Income Taxes (All Registrants)

Corporate Tax Reform (All Registrants)

On December 22, 2017, President Trump signed the TCJA into law. The TCJA makes many significant changes to the Internal Revenue Code, including, but not limited to, (1) reducing the U.S. federal corporate tax rate from 35% to 21%; (2) creating a 30% limitation on deductible interest expense (not applicable to regulated utilities); (3) allowing 100% expensing for the cost of qualified property (not applicable to regulated utilities); (4) eliminating the domestic production activities deduction; (5) eliminating the corporate alternative minimum tax and changing how existing alternative minimum tax credits can be realized; and (6) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017. The most significant change that impacts the Registrants is the reduction of the corporate federal income tax rate from 35% to 21% beginning January 1, 2018.

Pursuant to the enactment of the TCJA, the Registrants remeasured their existing deferred income tax balances as of December 31, 2017 to reflect the decrease in the corporate income tax rate from 35% to 21%, which resulted in a material decrease to their net deferred income tax liability balances as shown in the table below. Generation recorded a corresponding net decrease to income tax expense, while the Utility Registrants recorded corresponding regulatory liabilities or assets to the extent such amounts are probable of settlement or recovery through customer rates and an adjustment to income tax expense for all other amounts. The amount and timing of potential settlements of the established net regulatory liabilities will be determined by the Utility Registrants’ respective rate regulators, subject to certain IRS “normalization” rules. See Note 6 — Regulatory Matters for additional information.

The Registrants assessed the majority of the applicable provisions in the TCJA and have recorded the associated impacts as of December 31, 2017. As discussed further below, under SAB 118 issued by the SEC in December 2017, the Registrants have recorded provisional income tax amounts as of December 31, 2017 for changes pursuant to the TCJA related to depreciation for which the impacts could not be finalized upon issuance of the Registrants’ financial statements, but for which reasonable estimates could be determined.

On August 3, 2018, the U.S. Department of Treasury in conjunction with the IRS released proposed regulations clarifying the immediate expensing depreciation provisions enacted by the TCJA, specifically that regulated utility property acquired after September 27, 2017 and placed in service by December 31, 2017 qualifies for 100% expensing. Until the proposed regulations are finalized, taxpayers may rely on the proposed regulations for tax years ending after September 28, 2017.

While the Registrants have recorded the impacts of the TCJA based on their interpretation of the provisions as enacted, it is expected that Treasury and the IRS will issue additional interpretative guidance in the future which could result in changes to previously finalized provisions. At this time, many of the states in which Exelon does business have issued guidance regarding TCJA and the impact is not material.

The one-time impacts recorded by the Registrants to remeasure their deferred income tax balances at the 21% corporate federal income tax rate as of December 31, 2017 are presented below. The impact of the August 3, 2018 proposed regulations to these balances is not material.



	Exelon^(b)		Generation		ComEd		PECO		BGE		PHI		Pepco		DPL		ACE
Net Decrease to Deferred Income Tax Liability Balances	$	8,624	$	1,895	$	2,819	$	1,407	$	1,120	$	1,944	$	968	$	540	$	456



	Exelon		Generation	ComEd		PECO^(c)		BGE		PHI		Pepco		DPL		ACE
Net Regulatory Liability Recorded^(a)	$	7,315	N/A	$	2,818	$	1,394	$	1,124	$	1,979	$	976	$	545	$	458



	Exelon^(b)		Generation		ComEd		PECO		BGE			PHI			Pepco			DPL			ACE
Net Deferred Income Tax Benefit/(Expense) Recorded	$	1,309	$	1,895	$	1	$	13	$	(4	)	$	(35	)	$	(8	)	$	(5	)	$	(2	)

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(a)	Reflects the net regulatory liabilities recorded on a pre-tax basis before taking into consideration the income tax benefits associated with the ultimate settlement with customers.


(b)	Amounts do not sum across due to deferred tax adjustments recorded at the Exelon Corporation parent company, primarily related to certain employee compensation plans.


(c)	Given the regulatory treatment of income tax benefits related to electric and gas distribution repairs, PECO was in an overall net regulatory asset position as of December 31, 2017 after recording the impacts related to the TCJA. See Note 6 - Regulatory Matters for additional information.

