Taxes on Income

Registrant provides deferred income taxes for temporary differences under the accounting guidance for income taxes for certain transactions which are recognized for income tax purposes in a period different from that in which they are reported in the financial statements. The most significant items are the tax effects of differences in asset basis (including accelerated depreciation and capitalization methods), certain regulatory balancing accounts and advances for, and contributions in aid of, construction. The accounting guidance for income taxes also requires that rate-regulated enterprises record deferred income taxes for temporary differences given flow-through treatment at the direction of a regulatory commission. The resulting deferred tax assets and liabilities are recorded at the expected cash flow to be reflected in future rates. Given that the CPUC has consistently permitted the recovery of flowed-through tax effects, GSWC has established regulatory liabilities and assets offsetting such deferred tax assets and liabilities (Note 2). Deferred investment tax credits (“ITC”) are amortized ratably to deferred tax expense over the lives of the property giving rise to the credits.

GSWC is included in AWR’s consolidated federal income tax and combined California state franchise tax returns. California unitary apportionment provides a benefit or detriment to AWR’s state taxes, depending on a combination of the profitability of AWR’s non-California activities as well as the proportion of its California sales to total sales. Consistent with the method adopted for regulatory purposes, GSWC’s tax expense is computed as if GSWC were autonomous and files separate returns. Given that all of GSWC’s activities are conducted within California, GSWC’s state tax expense does not reflect apportionment of its income.

As a regulated utility, GSWC treats certain temporary differences as flow-through adjustments in computing its income tax provision consistent with the income tax approach approved by the CPUC for ratemaking purposes. Flow-through adjustments increase or decrease tax expense in one period, with an offsetting decrease or increase occurring in another period. Giving effect to these temporary differences as flow-through adjustments typically results in a greater variance between the effective tax rate (“ETR”) and the statutory federal income tax rate in any given period than would otherwise exist if GSWC were not required to account for its income taxes as a regulated enterprise. The GSWC ETRs deviate from the statutory rate primarily due to state taxes and differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements (principally plant-, rate-case- and compensation-related items). The ETR at the AWR consolidated level also fluctuates as a result of ASUS's state income taxes, which vary among the jurisdictions in which it operates, and certain permanent differences.

Changes in Tax Law

In December 2015, the Protecting Americans From Tax Hikes Act of 2015 extended bonus depreciation for qualifying property through 2019. For 2015 through 2017, bonus depreciation was extended at a 50% rate. For 2018-2019, bonus depreciation will be phased down to 40% and 30%, respectively. Although the change in law reduces AWR’s current taxes payable over these years, it does not reduce its total income tax expense or ETR.

During the fourth quarter of 2014, the Company reflected a change in its tax method of accounting for certain repair and maintenance expenditures pursuant to regulations issued by the U.S. Treasury Department in September 2013. In connection with filing its 2014 federal tax return during the third quarter of 2015, the Company filed an application for an automatic change in tax accounting method with the Internal Revenue Service ("IRS") for the 2014 tax year to implement the new method (effective January 1, 2014). The tax accounting method change included a cumulative adjustment for 2013 and prior years, and permits the expensing of certain utility asset replacement costs that were previously being capitalized and depreciated for book and tax purposes. As a result of the change, the Company will deduct a significant amount of asset costs, which consist primarily of water mains and connections.

During the fourth quarter of 2014, GSWC recorded a cumulative adjustment for 2013 and prior years as well as the 2014 estimated deduction, and recognized a total deferred income tax liability of $30.8 million for federal and state repair-and-maintenance deductions as of December 31, 2014. Although this change reduces AWR’s current taxes payable, it does not reduce total income tax expense or the ETR.

The significant components of the deferred tax assets and liabilities as reflected in the balance sheets at December 31, 2015 and 2014 are:



	AWR						GSWC
	December 31,						December 31,
(dollars in thousands)	2015			2014			2015			2014
Deferred tax assets:
Regulatory-liability-related: ITC	$	952		$	1,001		$	952		$	1,001
Regulatory-liability-related: California Corp Franchise Tax	4,530			4,328			4,530			4,328
Other non-property-related	2,486			2,395			1,997			2,136
Contributions and advances	8,026			8,335			8,026			8,335
	$	15,994		$	16,059		$	15,505		$	15,800
Deferred tax liabilities:
Fixed assets	$	(178,004	)	$	(163,232	)	$	(179,660	)	$	(164,724	)
Regulatory-asset-related: depreciation and other	(21,658		)	(22,941		)	(21,658		)	(22,941		)
California Corp Franchise Tax	(2,440		)	(4,069		)	(3,051		)	(4,831		)
Other property-related	(66		)	(59		)	(65		)	(59		)
Balancing and memorandum accounts	(1,824		)	(4,071		)	(1,824		)	(4,071		)
Deferred charges	(4,849		)	(5,461		)	(4,905		)	(5,461		)
	(208,841		)	(199,833		)	(211,163		)	(202,087		)
Accumulated deferred income taxes - net	$	(192,847	)	$	(183,774	)	$	(195,658	)	$	(186,287	)

