NOTE 3

INCOME TAXES

Deferred income taxes reflect temporary differences between the valuation of assets and liabilities for financial and tax reporting. Pursuant to the enactment of the TCJA, the Company adjusted its existing deferred income tax balances as of December 31, 2017 to reflect the decrease in the corporate income tax rate from 34% to 21%, which resulted in a decrease in the net deferred income tax liability of approximately $23.5 million. Artesian Resources recorded a net benefit to continuing operations of approximately $1.0 million, while the regulated utility subsidiaries recorded a regulatory liability related to deferred income taxes to be passed through to customers in the form of reduced tariff rates or approved DSIC rate (see Note 1) in the amount of approximately $22.5 million. The amount and timing of potential settlements of the established net regulatory liabilities will be determined by the utilities' respective rate regulators, subject to certain Internal Revenue Service normalization rules. The normalization rules require that the benefits to customers be spread over the remaining useful life of the underlying assets giving rise to the associated deferred income taxes.

At December 31, 2017, for federal income tax purposes, there were alternative minimum tax credit carry-forwards aggregating $1.8 million resulting from the payment of alternative minimum tax in prior years. Effective January 1, 2018, these alternative minimum tax credit carry-forwards are available for refund. The Company has reclassified all of its AMT credits into the current tax receivable as of December 31, 2017 since they are expected to be utilized in 2018.

As of December 31, 2017, Artesian Resources had fully utilized all of its federal net operating loss carrybacks and carry-forwards. As of December 31, 2017, Artesian Resources has separate company state net operating loss carry-forwards aggregating approximately $15.4 million. These net operating loss carry-forwards will expire if unused between 2019 and 2038. 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. The valuation allowance increased to approximately $360,000 in 2017 from approximately $286,000 in 2016. Management believes that it is more likely than not that the Company will realize the benefits of these net deferred tax assets.

Components of Income Tax Expense
In thousands	For the Year Ended December 31,
State income taxes	2017				2016		2015
Current		$	489		$	1,050	$	499
Deferred			1,368			860		1,299
Total state income tax expense		$	1,857		$	1,910	$	1,798

	For the Year Ended December 31,
Federal income taxes			2017			2016		2015
Current		$	(1,418	)	$	1,799	$	2,168
Deferred			6,856			4,622		3,818
Total federal income tax expense		$	5,438		$	6,421	$	5,986

Reconciliation of effective tax rate:
	For the Year Ended December 31,
In thousands	2017				2017			2016				2016			2015			2015
	Amount				Percent			Amount				Percent			Amount			Percent
Reconciliation of effective tax rate
Income before federal and state income taxes		$	21,278			100.0	%		$	21,285			100.0	%		$	19,088		100.0	%

Amount computed at statutory rate			7,234			34.0	%			7,237			34.0	%			6,490		34.0	%
Reconciling items
State income tax-net of federal tax benefit			1,297			6.1	%			1,327			6.2	%			1,214		6.4	%
Federal rate change			(957	)		(4.5	%)			--			--				--		--
Other			(279	)		(1.3	)%			(233	)		(1.1	)%			80		0.4	%
Total income tax expense and effective rate		$	7,295			34.3	%		$	8,331			39.1	%		$	7,784		40.8	%

Deferred income taxes at December 31, 2017, 2016, and 2015 were comprised of the following:

	For the Year Ended December 31,
In thousands	2017			2016			2015

Deferred tax assets related to:
Federal alternative minimum tax credit carry-forwards	$	-		$	2,474		$	3,971
Federal and state operating loss carry-forwards		1,094			752			675
Bad debt allowance		80			104			110
Valuation allowance		(360	)		(286	)		(182	)
Stock options		207			452			415
Other		161			320			291
Total deferred tax assets	$	1,182		$	3,816		$	5,280

Deferred tax liabilities related to:
Property plant and equipment basis differences	$	(52,629	)	$	(70,711	)	$	(66,508	)
Bond retirement costs		(1,437	)		0			0
Uncertain tax position		(145	)		(80	)		(247	)
Expenses of rate proceedings		(8	)		(19	)		(213	)
Property taxes		(500	)		(663	)		(527	)
Other		(600	)		(796	)		(756	)
Total deferred tax liabilities	$	(55,319	)	$	(72,269	)	$	(68,251	)


Net deferred tax liability	$	(54,137	)	$	(68,453	)	$	(62,971	)

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, 2017 Valuation allowance for deferred tax assets		$	286		$	74		—		$	360
For the Year Ended December 31, 2016 Valuation allowance for deferred tax assets		$	182		$	104		—		$	286
For the Year Ended December 31, 2015 Valuation allowance for deferred tax assets		$	65		$	117		—		$	182

Under FASB ASC Topic 740, the Company established two reserves for uncertain tax positions based upon management's judgment as to the sustainability of these positions.

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 2017 Federal tax return when filed of $4.5 million for qualifying capital expenditures made during the year.

In December 2015, the Company was notified by the IRS that its Federal tax filing for 2014 would be reviewed along with the effects of the net operating loss generated in 2014 and carryback to the 2012 and 2013 tax years. This review, which began in the first quarter of 2016 and was completed in the second quarter of 2016, resulted in no change to the tax liability. Since the Company had previously recorded a provision for the possible disallowance of a portion of the repair deduction in prior periods, the completion of the audit resulted in the reversal of the reserve, including interest and penalties, in the amount of approximately $201,000. While the Company maintains the belief that the deduction taken on its tax return is appropriate, the methodology for determining the deduction has not been agreed to by the tax authorities. Therefore, as required by FASB ASC 740, the Company reserved an additional liability related to a portion of the repair deduction for 2017.

Additionally, the Company reserved a liability related to the difference in the tax depreciation utilizing the half-year convention rather than the mid-quarter convention.

The following table provides the changes in the Company's uncertain tax position:

	For the years ended December 31,
In thousands	2017			2016
Balance at beginning of year	$	80		$	247
Additions based on tax positions related to the current year		118			23
Additions based on tax positions related to prior years		8			11
Reductions for tax positions of prior years		-			(201	)
Settlements		-			-
Federal tax rate change		(61	)
Lapses in Statutes of Limitations		-			-
Balance at end of year	$	145		$	80