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June 29, 2022

IRS rules on when normalization rules apply to depreciable property included in setting rates

In PLR 202225004, the IRS ruled that the normalization rules under IRC Section 168(i)(9) and TCJA Section 13001(d) apply to the portion of accumulated deferred federal income tax liabilities (ADFIT) and excess deferred federal income tax liabilities (EDFIT) in the context of a rider, which results in a specific rate-making process for specific costs.


Taxpayer is a regulated public utility that generates, transmits and sells electricity. Commission sets Taxpayer's rates based on its costs and treats ADFIT and EDFIT as a reduction to rate base.

Commission periodically sets base rates through general rate case proceedings and adjustments for specific expenses (i.e, stand-alone rate adjustments apart from the base rate, also known as riders). Rider U was used to adjust rates to recover the cost of relocating overhead electric distribution lines underground. Rider U includes costs depreciable under IRC Section 168, with the depreciable assets being public utility property (PUP) under IRC Section 168(i)(10). Rider U rates are set annually and are subject to annual true-ups when actual cost information is available.

A tracker mechanism records when timing differences exist between (1) when the costs would otherwise be recognized as an expense in the books without the Rider U rate adjustment mechanism and (2) when the costs are recovered from customers. The tracker mechanism balances are reflected in the annual rate calculations that are set when the Rider U is filed each year with the Commission.

The costs recovered by Rider U may be more or less than the relocation project, resulting in an under- or over-recovery of costs. Taxpayer used a proportionate methodology in its average rate assumption method (ARAM) calculation "to allocate total Rider U under-recoveries to the individual underlying costs based on the relative amounts of costs eligible for recovery pursuant to the associated Rider."

"The holding in this ruling request will be applied to other Riders involving depreciation of public utility property that have a similar tracking mechanism and under-recovered balance to Rider U," according to the IRS.

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 the difference.

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

According to the IRS, whether "IRC Section 168(i)(9) and TCJA Section 13001(d) normalization requirements apply to the depreciation portion of Rider U under-recoveries is based on whether this difference in expense recognition is a depreciation-related book/tax difference."

The IRS went on to say that the "detailed regulatory reporting classification of an expense deferral (that is, reducing the specific underlying expense account or increasing Regulatory Credits) should not affect the application of the normalization rules. The substance of the ratemaking economics with consideration of the broader consistency with the related regulatory reporting, not specific financial statement line items or trial balance accounts, should determine how the TCJA section 13001(d) normalization rules apply."

The IRS first concluded that the ADFIT and associated EDFIT applicable to the portion of under-recovered depreciation expense in Rider U rate adjustment clause proceedings are subject to the IRC Section 168(i)(9) and TCJA Section 13001(d) normalization requirements. Therefore, these amounts must be excluded from the ratemaking formula as the depreciation expense is not included in rates.

Second, Taxpayer's proportionate method of computing the Rider U under-recovery costs by deferring recognition and rate recovery of depreciation expense related to PUP as of the applicable date complies with the IRC Section 168(i)(9) and TCJA Section 13001(d) normalization requirements.

Third, the EDFIT cannot be reduced more rapidly or to a greater extent than the reserve would be reduced under the ARAM. Thus, Taxpayer would violate the normalization requirements under TCJA Section 13001(d) if it refunded EDFIT associated with its entire under-recovery of Rider U costs because this would refund the ETR under TCJA Section 13001(d)(3)(A) more rapidly or to a greater extent than the ETR would be reduced under the TCJA Section 13001(d)(3)(B) ARAM.


The IRS concluded that, in the context of a rider, deferral of certain costs for book purposes, such as depreciation, are subject to normalization rules, so it does not matter what the journal entries (revenue or expense) create the deferral. The IRS seemingly relies on the consistency rule, which prohibits taxpayers from including the tax items (e.g., ADFIT, tax expense, EDFIT) if the book items, such as book depreciation and plant balances, are not included in rates.

The ruling also highlights the need for taxpayers to scrutinize any rider mechanisms they may have employed in their ratemaking process to make sure they comply with the normalization requirements.


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