The net regulatory liabilities above include (1) amounts subject to IRS “normalization” rules that are required to be passed back to customers generally over the remaining useful life of the underlying assets giving rise to the associated deferred income taxes, and (2) amounts for which the timing of settlement with customers is subject to determinations by the rate regulators. The table below sets forth the Registrants’ estimated categorization of their net regulatory liabilities as of December 31, 2017. The amounts in the table below are shown on an after-tax basis reflecting future net cash outflows after taking into consideration the income tax benefits associated with the ultimate settlement with customers.



	Exelon		ComEd		PECO^(a)		BGE		PHI		PEPCO		DPL		ACE
Subject to IRS Normalization Rules	$	3,040	$	1,400	$	533	$	459	$	648	$	299	$	195	$	153
Subject to Rate Regulator Determination	1,694		573		43		324		754		391		194		170
Net Regulatory Liabilities	$	4,734	$	1,973	$	576	$	783	$	1,402	$	690	$	389	$	323

__________

(a)

Given the regulatory treatment of income tax benefits related to electric and gas distribution repairs, PECO remains in an overall net regulatory asset position as of December 31, 2017 after recording the impacts related to the TCJA. As a result, the amount of customer benefits resulting from the TCJA subject to the discretion of PECO's rate regulators are lower relative to the other Utility Registrants. See Note 6 - Regulatory Matters for additional information.

The net regulatory liability amounts subject to the IRS normalization rules generally relate to property, plant and equipment with remaining useful lives ranging from 30 to 40 years across the Utility Registrants. For the other amounts, the pass back period is subject to determinations by the rate regulators. See Note 6 - Regulatory Matters for the status of and information regarding the Registrants' TCJA-related regulatory filings.

Rate Reconciliation

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



	Three Months Ended September 30, 2018
	Exelon	Generation	ComEd	PECO	BGE	PHI	Pepco	DPL	ACE
U.S. Federal statutory rate	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%
Increase (decrease) due to:
State income taxes, net of Federal income tax benefit	(1.2)	(9.0)	8.3	(3.6)	7.3	0.2	1.0	6.6	7.3
Qualified nuclear decommissioning trust fund income	2.4	5.8	—	—	—	—	—	—	—
Amortization of investment tax credit, including deferred taxes on basis difference	(0.6)	(1.1)	(0.2)	(0.1)	—	(0.2)	(0.1)	(0.3)	(0.3)
Plant basis differences	(2.5)	—	(0.3)	(15.2)	(0.8)	(2.0)	(3.4)	(0.7)	(1.3)
Production tax credits and other credits	(1.2)	(2.9)	(0.1)	—	—	—	—	—	—
Noncontrolling interests	(1.1)	(2.8)	—	—	—	—	—	—	—
Excess deferred tax amortization	(6.8)	—	(7.8)	(4.6)	(7.9)	(17.7)	(21.2)	(14.0)	(15.4)
Tax Cuts and Jobs Act of 2017	1.3	3.5	—	—	—	0.2	0.1	—	—
Other	3.2	5.6	0.3	0.9	2.6	0.6	0.3	0.6	0.3
Effective income tax rate	14.5%	20.1%	21.2%	(1.6)%	22.2%	2.1%	(2.3)%	13.2%	11.6%



	Three Months Ended September 30, 2017^(a)
	Exelon	Generation	ComEd	PECO	BGE	PHI	Pepco	DPL	ACE
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	2.2	5.6	6.6	(0.1)	5.3	5.1	2.2	5.3	5.6
Qualified nuclear decommissioning trust fund income	2.6	5.8	—	—	—	—	—	—	—
Amortization of investment tax credit, including deferred taxes on basis difference	(1.1)	(2.2)	(0.2)	(0.1)	(0.1)	(0.2)	(0.1)	(0.2)	(0.4)
Plant basis differences	(2.6)	—	(0.3)	(14.6)	(0.8)	(4.9)	(6.7)	(1.9)	(3.4)
Production tax credits and other credits	(2.2)	(4.9)	—	—	—	—	—	—	—
Noncontrolling interests	0.5	1.1	—	—	—	—	—	—	—
Fitzpatrick bargain purchase gain	(0.2)	(0.4)	—	—	—	—	—	—	—
Other	(0.1)	0.3	(0.2)	(0.2)	(0.2)	0.2	—	(0.2)	0.1
Effective income tax rate	34.1%	40.3%	40.9%	20.0%	39.2%	35.2%	30.4%	38.0%	36.9%



