Income Taxes (All Registrants)

The effective income tax rate from continuing operations varies from the U.S. Federal statutory rate principally due to the following:



	Three Months Ended March 31, 2017
									Successor
	Exelon	Generation	ComEd	PECO	BGE	Pepco	DPL	ACE	PHI
U.S. Federal statutory rate	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%
Increase (decrease) due to:
State income taxes, net of Federal income tax benefit	0.9	1.0	4.9	0.1	5.2	4.6	5.3	5.6	4.9
Qualified nuclear decommissioning trust fund income	3.4	7.6	—	—	—	—	—	—	—
Amortization of investment tax credit, including deferred taxes on basis difference	(0.4)	(0.7)	(0.2)	(0.1)	(0.1)	(0.1)	(0.3)	(0.4)	(0.2)
Plant basis differences	(2.4)	—	(0.2)	(13.2)	(0.9)	(5.8)	(1.9)	(3.4)	(3.8)
Production tax credits and other credits	(0.6)	(1.4)	—	—	—	—	—	—	—
Noncontrolling interests	(0.1)	(0.3)	—	—	—	—	—	—	—
Merger expenses^(a)	(11.4)	(3.3)	—	—	—	(34.2)	(21.9)	(167.1)	(42.4)
Fitzpatrick bargain purchase gain	(6.6)	(14.5)	—	—	—	—	—	—	—
Other	—	(0.1)	—	0.3	(0.2)	0.5	—	(3.0)	(0.4)
Effective income tax rate	17.8%	23.3%	39.5%	22.1%	39.0%	0.0%	16.2%	(133.3)%	(6.9)%



									Successor	Predecessor
	Three Months Ended March 31, 2016								March 24, 2016 to March 31, 2016	January 1, 2016 to March 23, 2016
	Exelon	Generation	ComEd	PECO	BGE	Pepco^(b)	DPL^(b)	ACE^(b)	PHI^(b)	PHI
U.S. Federal statutory rate	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%
Increase (decrease) due to:
State income taxes, net of Federal income tax benefit ^(c)	(1.1)	3.7	5.1	1.0	5.2	(2.5)	(2.7)	5.9	5.4	11.9
Qualified nuclear decommissioning trust fund income	5.6	4.2	—	—	—	—	—	—	—	—
Amortization of investment tax credit, including deferred taxes on basis difference	(1.6)	(1.0)	(0.3)	(0.1)	(0.1)	—	0.1	0.2	—	(0.9)
Plant basis differences	(5.5)	—	(0.1)	(9.3)	(0.6)	2.8	0.7	0.6	—	(13.5)
Production tax credits and other credits	(5.1)	(3.9)	—	—	—	—	—	—	—	—
Noncontrolling interests	0.5	0.3	—	—	—	—	—	—	—	—
Merger expenses	33.6	—	—	—	—	(16.5)	(22.1)	(17.0)	(15.1)	11.1
Other	(2.0)	(1.6)	0.4	(0.9)	—	—	0.1	0.1	0.2	3.6
Effective income tax rate	59.4%	36.7%	40.1%	25.7%	39.5%	18.8%	11.1%	24.8%	25.5%	47.2%

(a) Includes a remeasurement of uncertain federal and state income tax positions, see below.


(b)	Pepco, DPL and ACE recognized a loss before income taxes for the three months ended March 31, 2016, and PHI recognized a loss before income taxes for the period of March 24, 2016, through March 31, 2016. As a result, positive percentages represent an income tax benefit for the periods presented.

-31

Accounting for Uncertainty in Income Taxes

The Registrants have the following unrecognized tax benefits as of March 31, 2017 and December 31, 2016:



												Successor
	Exelon		Generation		ComEd			PECO		BGE		PHI		Pepco		DPL		ACE
March 31, 2017	$	769	$	470	$	(12	)	$	—	$	120	$	112	$	59	$	21	$	—



												Successor
	Exelon		Generation		ComEd			PECO		BGE		PHI		Pepco		DPL		ACE
December 31, 2016	$	916	$	490	$	(12	)	$	—	$	120	$	172	$	80	$	37	$	22

