The IRS in PLR 202017015 ruled that the normalization rules, and the Form 3115 consent requiring application of the normalization rules, did not apply to the resulting IRC Section 481(a) adjustments after a public utility company changed its method of accounting to deduct the cost of repairs.

As a result, the public utility company is not required to apply the Average Rate Assumption Method (ARAM) to the excess accumulated deferred income taxes (EADIT) associated with the repairs, so it has the option to use a method that would amortize the EADIT more rapidly than under the ARAM method.

Facts

Taxpayer is a regulated water and wastewater utility company. Commission sets the rates that Taxpayer may charge for water or sewage disposal services through a combination of periodic general rate case proceedings and infrastructure surcharge proceedings.

In a rate proceeding with the Commission, Taxpayer agreed, for purposes of certain rates, to use estimated EADIT, which results in approximately the same amount as using the ARAM for the entirety of Taxpayer's EADIT. For Taxpayer's deduction for repair costs, however, Taxpayer and the Commission agreed that Taxpayer would seek a private letter ruling from the IRS requesting a determination on whether the Commission may order an amortization of EADIT for those deductions that is faster than the ARAM (which would result in lower rates for the consumers).

The IRS said there was no issue as to which accumulated deferred income tax liabilities (ADIT) and EADIT were subject to the normalization rules, which require accelerated depreciation. The only issue concerned timing differences (accelerated tax deductions in excess of book deductions, which gives rise to the accumulated deferred income taxes) in Taxpayer's repair and maintenance tax deductions. Specifically, the question concerning EADIT for repairs was due to differing interpretations of the consent agreement in Form 3115 that Taxpayer's parent received from the IRS after requesting a change in accounting method to claim a tax deduction for repairs, with a resulting adjustment, under IRC Section 481(a).

The consent agreement said, among other things, that (1) public utility properties must use normalization rules, (2) the taxpayer must, at the beginning of the year of change in accounting methods, adjust its deferred tax reserve account by the amount of the tax liability deferral associated with the IRC Section 481(a) adjustment, and (3) the taxpayer must provide a copy of its Form 3115 and accompanying information to the regulators within 30 days of the tax filing or receiving the PLR.

The question is whether the consent agreement requires Taxpayer to apply the normalization rules and reporting requirements to the results of (1) its request to change its accounting method for repairs under IRC Section 162 (deductions for business expenses), or (2) its request to change its units of property for determining dispositions under IRC Section 168 (depreciation). An additional question concerns whether the EADIT that existed immediately before the beginning of the year of change for the changes in tax method of accounting and resulted from a different depreciation method remains subject to the deferred tax normalization rules.

Law and analysis

IRC Section 481(a) requires adjustments to prevent amounts from being duplicated or omitted when a taxpayer computes its taxable income under a method of accounting different from the method used to compute its taxable income for the preceding tax year.

When an IRC Section 481(a) change in accounting occurs, Revenue Procedure 97-27, Section 2.05(1) requires income for the tax year preceding the year of change to be determined under the method of accounting that was then employed. Conversely, income for the year of change and the following tax years must be determined under the new method of accounting as if the taxpayer had always used the new method.

Taxpayer requested rulings on whether the normalization rules and consent agreement applied to:

• Current repairs after the change in method of accounting
• The net IRC Section 481(a) deduction on Form 3115 (for the tax year immediately preceding the year of change for the changes in tax methods of accounting subject to Taxpayer's consent agreement)
• Prior depreciation claimed for repairs in the IRC Section 481(a) deduction on Form 3115

For all three issues, the IRS ruled that the normalization rules do not apply, so the consent agreement would not require the normalization rules to apply. Because the normalization rules do not apply, the net EADIT from the timing difference (the difference in recognizing the expensing of the fixed-asset costs between tax rules and book rules) does not have to use the ARAM. As a result, the Taxpayer can apply an alternate method that allows the amortization of the EADIT at a faster rate.

Implications

Every investor-owned utility has had to determine how to handle the EADIT associated with tax reform, when the applicable tax rate was lowered from 35% to 21%. A key consideration has been to determine which amount of EADIT is and is not subject to the normalization rules for purposes of determining an appropriate amortization methodology for returning the EADIT to ratepayers. Method changes for repairs and other fixed-asset-related basis adjustments are very common in the utility industry.

As this ruling highlights, care should be taken in considering what portion of the fixed asset deferred tax liabilities are considered subject to the normalization rules, particularly when a utility has had a method change related to property, plant and equipment. This consideration directly applies to those utilities still negotiating with public commissions about giving back excess deferred taxes, as well as settlements that have already occurred.

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