INCOME TAX EXPENSE



Income Tax Expense
Year Ended December 31	2012			2011			2010
Millions
Current Tax Expense (Benefit)
Federal (a)	—			$1.4			$(23.0)
State (a)	$0.5			(1.6		)	1.3
Total Current Tax Expense (Benefit)	0.5			(0.2		)	(21.7		)
Deferred Tax Expense
Federal (b)	38.1			27.3			61.4
State (b)	(1.7		)	9.5			5.3
Change in Valuation Allowance (c)	2.0			(0.1		)	0.2
Investment Tax Credit Amortization	(0.9		)	(0.9		)	(0.9		)
Total Deferred Tax Expense	37.5			35.8			66.0
Total Income Tax Expense		$38.0			$35.6			$44.3

(a)

For the years ended December 31, 2012 and 2011, the federal and state current tax expense (benefit) was due to NOLs which resulted primarily from the bonus depreciation provision of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The 2012 and 2011 federal and state NOLs will be carried forward to offset future taxable income. For the year ended December 31, 2010, a federal current tax benefit was recorded as a result of tax planning initiatives and the bonus depreciation provision in the Small Business Jobs Act of 2010. The 2010 federal NOL was partially utilized by carrying it back against prior years’ income with the remainder carried forward to offset future years’ income.

(b)

For the year ended December 31, 2012, the state deferred tax benefit of $1.7 million is due to state renewable tax credits earned which will be carried forward to offset future state income tax expense. The year ended December 31, 2011, included an income tax benefit for the reversal of a $6.2 million deferred tax liability related to a revenue receivable that Minnesota Power agreed to forgo as part of a stipulation and settlement agreement in its 2010 rate case and a benefit of $2.9 million related to the MPUC approval of our request to defer the retail portion of the tax charge taken in 2010 as a result of the PPACA. Included in the year ended December 31, 2010, was a charge of $4.0 million as a result of the PPACA. (See Note 5. Regulatory Matters.)


(c)	For the year ending December 31, 2012, the change in the valuation allowance is due to state renewable tax credits earned in 2012 which are not expected to be utilized within their allowable tax carryforward period.



Reconciliation of Taxes from Federal Statutory
Rate to Total Income Tax Expense
Year Ended December 31	2012			2011			2010
Millions
Income Before Non-Controlling Interest and Income Taxes		$135.1			$129.2			$119.1
Statutory Federal Income Tax Rate	35		%	35		%	35		%
Income Taxes Computed at 35 percent Statutory Federal Rate		$47.3			$45.2			$41.7
Increase (Decrease) in Tax Due to:
State Income Taxes – Net of Federal Income Tax Benefit	1.2			6.0			4.5
Impact of the PPACA	—			—			4.0
Deferred Accounting for Retail Portion of the PPACA	—			(2.9		)	—
2010 Rate Case Stipulation Agreement - Deferred Tax Reversal	—			(6.2		)	—
Regulatory Differences for Utility Plant	(2.2		)	(1.2		)	(2.0		)
Production Tax Credits	(7.6		)	(4.3		)	(1.6		)
Other	(0.7		)	(1.0		)	(2.3		)
Total Income Tax Expense		$38.0			$35.6			$44.3

NOTE 14. INCOME TAX EXPENSE (Continued)

The effective tax rate on income was 28.1 percent for 2012 (27.6 percent for 2011; 37.2 percent for 2010). The 2012 effective rate was primarily impacted by renewable tax credits and by the deduction for AFUDC-Equity (included in Regulatory Differences for Utility Plant, above). The 2011 effective tax rate was primarily impacted by the deduction for AFUDC-Equity, the reversal of a deferred tax liability related to a revenue receivable that Minnesota Power agreed to forgo as part of a stipulation and settlement agreement in its 2010 rate case, renewable tax credits, and the MPUC’s approval of our request to defer the retail portion of the tax charge taken in 2010 as a result of the PPACA. The 2010 effective tax rate was primarily impacted by the PPACA eliminating the tax deduction for expenses that are reimbursed under Medicare Part D, the deduction for AFUDC-Equity, and renewable tax credits.