Exelon established a liability for an uncertain tax position associated with the tax deductibility of certain merger commitments incurred by Exelon in connection with the acquisitions of Constellation in 2012 and PHI in 2016. In the first quarter 2017, as a part of its examination of Exelon’s return, the IRS National Office issued guidance concurring with Exelon’s position that the merger commitments were deductible. As a result, Exelon, Generation, PHI, Pepco, DPL, and ACE decreased their liability for unrecognized tax benefits by $146 million, $19 million, $59 million, $21 million, $16 million, and $22 million, respectively, as of March 31, 2017, resulting in a benefit to Income taxes on Exelon’s, Generation’s, PHI’s, Pepco’s, DPL’s and ACE’s Consolidated Statements of Operations and Comprehensive Income and corresponding decreases in their effective tax rates.

Reasonably possible the total amount of unrecognized tax benefits could significantly increase or decrease within 12 months after the reporting date

Like-Kind Exchange

As of March 31, 2017, Exelon and ComEd have approximately $76 million and $(12) million, respectively, of unrecognized state income tax benefits that could significantly decrease and increase within the 12 months after the reporting date due to a final resolution of the like-kind exchange litigation described below. The recognition of these unrecognized tax benefits would decrease Exelon’s effective tax rate and increase ComEd’s effective tax rate.

Settlement of Income Tax Audits

As of March 31, 2017, Exelon, Generation, BGE, PHI, Pepco, and DPL have approximately $257 million, $57 million, $120 million, $80 million, $59 million, and $21 million of unrecognized federal and state tax benefits that could significantly decrease within the 12 months after the reporting date as a result of completing audits and potential settlements. Of the above unrecognized tax benefits, Exelon and Generation have $50 million that, if recognized, would decrease the effective tax rate. The unrecognized tax benefits related to BGE, DPL, and a portion of Pepco, if recognized, may be included in future regulated base rates and that portion would have no impact to the effective tax rate.

Other Income Tax Matters

Like-Kind Exchange (Exelon and ComEd)

Exelon, through its ComEd subsidiary, took a position on its 1999 income tax return to defer approximately $1.2 billion of tax gain on the sale of ComEd’s fossil generating assets. The gain was deferred by reinvesting a portion of the proceeds from the sale in qualifying replacement property under the like-kind exchange provisions of the IRC. The like-kind exchange replacement property purchased by Exelon included interests in three municipal-owned electric generation facilities which were properly leased back to the municipalities.

The IRS disagreed with this position and asserted that the entire gain of approximately $1.2 billion was taxable in 1999. Exelon was unable to reach agreement with the IRS regarding the dispute over the like-kind exchange position. The IRS asserted that the Exelon purchase and leaseback transaction was substantially similar to a leasing transaction, known as a SILO, which the IRS does not respect as the acquisition of an ownership interest in property. A SILO is a “listed transaction” that the IRS has identified as a potentially abusive tax shelter under guidance issued in 2005. Accordingly, the IRS asserted that the sale of the fossil plants followed by the purchase and leaseback of the municipal owned generation facilities did not qualify as a like-kind exchange and the gain on the sale is fully subject to tax. The IRS also asserted a penalty of approximately $90 million for a substantial understatement of tax.

On September 30, 2013, the IRS issued a notice of deficiency to Exelon for the like-kind exchange position. Exelon filed a petition on December 13, 2013 to initiate litigation in the United States Tax Court and the trial took place in August of 2015. Exelon was not required to remit any part of the asserted tax or penalty in order to litigate the issue.

On September 19, 2016, the Tax Court rejected Exelon’s position in the case and ruled that Exelon was not entitled to defer gain on the transaction. In addition, contrary to Exelon’s evaluation that the penalty was unwarranted, the Tax Court ruled that Exelon is liable for the penalty and interest due on the asserted penalty. Exelon expects to timely appeal this decision to the U.S. Court of Appeals for the Seventh Circuit in 2017.

