Note 3 – Income Taxes

Income tax expense differs from the amount computed by applying the statutory rate on book income subject to tax for the following reasons:

	(Thousands of Dollars)
	Years Ended December 31,
	2015			2014			2013
Income Tax at Statutory Rate	$	10,703		$	9,786		$	8,638
Tax Effect of:
Utility Plant Related		(920	)		(572	)		(527	)
State Income Taxes – Net		745			711			546
Employee Benefits		7			(6	)		(46	)
Other		16			18			10
Total Income Tax Expense	$	10,551		$	9,937		$	8,621

Income tax expense is comprised of the following:

	(Thousands of Dollars)
	Years Ended December 31,
	2015			2014			2013
Current:
Federal	$	(15,203	)	$	5,920		$	5,018
State		1,153			887			688
Deferred:
Federal		24,686			3,018			2,855
State		(6	)		191			139
Investment Tax Credits		(79	)		(79	)		(79	)
Total Income Tax Expense	$	10,551		$	9,937		$	8,621

The statutory review periods for income tax returns for the years prior to 2012 have been closed. The Company has been notified by the Internal Revenue Service (IRS) that the Company's 2014 federal income tax return has been selected for examination. In the event that there is interest and penalties associated with income tax adjustments in future examinations, these amounts will be reported under interest expense and other expense, respectively. Other than the effects of the provision against refundable taxes discussed below, there are no unrecognized tax benefits resulting from prior period tax positions.

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial purposes and the amounts used for income tax purposes. The components of the net deferred tax liability are as follows:

	(Thousands of Dollars)
	December 31,
	2015				2014
Utility Plant Related	$	63,281		$	43,996
Customer Advances		(3,510	)		(3,570	)
Employee Benefits		5,796			7,223
Investment Tax Credits (ITC)		832			910
Net Operating Loss Carryforwards		2,311			—
Other		(176	)		(343	)
Total Deferred Tax Liability and ITC	$	68,534		$	48,216

The IRS has issued final regulations pertaining to the deductibility of costs that qualify as repairs on tangible property. The regulations, which the Company adopted by filing a change in accounting method request with its 2014 Federal income tax return, redefine the characteristics previously used by the Company to determine tax deductibility of expenditures associated with tangible property. Under the regulations, the IRS has provided guidelines for certain industries, but not for regulated public water utilities. Consequently, the Company undertook a comprehensive study to support the adoption and integration of the new regulations into its tax policies prospectively, and to also determine the level of deductibility for income tax purposes for expenditures incurred on projects completed in prior years where such expenditures were capitalized, but may now be considered currently deductible as repairs under the new regulations. Included in its 2014 Federal income tax return, filed in September 2015, the Company submitted support which results in a net reduction of $17.6 million in taxes due to the federal government. While the Company believes that the deduction for qualifying tangible property repair costs included in its tax return is proper, it could be challenged under an examination by the IRS. Therefore, the Company has recorded a provision against refundable taxes of $2.3 million. The Company believes that the net operating loss carry-forward, expiring in 2034, resulting from adoption of the regulations (approximately $7.8 million) is more likely than not to be recovered.

It is probable that any net tax benefits that resulted from adopting the study findings will be considered in determining the revenue requirement used to set base rates for the Company in a future regulatory proceeding. Consequently, adoption of the new regulations did not and will not have a significant impact on the Company's financial statements or effective tax rate. Adoption of these new regulations resulted in a $10.3 million federal income tax refund request, a $1.5 million increase in regulatory assets for additional expenses incurred expected to be recovered from customers in the future, a $5.0 million decrease in accrued taxes for the amount of refund applied against future tax payments and a $16.8 million increase in accumulated deferred income taxes.