Income Taxes, Unrecognized Tax Benefits

9 Months Ended

Sep. 30, 2011

Income Taxes, Unrecognized Tax Benefits

Income Taxes, Unrecognized Tax Benefits

Income Taxes

We compute the income tax expense for each quarter based on our estimated annual effective tax rate for the year. The effective tax rate was 34.3% and 37.9% for the quarter and nine months ended September 30, 2011, respectively, compared to 40.8% and 42.5% for the same periods of 2010. The lower effective tax rates for the quarter and nine months ended September 30, 2011 are primarily due to lower pre-tax income due to extreme weather events in Texas and Maryland and nontaxable income from a consolidated VIE.

        The BGE effective tax rate was 176.2% and 35.1% for the quarter and nine months ended September 30, 2011, respectively, compared to 34.0% and 39.6% for the same periods of 2010. The higher effective tax rate for the quarter ended September 30, 2011 is due to a small pre-tax loss of $2.1 million primarily as a result of Hurricane Irene storm-related expenses and the impact of new guidance from the IRS National Office on electric transmission and distribution assets pertaining to capitalization versus repair expense, which increased the income tax benefit. The lower effective tax rate for the nine months ended September 30, 2011 is primarily due to the favorable impact from the IRS National Office guidance mentioned above and partial reversal during the quarter ended March 31, 2011 of the unfavorable tax adjustment recorded in the quarter ended March 31, 2010 to reflect the impact on our regulated electric business of the healthcare reform legislation that eliminated the tax exempt status of prescription drug subsidies received under Medicare Part D. The partial reversal in 2011 resulted from the Maryland PSC's authorization for BGE to create an electric regulatory asset for this tax law change and amortize the balance over a five-year period as provided in its March 2011 comprehensive order in BGE's most recent base rate case.

        Income tax expense for both Constellation Energy and BGE for the quarter and nine months ended September 30, 2011 reflects a deferred tax benefit for the costs incurred associated with our pending merger with Exelon. The ultimate treatment of these costs for tax purposes will be determined at the time the merger is closed or terminated. We discuss our pending merger with Exelon on page 9.

Income Tax Audits

We file income tax returns in the United States and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before 2007. In August 2011, we formally agreed to an assessment of tax by the IRS for the 2005 - 2007 tax years. The assessment did not have a material impact on our, or BGE's, financial condition or results of operation.

        The IRS has audited our consolidated federal income tax return for the 2008 tax year and completion of the audit is awaiting additional industry guidance from the IRS National Office regarding BGE's change of accounting for tax purposes with respect to certain electric and gas transmission and distribution expenditures. IRS industry guidance on electric transmission and distribution expenditures was issued in August 2011 and additional guidance on gas transmission and distribution expenditures is expected in 2012. Application and compliance with the IRS industry guidance for electric and gas transmission and distribution expenditures should result in the completion of the IRS examination for the 2008 tax year. The IRS is also currently auditing our consolidated federal income tax returns for the 2009 - 2010 tax years as well as examining the 2011 tax year concurrently as part of the IRS Compliance Assurance Process. Although the final outcome of the 2008 - 2011 IRS audit and future tax audits is uncertain, we believe that adequate provisions for income taxes have been made for potential liabilities resulting from such matters.

Unrecognized Tax Benefits

The following table summarizes the change in unrecognized tax benefits during 2011 and our total unrecognized tax benefits at September 30, 2011:

At September 30, 2011
	(In millions)
Total unrecognized tax benefits, January 1, 2011	$	239.8
Increases in tax positions related to the current year		0.9
Increases in tax positions related to prior years		29.7
Reductions in tax positions related to prior years		(89.1	)
Total unrecognized tax benefits, September 30, 20111	$	181.3

1 BGE's portion of our total unrecognized tax benefits at September 30, 2011 was $12.0 million.

        If the total amount of unrecognized tax benefits of $181.3 million were ultimately realized, our income tax expense would decrease by approximately $170 million. The $170 million includes state tax refund claims of $55.9 million that have been disallowed by tax authorities and are subject to appeals.

        It is reasonably possible that unrecognized tax benefits could decrease within the next year by approximately $12 million primarily as a result of an expected settlement with the IRS regarding BGE's change of accounting method for tax purposes with respect to certain gas transmission and distribution expenditures. This decrease is not expected to have a material impact on BGE's financial condition or results of operation.

        The decrease in unrecognized tax benefits for the nine months ended September 30, 2011 is primarily related to the issuance of guidance from the IRS National Office in August 2011 regarding electric transmission and distribution expenditures. The decrease did not have a material impact on our, or BGE's, financial position or results of operation.

        Interest and penalties recorded in our Consolidated Statements of Income (Loss) as tax expense relating to liabilities for unrecognized tax benefits were as follows:

	Quarter Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
	(In millions)
Interest and penalties recorded as tax (benefit) expense	$	(1.6	)	$	3.0	$	3.9	$	(4.3	)

BGE's portion of interest and penalties was immaterial for both periods presented.

        Accrued interest and penalties recognized in our Consolidated Balance Sheets were $20.7 million, of which BGE's portion was $1.1 million, at September 30, 2011, and $16.8 million, of which BGE's portion was $3.8 million, at December 31, 2010.