Income Taxes

Income Tax Expense (Benefit)

The jurisdictional components of income (loss) from continuing operations before income tax expense (benefit), attributable to Calpine, for the years ended December 31, 2013, 2012 and 2011, are as follows (in millions):



	2013			2012		2011
U.S.	$	(13	)	$	194	$	(232	)
International	29			24		20
Total	$	16		$	218	$	(212	)

The components of income tax expense (benefit) from continuing operations for the years ended December 31, 2013, 2012 and 2011, consisted of the following (in millions):



	2013			2012			2011
Current:
Federal	$	(2	)	$	(12	)	$	(16	)
State	(9		)	16			12
Foreign	(1		)	14			3
Total current	(12		)	18			(1		)
Deferred:
Federal	1			11			(33		)
State	4			(5		)	9
Foreign	9			(5		)	3
Total deferred	14			1			(21		)
Total income tax expense (benefit)	$	2		$	19		$	(22	)

For the years ended December 31, 2013, 2012 and 2011, our income tax rates did not bear a customary relationship to statutory income tax rates, primarily as a result of the impact of our valuation allowance, state income taxes and changes in unrecognized tax benefits. A reconciliation of the federal statutory rate of 35% to our effective rate from continuing operations for the years ended December 31, 2013, 2012 and 2011, is as follows:



	2013		2012		2011
Federal statutory tax expense (benefit) rate	35.0	%	35.0	%	(35.0	)%
State tax expense (benefit), net of federal benefit	(69.8	)	3.2		6.5
Depletion in excess of basis	(14.7	)	(0.2	)	—
Federal refunds	—		(4.7	)	—
Valuation allowances against future tax benefits	89.8		(30.3	)	57.1
Valuation allowance related to reconsolidation of CCFC	—		—		(36.0	)
Valuation allowance related to foreign taxes	(19.8	)	(8.2	)	—
Foreign taxes	(10.8	)	3.7		(0.9	)
Bankruptcy settlement	—		—		(15.7	)
Intraperiod allocation	4.5		4.6		19.9
Change in unrecognized tax benefits	(30.1	)	5.1		(6.6	)
Disallowed compensation	11.7		0.4		0.3
Stock-based compensation	8.6		0.2		0.1
Lobbying contributions	3.3		0.3		0.4
Other differences	4.8		(0.4	)	(0.5	)
Effective income tax expense (benefit) rate	12.5	%	8.7	%	(10.4	)%

Deferred Tax Assets and Liabilities

The components of deferred income taxes as of December 31, 2013 and 2012, are as follows (in millions):



	2013			2012
Deferred tax assets:
NOL and credit carryforwards	$	3,120		$	3,073
Taxes related to risk management activities and derivatives	60			90
Reorganization items and impairments	262			315
Foreign capital losses	18			25
Other differences	104			60
Deferred tax assets before valuation allowance	3,564			3,563
Valuation allowance	(2,246		)	(2,222		)
Total deferred tax assets	1,318			1,341
Deferred tax liabilities: property, plant and equipment	(1,310		)	(1,316		)
Net deferred tax asset	8			25
Less: Current portion deferred tax asset (liability)	12			(3		)
Less: Non-current deferred tax asset	7			28
Deferred income tax liability, non-current	$	(11	)	$	—

Consolidation of CCFC and Calpine Tax Reporting Groups — For federal income tax reporting purposes, our historical tax reporting group was comprised primarily of two separate groups, CCFC and its subsidiaries, which we referred to as the CCFC group, and Calpine Corporation and its subsidiaries other than CCFC, which we referred to as the Calpine group. During the first quarter of 2011, we elected to consolidate our CCFC and Calpine groups for federal income tax reporting purposes and Calpine filed a consolidated federal income tax return for the year ended December 31, 2011 that included the CCFC group. As a result of the consolidation, the CCFC group deferred tax liabilities will be eligible to offset existing Calpine group NOLs that were reserved by a valuation allowance. Accordingly, we recorded a one-time federal deferred income tax benefit of approximately $76 million during the first quarter of 2011 to reduce our valuation allowance.

