December 20, 2021
IRS rules public utility will not violate normalization rules under the TCJA by basing amortization on a specific date
In PLR 202150003, the IRS ruled that a public utility will not violate the normalization rules under the Tax Cuts and Jobs Act if it uses the alternative method of amortizing excess deferred income taxes (EDIT) as of a specific date. Thus, the public utility could base amortization on the adjusted rates as changed by a utility commission after the TCJA's enactment.
Facts and analysis
Taxpayer is a public utility that transports natural gas through its pipeline system across several states. Commission establishes the depreciation rates for "jurisdictional property" (under the jurisdiction of the public utility commission), which is used by regulated gas companies to provide jurisdictional services. Taxpayer uses a single composite depreciation rate.
For ratemaking purposes, the average remaining life of Taxpayer's assets are calculated by using the depreciation rate and Taxpayer's jurisdictional rate existing on the day the rates go into effect.
For federal income tax purposes, Taxpayer depreciates its property using a normalization method of accounting under IRC Section 168. In its accounting, Taxpayer depreciates its assets for ratemaking purposes, and then adjusts its accumulated deferred income taxes (ADIT) to reflect the difference between book depreciation and tax depreciation.
After the TCJA reduced the corporate tax rate from 35% to 21%, Taxpayer's ADIT became overfunded, which resulted in "protected EDIT" (the portion of the excess amount in ADIT attributable to accelerated depreciation).
In a settlement agreement, Commission approved Taxpayer's request to change the depreciation rates after analyzing the depreciation and salvage rates for Taxpayer's jurisdictional property (note, this is the first time the Commission approved such a change since passage of the TCJA). Applying these new rates changed the average remaining life for Taxpayer's assets as of that date.
Taxpayer asked the IRS to rule on whether amortizing the protected EDIT over the remaining life of its jurisdictional property as of the effective date of the new rates would result in a normalization violation.
Normalization rules under IRC Section 168
Under IRC Section 168(f)(2), the depreciation deduction determined under IRC Section 168 does not apply to any public utility property 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 for a shorter period than the method and period used to compute the taxpayer's depreciation expenses.
Normalization rules under TCJA Section 13001(d)
Under TCJA Section 13001(d)(1), a taxpayer that computes its cost of service in ratemaking by reducing the excess tax reserve more rapidly than under the average rate assumption method (ARAM) is not using the normalization method.
Section 13001(d)(2) of the TCJA allows taxpayer to use an alternative method if "as of the first day of the [tax] year that includes the date of enactment of the TCJA, the taxpayer was required by a regulatory agency to compute depreciation for public utility property on the basis of an average life or composite rate method, and the taxpayer's books and underlying records did not contain the vintage account data necessary to apply ARAM, the taxpayer will be treated as using a normalization method of accounting if, with respect to such jurisdiction, the taxpayer uses the alternative method for public utility property that is subject to the regulatory authority of that jurisdiction."
Under Section 13001(d)(3)(C) of the TCJA, Taxpayer's protected EDIT must be amortized over the remaining regulatory life of the property. The TCJA does not, however, specify whether the regulatory authority must determine the remaining regulatory life of the property as of any specific date.
Alternative method approved by IRS
The IRS ruled that Taxpayer will not violate the normalization rules by using the alternative method based on its "use of an average remaining life of Taxpayer's jurisdictional property calculated using the Commission-approved composite depreciation rate, [which was] changed after [enactment] of the TCJA and … approved in the Settlement … " The IRS noted that cost of removal (COR) amounts are not protected by the normalization rules.
This ruling will provide additional support for companies that have utilized the alternative method and had concerns about their eligibility and technical compliance with that method. The ruling's comment that the TCJA does not specify a date by which the remaining regulatory life must be determined may provide some flexibility in determining a plant's composite average remaining life.