In PLR 201842001, the IRS has ruled that a utility company did not violate the normalization requirements under Section 168 and Reg. Section 1.167(l)-1 by reflecting forthcoming tax refunds in its annual regulatory filings because the refunds did not decrease the utility's rate base.

Facts

Taxpayer is a rate-regulated utility company and a wholly-owned subsidiary of Parent. Parent's Year 1 consolidated federal tax return reported a tax overpayment. Parent applied the Year 1 overpayment to Year 2 estimated tax payments, including Taxpayer's share. When Parent made the Year 2 estimated tax payments, the additional 50% first year depreciation deduction (Bonus Depreciation) did not apply to otherwise qualified property (other than long production period property). Accordingly, Taxpayer calculated its Year 2 estimated tax payment without factoring in Bonus Depreciation for qualified property placed in service in the Year 2 tax year (other than long production period property).

The Tax Increase Prevention Act (TIPA) of 2014 retroactively extended the option to elect Bonus Depreciation for all qualified property placed in service before January 1, 2014. After TIPA's enactment, Parent elected Bonus Depreciation for the consolidated group's Year 2 federal income tax return. The election lowered Taxpayer's Year 2 tax liability, causing its Year 2 estimated tax payment to exceed the amount owed. Accordingly, Taxpayer filed a refund claim with the IRS for the Year 2 tax overpayment, but did not receive the refund before the due date of its annual regulatory filing. In its annual regulatory filings in Year 2, Taxpayer reflected the forthcoming refund without decreasing the rate base by the DTL associated with the refund amount.

Similarly, in Year 3, Parent made estimated tax payments, including for Taxpayer's share, without applying Bonus Depreciation. Subsequently, the Protecting Americans from Tax Hikes (PATH) Act of 2015 retroactively extended the option to elect Bonus Depreciation for all qualified property placed in service before January 1, 2016. After the enactment, Parent elected Bonus Depreciation for Year 3 and then filed a refund claim with the IRS, which the IRS granted, but did not pay before Taxpayer's annual regulatory filings were due. In its filing for Year 3, Taxpayer reflected the forthcoming refund without decreasing the rate base by the DTL associated with the refund amount.

Ruling

Section 168(f)(2) states that accelerated depreciation does not apply to any public utility property if the taxpayer does not use the normalization method of accounting. The normalization method of accounting requires a taxpayer to depreciate its public utility property when computing its tax expense for rate-making purposes, using a depreciation method that is not shorter than the method and period used to compute its depreciation expense for rate-making purposes. A taxpayer is not using the normalization method of accounting if it uses a procedure or adjustment inconsistent with the requirements Section 168(i)(9)(B)(i). Inconsistent procedures and adjustments include the use of an estimate or projection of the taxpayer's tax expense, depreciation expense, or reserve for deferred taxes unless the taxpayer also uses the same procedure or adjustment for rate-making purposes.

The IRS stated that a taxpayer's reserve for deferred taxes for normalization purposes should include only amounts of tax that are actually deferred and amounts of zero-cost capital that are actually received. As Taxpayer had not received the Year 2 and Year 3 refunds when it submitted its annual regulatory filings, decreasing the rate base by the amount of the forthcoming refunds would have violated the normalization rules. By reflecting the forthcoming tax refunds without reducing its rate base, Taxpayer complied with the normalization rules.

Implications

The ruling request appears to be driven largely by the utility's inability to reflect the benefit of the current year bonus depreciation in its estimated tax payments due to the tax law's enactment after the fourth quarter payment was due. To avoid normalization issues, utilities should be sure to check regulatory filings for which tax law changes occur late in the year. In particular, the TCJA was enacted last December and a similar situation may have presented itself.

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