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August 1, 2022

Normalization rules do not apply to cost of removal, the IRS rules again

  • The IRS has again ruled that public utilities do not violate the normalization rules by excluding the cost of removal from the average rate assumption method (ARAM) calculation when computing base rates.
  • The IRS has consistently ruled this way in similar fact patterns.
  • Public utilities with an inconsistent position should consider remedying it.

In PLR 202230005, the IRS ruled that a regulated gas and electric utility did not violate the normalization rules by excluding the cost-of removal (COR) component of book depreciation in the future ARAM calculation.


Taxpayer is a regulated electric and gas utility. A Commission establishes Taxpayer's rates based on its costs, including a return on capital (rate of return).

In calculating its deferred income tax liability, which affects its rates, Taxpayer computed the timing differences between (1) book depreciation (which included salvage value and COR expense) and (2) tax deductions for tax depreciation and incurred COR, based on a 35% corporate tax rate. The Tax Cuts and Jobs Act (TCJA) subsequently reduced the corporate income tax rate to 21%.

COR is a normalized expenditure and a component of book depreciation. From a tax perspective, the costs are deductible when the asset is removed from service. Thus, its inclusion in book depreciation creates a deferred tax asset (DTA) representing the future benefit from the eventual COR tax deduction and is included in Taxpayer's accumulated deferred income tax (ADIT). 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.

The Commission contends that the COR component of book depreciation should be included in the annual ARAM computation that Taxpayer uses to amortize ADIT. Taxpayer contends that doing this would accelerate the amortization of ADIT too quickly, in violation of the normalization rules.

Law and analysis

Under IRC Section 168(f)(2), the depreciation deduction determined under IRC Section 168 does not apply to any public utility property (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.

The IRS concluded that COR-related amounts are not protected by the normalization rules. “While COR may be a component of the calculation of the amount treated as book depreciation, it is a deduction under [IRC Section] 162 and not, like actual accelerated tax depreciation, under [IRC Section] 168. While method and life differences closely related to depreciation are created and reversed solely through depreciation, such is not the case with COR. While the COR timing differences may often originate as a component of book depreciation, it reverses through the incurred COR expenditure.”

The IRS went on to say that because COR is not subject to normalization, the COR-related amounts should not be used in the computation of the ETR. Further, (1) because ARAM is the required method for the reduction of the ETR and (2) COR is not included in the ETR, (3) COR should not be included in the ARAM calculations to return the ETR to ratepayers under the normalization rules, according to the IRS.


Taxpayers who may not yet have addressed any cost of removal elements within the company’s ARAM calculation should examine their records as soon as possible to consider whether any tax return disclosure and or conversation with regulators is warranted if it is concluded that the current method is inconsistent with the normalization rules.


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