Intraperiod Tax Allocation — In accordance with U.S. GAAP, intraperiod tax allocation provisions require allocation of a tax expense (benefit) to continuing operations due to current OCI gains (losses) with a partial offsetting amount recognized in OCI. The following table details the effects of our intraperiod tax allocations for the years ended December 31, 2013, 2012 and 2011 (in millions).



	2013			2012			2011
Intraperiod tax allocation expense included in continuing operations	$	1		$	9		$	42
Intraperiod tax allocation benefit included in OCI	$	(1	)	$	(9	)	$	(45	)

NOL Carryforwards — Our NOL carryforwards consist primarily of federal NOL carryforwards of approximately $7.5 billion, which expire between 2023 and 2033, and NOL carryforwards in 33 states and the District of Columbia totaling approximately $4.1 billion, which expire between 2014 and 2033, substantially all of which are offset with a full valuation allowance. We also have approximately $900 million in foreign NOLs, which expire between 2026 and 2033, substantially all of which are offset with a full valuation allowance. Under federal income tax law, our NOL carryforwards can be utilized to reduce future taxable income subject to certain limitations, including if we were to undergo an ownership change as defined by Section 382 of the IRC. If a subsequent ownership change were to occur as a result of future transactions in our stock, accompanied by a significant reduction in our market value immediately prior to the ownership change, our ability to utilize the NOL carryforwards may be significantly limited.

Deferred tax assets relating to tax benefits of employee stock-based compensation do not reflect stock options exercised and restricted stock that vested between 2011 and 2013. Some stock option exercises and restricted stock vestings result in tax deductions in excess of previously recorded deferred tax benefits based on the equity award value at the grant date. Although these additional tax benefits or “windfalls” are reflected in NOL carryforwards pursuant to accounting for stock-based compensation under U.S. GAAP, the additional tax benefit associated with the windfall is not recognized until the deduction reduces taxes payable, which will not occur for Calpine until a future period. Accordingly, since the tax benefit does not reduce our current taxes payable for the years ended December 31, 2013 and 2012 due to NOL carryforwards, these “windfall” tax benefits are not reflected in our NOLs in deferred tax assets at December 31, 2013 and 2012. The cumulative windfall balance included in federal and state NOL carryforwards, but not reflected in gross deferred tax assets as of December 31, 2013 and 2012 were $25 million and $9 million for federal, respectively, and $16 million and $7 million for state, respectively.

As a result of the settlement of certain bankruptcy claims and the final distribution to the holders of allowed unsecured claims in accordance with our Plan of Reorganization in 2011, we recognized approximately $66 million and $39 million for federal and state income tax purposes, respectively, in cancellation of debt income related to this distribution for federal income tax reporting in 2011.

Income Tax Audits — We remain subject to periodic audits and reviews by taxing authorities; however, we do not expect these audits will have a material effect on our tax provision. Any NOLs we claim in future years to reduce taxable income could be subject to IRS examination regardless of when the NOLs occurred. Due to significant NOLs, any adjustment of state returns or federal returns would likely result in a reduction of deferred tax assets rather than a cash payment of income taxes.

Canadian Tax Audits — In January 2013, we received an adjusted reassessment on one of two transfer pricing issues that we are disputing with the Canadian Revenue Authority (“CRA”). We proposed a settlement of the adjusted reassessment with the CRA and it has accepted our proposal. The adjustment to our transfer pricing increased taxable income and was offset by existing NOLs to which a valuation allowance had been applied.

On January 28, 2014, we received a letter from the CRA which informed us that they do not agree with our transfer price on the second issue and will be proposing an increase to taxable income for tax years 2006 and 2007. We continue to believe that our transfer pricing positions and policies are appropriate, and we intend to vigorously defend our position and challenge the CRA’s adjustments, including but not limited to appeal and litigation. If we are unsuccessful in our challenge, any adjustment to Canadian taxable income would first be offset against the existing NOLs that are available. If our existing Canadian NOL’s are not sufficient to offset the resulting adjustment to taxable income, additional assessments, including penalties and interest, would not have a material adverse effect on our financial condition, results of operations or cash flows.