	Nine Months Ended September 30, 2018
	Exelon	Generation	ComEd	PECO	BGE	PHI	Pepco	DPL	ACE
U.S. Federal statutory rate	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%	21.0%
Increase (decrease) due to:
State income taxes, net of Federal income tax benefit	1.7	(2.6)	8.2	(3.6)	6.6	2.7	2.4	6.5	7.3
Qualified nuclear decommissioning trust fund income	0.9	2.6	—	—	—	—	—	—	—
Amortization of investment tax credit, including deferred taxes on basis difference	(0.9)	(2.2)	(0.2)	(0.1)	(0.1)	(0.2)	(0.1)	(0.3)	(0.3)
Plant basis differences	(2.7)	—	(0.1)	(15.4)	(0.7)	(1.9)	(2.9)	(0.7)	(1.3)
Production tax credits and other credits	(1.8)	(5.1)	(0.1)	—	—	—	—	—	—
Noncontrolling interests	(1.1)	(3.2)	—	—	—	—	—	—	—
Excess deferred tax amortization	(6.1)	—	(7.6)	(3.4)	(8.1)	(14.5)	(16.5)	(11.0)	(14.0)
Tax Cuts and Jobs Act of 2017	0.2	1.3	(0.2)	—	—	0.3	—	—	—
Other	0.4	2.0	0.1	—	0.9	0.3	—	0.4	0.9
Effective income tax rate	11.6%	13.8%	21.1%	(1.5)%	19.6%	7.7%	3.9%	15.9%	13.6%



	Nine Months Ended September 30, 2017^(a)
	Exelon	Generation	ComEd	PECO	BGE	PHI	Pepco	DPL	ACE
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	0.7	2.2	5.9	(0.1)	5.2	4.9	3.0	5.1	5.6
Qualified nuclear decommissioning trust fund income	4.0	13.6	—	—	—	—	—	—	—
Amortization of investment tax credit, including deferred taxes on basis difference	(0.9)	(2.7)	(0.2)	(0.1)	(0.1)	(0.2)	(0.1)	(0.2)	(0.4)
Plant basis differences	(3.4)	—	(0.3)	(14.4)	(0.8)	(4.6)	(6.3)	(1.8)	(3.4)
Production tax credits and other credits	(1.8)	(6.0)	—	—	—	—	—	—	—
Noncontrolling interests	0.1	0.3	—	—	—	—	—	—	—
Merger expenses^(c)	(5.4)	(2.4)	—	—	—	(11.8)	(8.0)	(10.0)	(23.0)
FitzPatrick bargain purchase gain	(3.2)	(10.9)	—	—	—	—	—	—	—
Like-Kind Exchange^(b)	(1.7)	—	1.7	—	—	—	—	—	—
Other	0.1	(0.4)	0.2	—	0.2	—	(0.3)	0.6	(0.3)
Effective income tax rate	23.5%	28.7%	42.3%	20.4%	39.5%	23.3%	23.3%	28.7%	13.5%

_________


(a)	Exelon retrospectively adopted the new standard Revenue from Contracts with Customers. The standard was adopted as of January 1, 2018. The effective income tax rates are recast to reflect the impact of the new standard.


(b)	Exelon and ComEd recorded the impact of the IRS's finalization of the LKE computation in the second quarter of 2017.


(c)	Includes a remeasurement of uncertain federal and state income tax positions.

Accounting for Uncertainty in Income Taxes

The Registrants have the following unrecognized tax benefits as of September 30, 2018 and December 31, 2017:



	Exelon		Generation		ComEd		PECO		BGE		PHI		Pepco		DPL		ACE
September 30, 2018	$	804	$	527	$	2	$	—	$	120	$	134	$	67	$	21	$	14



	Exelon		Generation		ComEd		PECO		BGE		PHI		Pepco		DPL		ACE
December 31, 2017	$	743	$	468	$	2	$	—	$	120	$	125	$	59	$	21	$	14

As a result of a court decision issued in July 2018 to an unrelated taxpayer, Exelon's and Generation’s unrecognized federal and state tax benefits increased in the third quarter of 2018 by approximately $71 million. Approximately $20 million of this increase impacted Exelon's and Generation’s effective tax rate and resulted in a charge to earnings in the third quarter of 2018.