The current and deferred components of income tax expense are as follows:



	AWR
	Year Ended December 31,
(dollars in thousands)	2015		2014		2013
Current
Federal	$	21,866	$	5,595	$	13,741
State	5,442		137		5,930
Total current tax expense	$	27,308	$	5,732	$	19,671
Deferred
Federal	$	8,948	$	24,815	$	14,769
State	1,475		7,501		1,343
Total deferred tax expense	10,423		32,316		16,112
Total income tax expense	$	37,731	$	38,048	$	35,783



	GSWC
	Year Ended December 31,
(dollars in thousands)	2015		2014			2013
Current
Federal	$	16,196	$	408		$	10,768
State	5,557		(2,754		)	6,315
Total current tax expense	$	21,753	$	(2,346	)	$	17,083
Deferred
Federal	$	8,536	$	24,373		$	14,691
State	2,183		9,979			1,360
Total deferred tax expense	10,719		34,352			16,051
Total income tax expense	$	32,472	$	32,006		$	33,134

The reconciliations of the effective tax rates to the federal statutory rate are as follows:



	AWR
	Year Ended December 31,
(dollars in thousands, except percent)	2015			2014			2013
Federal taxes on pretax income at statutory rate	$	34,375		$	34,687		$	34,464
Increase (decrease) in taxes resulting from:
State income tax, net of federal benefit	4,843			4,781			5,111
Flow-through on fixed assets	626			651			646
Flow-through on pension costs	267			(507		)	612
Flow-through on removal costs	(929		)	(1,571		)	(2,141		)
Domestic production activities deduction	(1,560		)	(643		)	(2,944		)
Investment tax credit	(88		)	(91		)	(91		)
Other – net	197			741			126
Total income tax expense from operations	$	37,731		$	38,048		$	35,783
Pretax income from operations	$	98,215		$	99,106		$	98,469
Effective income tax rate	38.4		%	38.4		%	36.3		%



	GSWC
	Year Ended December 31,
(dollars in thousands, except percent)	2015			2014			2013
Federal taxes on pretax income at statutory rate	$	28,022		$	27,952		$	28,622
Increase (decrease) in taxes resulting from:
State income tax, net of federal benefit	5,151			4,693			5,372
Flow-through on fixed assets	626			651			646
Flow-through on pension costs	267			(507		)	612
Flow-through on removal costs	(929		)	(1,571		)	(2,141		)
Domestic production activities deduction	(1,268		)	(55		)	(1,316		)
Investment tax credit	(88		)	(91		)	(91		)
Other – net	691			934			1,430
Total income tax expense from operations	$	32,472		$	32,006		$	33,134
Pretax income from operations	$	80,063		$	79,863		$	81,776
Effective income tax rate	40.6		%	40.1		%	40.5		%

AWR and GSWC had no unrecognized tax benefits at December 31, 2015, 2014 and 2013.

Registrant’s policy is to classify interest on income tax over/underpayments in interest income/expense and penalties in “other operating expenses.”

At December 31, 2015, 2014 and 2013, AWR included $504,000, $504,000 and $757,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. AWR recognized no interest income or expense during the year ended December 31, 2015, and recognized $19,000 and $99,000 of interest income during the years ended December 31, 2014 and 2013, respectively. At December 31, 2015, 2014 and 2013, GSWC included $512,000, $472,000 and $704,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. GSWC recognized $3,000 of interest expense, and $14,000 and $21,000 of interest income from taxing authorities during the years ended December 31, 2015, 2014 and 2013, respectively.

At December 31, 2015, 2014 and 2013, Registrant had no significant accruals for income-tax-related penalties and had no significant income-tax-related penalties recognized during the years ended December 31, 2015, 2014 and 2013.

Registrant files federal and various state income tax returns. AWR’s federal 2010 through 2012 refund claims were examined during 2015, and the Internal Revenue Service (“IRS”) completed its examination of them in February 2016. Its 2012-2014 tax years remain subject to examination by the IRS. AWR has filed protective refund claims with the applicable state taxing authority for the 2002 through 2008 tax years in connection with the matters on the federal claims for these years and other state tax matters. During 2012, the California Franchise Tax Board commenced examining these claims. The 2009-2014 tax years remain subject to examination by state taxing authorities.