In the first quarter of 2013, Exelon concluded that it was no longer more likely than not that the like-kind exchange position would be sustained and recorded charges to earnings representing the amount of interest expense (after-tax) and incremental state income tax expense that would be payable in the event Exelon is unsuccessful in litigation. Prior to the Tax Court’s decision, however, Exelon did not believe it was likely a penalty would be assessed based on applicable case law and the facts of the transaction. As a result, no charge had been recorded for the penalty or for after-tax interest on the penalty. While it has strong arguments on appeal with respect to both the merits and the penalty, Exelon has determined that, pursuant to accounting standards, it is no longer more likely than not to avoid ultimate imposition of the penalty. As a result, in the third quarter of 2016, Exelon and ComEd recorded a charge to earnings of approximately $106 million and $86 million, respectively, of penalty and approximately $94 million and $64 million, respectively, of after-tax interest. Exelon and ComEd recorded the penalty and pre-tax interest due on the asserted penalty to Other, net and Interest expense, net, respectively, on their Consolidated Statements of Operations. Consistent with Exelon’s agreement to continue to hold ComEd harmless from any unfavorable impact on its equity, ComEd recorded on its Consolidated Balance Sheets as of September 30, 2016, a $150 million receivable and non-cash equity contributions from Exelon. In addition, while further adjustments may be required, Exelon currently estimates that its income tax expense may decrease by as much as $50 million and ComEd’s income tax expense may increase by as much as $20 million resulting from the IRS's completion of its calculation of tax, penalties, and interest in the second quarter of 2017.

In order to appeal the decision, Exelon is required to pay the tax, penalties and interest at the time Exelon files its appeal (expected in the third quarter of 2017). While the final calculation of tax, penalties and interest has not yet been finalized by the IRS, Exelon estimates that a payment of approximately $1.3 billion related to the like-kind exchange will be due, including $300 million from ComEd, in the third quarter of 2017. While Exelon will receive a tax benefit of approximately $350 million associated with the deduction for the interest, Exelon currently has a net operating loss carryforward and thus does not expect to realize the cash benefit until 2018. After taking into account these interest deduction tax benefits, the total estimated net cash outflow for the like-kind exchange is approximately $950 million, of which approximately $300 million is attributable to ComEd after giving consideration to Exelon’s agreement to hold ComEd harmless from any unfavorable impacts of after-tax interest or penalty amounts on ComEd’s equity. Upon a final appellate decision, which could take up to several years, Exelon expects to receive approximately $80 million related to final interest computations.

Of the above amounts payable, Exelon deposited with the IRS $1.25 billion in October of 2016. The remaining amount will be paid in the third quarter of 2017 at the time Exelon files its appeal of the Tax Court decision. Exelon funded the $1.25 billion deposit with a combination of cash on hand and short-term borrowings. The deposit is reflected as a current asset and the related liabilities for the tax, penalty, and interest are included on Exelon’s balance sheet as current obligations.

As of March 31, 2017, ComEd has a total receivable from Exelon pursuant to the hold harmless agreement of $345 million, which is included in Current Receivables from Affiliates on ComEd’s Consolidated Balance Sheet. Under the agreement, Exelon will settle this receivable with ComEd no later than the time that the payments related to the like-kind exchange are due to the IRS, currently anticipated in the third quarter of 2017. Exelon will not seek recovery from ComEd customers for any interest or penalty payment amounts associated with the like-kind exchange tax position.

As previously disclosed, in the first quarter of 2014, Exelon entered into an agreement to terminate its investment in one of the three municipal-owned electric generation properties in exchange for a net early termination amount of $335 million. In the first quarter of 2016, Exelon terminated its interests in the remaining two municipal-owned electric generation properties in exchange for $360 million.

Long-Term Marginal State Income Tax Rate (Exelon, Generation and PHI)

Exelon, Generation and PHI periodically review events that may significantly impact how income is apportioned among the states and, therefore, the calculation of their respective deferred state income taxes. Events that may require Exelon, Generation and PHI to update their long-term state tax apportionment include significant changes in tax law and/or significant operational changes. Exelon and PHI's long-term marginal state income tax rate was revised in the first quarter of 2017 as a result of a statutory rate change pursuant to Exelon's marginal state income tax rate policy, resulting in the recording of a deferred state tax benefit for Exelon of $21 million, net of tax.