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 September 30, 2018, Exelon and ComEd have approximately $33 million and $2 million, respectively, of unrecognized federal and state tax benefits related to the like-kind exchange litigation described further below. If Exelon decides not to appeal the October 2018 U.S. Court of Appeals for the Seventh Circuit's decision, Exelon's and ComEd's unrecognized tax benefits will decrease in the fourth quarter. See below for further details.

Settlement of Income Tax Audits, Refund Claims, and Litigation

As of September 30, 2018, Exelon, Generation, PHI and ACE have approximately $515 million, $501 million, $14 million and $14 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, potential settlements, and the outcomes of pending court cases. Of the above unrecognized tax benefits, Exelon and Generation have $473 million that, if recognized, would decrease the effective tax rate. The unrecognized tax benefits related to PHI and ACE, if recognized, may be included in future regulated base rates and that portion would have no impact to the effective tax rate.

As of September 30, 2018, Exelon, Generation, BGE, PHI, Pepco and DPL have approximately $241 million, $33 million, $120 million, $88 million, $67 million, and $21 million, respectively, of unrecognized state tax benefits that will decrease in the fourth quarter of 2018 due to the receipt of favorable guidance with respect to the deductibility of certain depreciable fixed assets. The recognition of these tax benefits will decrease the effective tax rate at Exelon and Generation in the fourth quarter of 2018, which will result in an income tax benefit of approximately $26 million. The recognition of the tax benefits related to BGE, PHI, Pepco and DPL will be offset by corresponding regulatory liabilities and that portion will have no immediate impact to their 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. As previously disclosed, Exelon terminated its investment in one of the leases in 2014 and the remaining two leases were terminated in 2016.

The IRS asserted that the Exelon purchase and leaseback transaction was substantially similar to a leasing transaction, known as a SILO, which is a listed transaction that the IRS has identified as a potentially abusive tax shelter. Thus, they disagreed with Exelon's position and asserted that the entire gain of approximately $1.2 billion was taxable in 1999. In 2013, the IRS issued a notice of deficiency to Exelon and Exelon filed a petition to initiate litigation in the United States Tax Court. In 2016, the Tax Court held that Exelon was not entitled to defer gain on the transaction. In addition to the tax and interest related to the gain deferral, the Tax Court also ruled that Exelon was liable for $90 million in penalties and interest on the penalties. Exelon has fully paid the amounts assessed resulting from the Tax Court decision.

In September 2017, Exelon appealed the Tax Court decision to the U.S. Court of Appeals for the Seventh Circuit. In October 2018, the U.S. Court of Appeals for the Seventh Circuit affirmed the Tax Court’s decision. Exelon is evaluating whether to pursue any further appeals of the decision.

State Income Tax Law Changes

On April 24, 2018, Maryland enacted companion bills, House Bill 1794 and Senate Bill 1090, providing for a phase in of a single sales factor apportionment formula from the current three factor formula for determining an entity's Maryland state income taxes. The single sales factor will be fully phased in by 2022.

In the second quarter of 2018, Exelon, Generation, PHI, Pepco and DPL recorded a one-time increase to deferred income taxes of approximately $16 million, $5 million, $17 million, $16 million and $1 million, respectively. At PHI, Pepco and DPL, the increase to the Maryland deferred income tax liability was offset by regulatory assets. Further, the change in tax law is not expected to have a material ongoing impact to Exelon's, Generation's, PHI's, Pepco's or DPL's future results of operations.

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

In the third quarter of 2018, Exelon reviewed and updated its marginal state income tax rates based on 2017 state apportionment rates. As a result of the rate changes, in the third quarter of 2018, Exelon, Generation, PHI and DPL recorded a one-time decrease to deferred income taxes of approximately $50 million, $53 million, $4 million and $2 million, respectively. Pepco recorded a one-time increase to deferred incomes taxes of approximately $1 million. Exelon, PHI and DPL recorded a corresponding regulatory liability of approximately $1 million, $1 million and $2 million, respectively. Pepco recorded a corresponding regulatory asset of approximately $1 million. In the third quarter of 2018, Exelon, Generation and PHI recorded a decrease to income tax expense (net of federal taxes) of approximately $50 million, $53 million and $3 million, respectively.