Deferred Tax Assets and Liabilities
As of December 31	2012			2011
Millions
Deferred Tax Assets
Employee Benefits and Compensation		$120.2			$132.7
Property Related	59.8			56.4
NOL Carryforwards	90.8			61.7
Tax Credit Carryforwards	28.3			12.2
Other	24.6			20.4
Gross Deferred Tax Assets	323.7			283.4
Deferred Tax Asset Valuation Allowance	(2.4		)	(0.4		)
Total Deferred Tax Assets		$321.3			$283.0
Deferred Tax Liabilities
Property Related		$577.1			$482.7
Regulatory Asset for Benefit Obligations	104.3			117.9
Unamortized Investment Tax Credits	11.9			12.8
Partnership Basis Differences	28.6			24.4
Other	30.1			24.0
Total Deferred Tax Liabilities		$752.0			$661.8
Net Deferred Income Taxes		$430.7			$378.8
Recorded as:
Net Current Deferred Tax Liabilities (a)		$6.9			$5.2
Net Long-Term Deferred Tax Liabilities	423.8			373.6
Net Deferred Income Taxes		$430.7			$378.8


(a)	Included in Other Current Liabilities.



NOL and Tax Credit Carryforwards
Year Ended December 31	2012		2011
Millions
Federal NOL carryforwards (a)		$244.1		$162.0
Federal tax credit carryforwards	$16.0		$8.4
State NOL carryforwards (a) (b)	$90.6		$73.1
State tax credit carryforwards (c)	$10.3		$3.8


(a)	Pretax amounts


(b)	Net of $0.4 million valuation allowance.


(c)	Net of $2.0 million valuation allowance.

NOTE 14. INCOME TAX EXPENSE (Continued)

In 2012, we generated federal and various state NOLs and tax credit carryforwards primarily due to the bonus depreciation provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The 2012 federal NOL will be utilized by carrying it forward to offset future years’ income. The federal NOL and tax credit carryforward periods expire between 2019 and 2032; included in the federal NOL carryforward are charitable contribution carryforwards which expire between 2014 and 2016. We expect to fully utilize the federal NOL, charitable contributions, and federal tax credit carryforwards; therefore no valuation allowance has been recognized as of December 31, 2012.

The state NOLs and tax credits will be carried forward to future tax years. We have established a valuation allowance against certain state NOL and tax credits that we do not expect to utilize before their expiration. The state NOL and tax credit carryforward periods expire between 2024 and 2032; included in the state NOL carryforwards are charitable contribution carryforwards which expire between 2014 and 2016.



Gross Unrecognized Income Tax Benefits	2012			2011			2010
Millions
Balance at January 1		$11.4			$12.3			$9.5
Reductions for Tax Positions Related to the Current Year	—			—			(0.2		)
Additions for Tax Positions Related to Prior Years	—			—			4.4
Reductions for Tax Positions Related to Prior Years	(8.7		)	(0.9		)	—
Reductions for Settlements	—			—			(0.3		)
Reductions for Expired Statute of Limitations	—			—			(1.1		)
Balance as of December 31		$2.7			$11.4			$12.3

Unrecognized tax benefits are the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured pursuant to the “more-likely-than-not” criteria. The unrecognized tax benefit balance includes permanent tax positions, which if recognized would affect the annual effective tax rate. In addition, the unrecognized tax benefit balance includes temporary tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. A change in the period of deductibility would not affect the effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.

The gross unrecognized tax benefits as of December 31, 2012, includes $0.5 million of net unrecognized tax benefits that, if recognized, would affect the annual effective income tax rate. The decrease in the unrecognized tax benefit balance of $8.7 million in 2012 was due to the removal of our uncertain tax position for our tax accounting method change for deductible repairs. During 2012, the IRS issued a directive from its Large Business and International Division to its local examination teams that led to the removal of the repairs uncertain tax position in 2012.

As of December 31, 2012, we had $0.5 million ($1.1 million for 2011 and $0.7 million for 2010) of accrued interest related to unrecognized tax benefits included in our Consolidated Balance Sheet. We classify interest related to unrecognized tax benefits as interest expense and tax-related penalties in operating expenses in our Consolidated Statement of Income. In 2012, we recognized a $0.6 million decrease in interest expense (interest expense of $0.4 million for 2011 and a reduction of interest expense of $0.2 million for 2010). There were no penalties recognized in 2012, 2011 or 2010.

ALLETE and its subsidiaries file a consolidated federal income tax return as well as combined and separate state income tax returns in various jurisdictions. ALLETE is currently under examination by the IRS for the tax years 2005 through 2009. ALLETE is no longer subject to federal or state examination for years before 2005.

During the next 12 months it is reasonably possible the amount of unrecognized tax benefits could be reduced by $2.5 million due to statute expirations and anticipated audit settlements. This amount is primarily due to temporary tax positions.