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October 19, 2021

IRS rules cost of removal is not protected by normalization, salvage value is

In PLR 202141001, the IRS ruled that a regulated electric company's net deferred tax asset (DTA) related to the cost of removal (COR) is not subject to normalization rules. The company's deferred tax liability (DTL) and DTA from the salvage value is, however, subject to the normalization rules. As a result, the company's public utility property (PUP) depreciates slower, which impacts the rate at which the excess deferred taxes are returned to customers.


Taxpayer is a regulated electric utility company. Commission establishes Taxpayer's rates based on its costs, including a return on the capital (rate of return). Taxpayer claimed accelerated depreciation on its PUP resulting from the accumulated deferred federal income taxes (ADFIT) and excess deferred federal income taxes (EDFIT) and normalized the federal income taxes deferred under the normalization rules.

The net positive value or net cost of disposing of an asset at the end of its life is incorporated into the annual depreciation charge. COR is a component of the applicable depreciation rate and the salvage value is factored into COR. Taxpayer broke out the COR and salvage rates separately from depreciation.

COR is a normalized expenditure and is a component of book depreciation, which is factored into customer rates. From a tax perspective, the costs are deductible when the asset is removed from service and the removal costs are incurred. Taxpayer reported the customer payments that fund the COR reserve as taxable income over the operating life of the asset, claiming an offsetting tax deduction only at the end of the asset's life. Recovering COR through rates before the applicable tax deduction can be claimed creates a DTA.

In its accounting, Taxpayer distinguished between COR book/tax differences and depreciation life/method differences. The Tax Cuts and Jobs Act (TCJA) changed the corporate tax rate from 35% to 21%, which produces both a deferred tax shortfall as well as an excess tax reserve (ETR). Under the normalization rules, the ETR must be returned to the customers through ratemaking.

In anticipation of returning ETR to customers, Taxpayer separately computed both its (1) DTA related to COR and the associated excess tax deficit to be recovered from customers and (2) DTL related to method/life differences and the associated ETR to be returned to customers, which included gross salvage value.

Taxpayer computed the average rate assumption method (ARAM) under the TCJA to update its filing with the Commission to reflect the TCJA tax rate of 21%. Commission asserted that when computing the return of ADFIT to customers under ARAM, the COR accrual should be included in the calculation resulting in a larger amount of book depreciation and an earlier return of ETR to customers. This was in contrast to the computational method proposed by Taxpayer, which separately computed the DTA and DTL.

Law and analysis

Under IRC Section 168(f)(2), the depreciation deduction determined under IRC Section 168 does not apply to any PUP if the taxpayer does not use a normalization method of accounting.

To use a normalization method of accounting, the taxpayer must, under IRC Section 168(i)(9)(A)(i), use the same depreciation method in determining its tax expense for ratemaking and operations purposes. The method used may not be shorter in period than the method and period used to compute the taxpayer's depreciation expenses.

If the amount allowable as a deduction under IRC Section 168 differs from the amount that would be allowable as a deduction under IRC Section 167, the taxpayer must, under IRC Section 168(i)(9)(A)(ii), adjust the reserve to reflect the deferral of taxes resulting from such difference.

Under TCJA Section 13001(d)(1), a taxpayer that computes its cost of service in ratemaking by reducing the ETR more rapidly than under ARAM is not using the normalization method.

Because Treas. Reg. Section 168(i)(9)(A) generally does not refer to COR, the COR-related amounts are not "protected" by the normalization rules. Rather, the IRS said, COR is a deduction under IRC Section 162 and not related to actual accelerated tax depreciation.

The IRS ruled that although COR is not protected under the normalization rules, salvage value is specifically included under IRC Section 168(i)(9)(A)(ii) as a protected part of normalized ETR. Therefore, Taxpayer's DTL and DTA resulting from recovery of the salvage component of book depreciation when it claims its COR deduction is subject to normalization.

The IRS also ruled that because COR is not subject to normalization, including the COR-related amounts in the excess taxes used to compute the ETR does not satisfy TCJA Section 13001(d), under which a taxpayer cannot reduce the ETR more rapidly or to a greater extent than such reserve would be reduced under ARAM. Conversely, leaving the COR out of the ETR computation does satisfy those requirements.


This ruling, along with prior rulings, gives companies additional clarity around the scope of the normalization rules as it applies to cost of removal and salvage value. In this ruling, the Taxpayer used its historical plant-related records to separately compute both its DTA related to COR and its DTL related to method/life differences, which included gross salvage value. The difference between these computations affected the timing in which excess deferred taxes are included in rates charged to customers. Companies whose facts may differ may need to consider the applicability of the conclusions in this ruling to other fact patterns.


Contact Information
For additional information concerning this Alert, please contact:
Americas Power & Utilities Tax Group
   • Mike Reno (
   • Jim Barrett (
   • Kimberly Johnston (