NOTE 3

INCOME TAXES

Deferred income taxes reflect temporary differences between the valuation of assets and liabilities for financial and tax reporting.

As of December 31, 2015, Artesian Resources had fully utilized all of its federal net operating loss carrybacks and carry-forwards. As of December 31, 2015, Artesian Resources has separate company state net operating loss carry-forwards aggregating approximately $12.0 million, which will expire if unused between 2019 and 2036. Artesian Resources has recorded a valuation allowance to reflect the estimated amount of deferred tax assets that may not be realized due to the expiration of the state net operating loss carry-forwards. Management believes it is more likely than not that the Company will realize the majority of the benefits of these net deferred tax assets. Artesian Resources has recorded a valuation allowance of approximately $65,000 and $182,000 in 2014 and 2015, respectively to reflect the estimated amount of deferred tax assets that may not be realized before expiration.

At December 31, 2015, for federal income tax purposes, there were alternative minimum tax credit carry-forwards aggregating $4.0 million resulting from the payment of alternative minimum tax in prior years. These alternative minimum tax credit carry-forwards may be carried forward indefinitely to offset future regular federal income taxes. The Company remains subject to examination by federal and state authorities for tax years 2012 through 2015 and is currently under federal audit by the Internal Revenue Service for the tax years 2012, 2013 and 2014.

Components of Income Tax Expense
In thousands	For the Year Ended December 31,
State income taxes	2015			2014			2013
Current		$	499	$	173		$	526
Deferred			1,299		1,231			706
Total state income tax expense		$	1,798	$	1,404		$	1,232

	For the Year Ended December 31,
Federal income taxes			2015		2014			2013
Current		$	2,168	$	(1,073	)	$	1,199
Deferred			3,818		6,044			3,157
Total federal income tax expense		$	5,986	$	4,971		$	4,356

Reconciliation of effective tax rate:
	For the Year Ended December 31,
In thousands	2015			2015			2014			2014			2013			2013
	Amount			Percent			Amount			Percent			Amount			Percent
Reconciliation of effective tax rate
Income before federal and state income taxes		$	19,088		100.0	%		$	15,881		100.0	%		$	13,890		100.0	%

Amount computed at statutory rate			6,490		34.0	%			5,400		34.0	%			4,722		34.0	%
Reconciling items
State income tax-net of federal tax benefit			1,214		6.4	%			918		5.8	%			804		5.8	%
Other			80		0.4	%			57		0.3	%			62		0.4	%
Total income tax expense and effective rate		$	7,784		40.8	%		$	6,375		40.1	%		$	5,588		40.2	%

Deferred income taxes at December 31, 2015, 2014, and 2013 were comprised of the following:

	For the Year Ended December 31,
In thousands	2015			2014			2013

Deferred tax assets related to:
Federal alternative minimum tax credit carry-forwards	$	3,971		$	5,459		$	4,643
Federal and state operating loss carry-forwards		675			1,045			544
Bad debt allowance		110			99			88
Valuation allowance		(182	)		(65	)		(61	)
Stock options		415			397			343
Other		291			269			264
Total deferred tax assets	$	5,280		$	7,204		$	5,821

Deferred tax liabilities related to:
Property plant and equipment basis differences	$	(66,508	)	$	(63,427	)	$	(55,066	)
Uncertain tax position		(247	)		(179	)		—
Expenses of rate proceedings		(213	)		(214	)		(86	)
Property taxes		(527	)		(505	)		(592	)
Other		(756	)		(734	)		(657	)
Total deferred tax liabilities	$	(68,251	)	$	(65,059	)	$	(56,401	)


Net deferred tax liability	$	(62,971	)	$	(57,855	)	$	(50,580	)

Deferred taxes, which are classified into a net current and non-current balance, are presented in the balance sheet as follows:
Current deferred tax liability	$	(815	)	$	(812	)	$	(838	)
Non-current deferred tax liability		(62,156	)		(57,043	)		(49,742	)
Net deferred tax liability	$	(62,971	)	$	(57,855	)	$	(50,580	)

Schedule of Valuation Allowance
	Balance at Beginning of Period			Additions Charged to Costs and Expenses			Deductions		Balance at End of Period
In thousands

Classification
For the Year Ended December 31, 2015 Valuation allowance for deferred tax assets		$	65		$	117		—		$	182
For the Year Ended December 31, 2014 Valuation allowance for deferred tax assets		$	61		$	4		—		$	65
For the Year Ended December 31, 2013 Valuation allowance for deferred tax assets		$	57		$	4		—		$	61

Under FASB ASC Topic 740, an uncertain tax position represents our expected treatment of a tax position taken, or planned to be taken in the future, that has not been reflected in measuring income tax expense for financial reporting purposes. In 2014, the Company changed its tax method of accounting for qualifying utility system repairs effective with the tax year ended December 31, 2014 and for prior tax years. The tax accounting method was changed to permit the expensing of qualifying utility asset improvement costs that were previously being capitalized and depreciated for book and tax purposes. The Company will recognize a tax deduction on its 2015 Federal tax return when filed of $1.4 million for qualifying capital expenditures made during the year.

The Company establishes reserves for uncertain tax positions based upon management's judgment as to the sustainability of these positions. These accounting estimates related to the uncertain tax position reserve require judgments to be made as to the sustainability of each uncertain tax position based on its technical merits. The Company believes its tax positions comply with applicable law and that it has adequately recorded reserves as required. However, to the extent the final tax outcome of these matters is different than the estimates recorded, the Company would then adjust its tax reserves or unrecognized tax benefits in the period that this information becomes known. The Company has elected to recognize accrued interest (net of related tax benefits) and penalties related to uncertain tax positions as a component of its income tax expense. The Company has accrued approximately $17,000 in penalties and interest for the year.

The following table provides the changes in the Company's unrecognized tax benefits:		For the years ended December 31,
In thousands		2015		2014
Balance at beginning of year		$	179	$	—
Additions based on tax positions related to the current year			51		179
Additions based on tax positions related to prior years			17		—
Reductions for tax positions of prior years			—		—
Settlements			—		—
Lapses in Statutes of Limitations			—		—
Balance at end of year	S		247	$	179