$	(17	)	$	(62	)	$	(172	)

Deferred Tax Assets and Liabilities

The components of net accumulated deferred income tax asset (liability) were:



	December 31,
(in millions)	2013			2012
Deferred tax assets
State taxes	$	3		$	—
Deferred income	2			2
Derivative instruments	6			24
Impairment of loan to affiliate - tax	539			539
Property, plant and equipment - basis differences	107			—
Net operating loss carryforwards	88			—
Accrued charges and liabilities	22			16
Total	767			581
Valuation allowance	(767		)	(533		)
Net deferred tax assets	—			48
Deferred tax liabilities
State taxes	—			3
Property, plant and equipment - basis differences	—			45
Total	—			48
Deferred taxes, net	$	—		$	—

Valuation Allowance

As of December 31, 2013 and 2012, Midwest Generation recorded a valuation allowance on its net deferred tax assets of $767 million and $533 million, respectively, as a result of recently recognized losses and the indications of expected future losses. The net increase during 2013 of $234 million was due to the accumulation of unpaid tax benefits related to net operating losses and $167 million related to an asset impairment charge described above. In 2012, $521 million of the valuation allowance was recorded to net loss on the consolidated statements of operations and $12 million was reflected in accumulated other comprehensive loss.

Intercompany Tax-Allocation Agreement

At December 31, 2012, $106 million of tax benefits that would have been collected by Midwest Generation in a hypothetical tax return prepared on a separate return basis but was not collectible under Midwest Generation's tax allocation agreement were accounted for as non-cash distributions to Midwest Generation's parent. Midwest Generation's tax-allocation agreement only permits the use of net operating losses to offset future taxable income and does not include the right to receive payments.

Net Operating Loss Carryforwards

As of December 31, 2013, on a separate return basis, Midwest Generation had $517 million of federal net operating loss carryforwards which expire in 2031 and 2033, $341 million of state net operating loss carryforwards which expire between 2025 and 2033, if unused. Under the Acquisition Agreement, prior to the closing date, Midwest Generation may reorganize into a single-member limited liability corporation, in which case it will become a disregarded entity for tax purposes and its existing income tax attributes will accumulate to EME. For additional information, see Note 16—Restructuring—Plan of Reorganization.

Effective Tax Rate

The table below provides a reconciliation of income tax benefit computed at the federal statutory income tax rate to the income tax benefit:



	Years Ended December 31,
(in millions)	2013			2012			2011
Loss before income taxes	(650		)	$	(1,526	)	$	(442	)
Benefit for income taxes at federal statutory rate of 35%	$	(228	)	$	(534	)	$	(155	)
State tax, net of federal benefit	(26		)	(52		)	(19		)
Change in valuation allowance	234			521			—
Other	3			3			2
Total benefit for income taxes	$	(17	)	$	(62	)	$	(172	)
Effective tax rate	3		%	4		%	39		%

Accounting for Uncertainty in Income Taxes

Unrecognized Tax Benefits

The following table provides a reconciliation of unrecognized tax benefits:



(in millions)	2013		2012		2011
Balance at January 1	$	44	$	44	$	44
No activity	—		—		—
Balance at December 31	$	44	$	44	$	44

As of December 31, 2013 and 2012, $41 million of the unrecognized tax benefits, if recognized, would impact the effective tax rate. Midwest Generation believes that it is reasonably possible that unrecognized tax benefits could be reduced by an amount up to $36 million within the next 12 months as a result of settling the audit for tax years 2003 through 2006.

Accrued Interest and Penalties

The total amount of accrued interest expense and penalties was $26 million and $23 million as of December 31, 2013 and 2012, respectively. The net after-tax interest expense and penalties recognized in income tax expense was $2 million, $2 million and $3 million for 2013, 2012 and 2011, respectively.

Bonus Depreciation Impact (EME, Midwest Generation)

The Small Business Jobs Act of 2010 and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act) extended 50% bonus depreciation for qualifying property through 2012 and created a new 100% bonus depreciation for qualifying property placed in service between September 9, 2010 and December 31, 2011. The 50% bonus depreciation provisions continued for qualifying property placed in service through 2013 as a result of the American Taxpayer Relief Act signed into law in January 2013. Based on these rules, EME and Midwest Generation continue to accelerate federal tax deductions in 2012 and 2013 for qualifying capital expenditures.