Valuation Allowance — U.S. GAAP requires that we consider all available evidence, both positive and negative, and tax planning strategies to determine whether, based on the weight of that evidence, a valuation allowance is needed to reduce the value of deferred tax assets. Future realization of the tax benefit of an existing deductible temporary difference or carryforward ultimately depends on the existence of sufficient taxable income of the appropriate character within the carryback or carryforward periods available under the tax law. Due to our history of losses, we were unable to assume future profits; however, since our emergence from Chapter 11, we are able to consider available tax planning strategies.

As of December 31, 2013, we have provided a valuation allowance of approximately $2.2 billion on certain federal, state and foreign tax jurisdiction deferred tax assets to reduce the amount of these assets to the extent necessary to result in an amount that is more likely than not to be realized. The net change in our valuation allowance was a increase of $24 million for the year ended December 31, 2013, and a decrease of $114 million and $50 million for the years ended December 31, 2012 and 2011, respectively; all primarily related to changes in our estimates of our ability to utilize our NOL carryforwards.

As a result of a recent favorable response to an IRS letter ruling request, during the first quarter of 2014, we expect to make an election which will increase the tax basis of certain assets resulting in an increase to our net state deferred tax assets by approximately $18 million with a corresponding decrease in our state income tax expense.

Tangible Property Regulations — On September 13, 2013, the United States Treasury Department and the IRS issued final regulations providing comprehensive guidance on the tax treatment of costs incurred to acquire, repair or improve tangible property. The final regulations are generally effective for taxable years beginning on or after January 1, 2014. On January 24, 2014, the IRS issued procedural guidance pursuant to which taxpayers will be granted automatic consent to change their tax accounting methods to comply with the final regulations. We are currently assessing the future impact of these regulations, but do not anticipate a material impact on our financial condition, results of operations or cash flows.

Unrecognized Tax Benefits

At December 31, 2013, we had unrecognized tax benefits of $68 million. If recognized, $19 million of our unrecognized tax benefits could impact the annual effective tax rate and $49 million, related to deferred tax assets, could be offset against the recorded valuation allowance resulting in no impact to our effective tax rate. We had accrued interest and penalties of $13 million and $24 million for income tax matters at December 31, 2013 and 2012, respectively. We recognize interest and penalties related to unrecognized tax benefits in income tax expense (benefit) on our Consolidated Statements of Operations and recorded $(11) million, $4 million and $1 million for the years ended December 31, 2013, 2012 and 2011, respectively.

A reconciliation of the beginning and ending amounts of our unrecognized tax benefits for the years ended December 31, 2013, 2012 and 2011, is as follows (in millions):



	2013			2012			2011
Balance, beginning of period	$	(92	)	$	(74	)	$	(88	)
Increases related to prior year tax positions	(7		)	(19		)	—
Decreases related to prior year tax positions	8			1			1
Decreases related to settlements	10			—			—
Decrease related to lapse of statute of limitations	13			—			13
Balance, end of period	$	(68	)	$	(92	)	$	(74	)

U.S. Federal Income Tax Refund

In 2004, we deducted a portion of our foreign dividends as allowed by the IRC when we filed our federal income tax return. Upon further review and analysis, we determined our foreign dividends should have been offset against our current 2004 operating loss. In 2009, we filed an amended federal income tax return that reflected this change and would result in a refund of approximately $10 million. This amended federal return has been under audit by the IRS since it was filed. In October 2012, the IRS approved our amended tax return, and we received a refund of approximately $13 million which included approximately $3 million in accrued interest. The benefit of this refund is reflected in our Consolidated Financial Statements in the fourth quarter of 2012.