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April 26, 2024

IRS rules that public utility commission's ratemaking methodology conflicts with normalization rules

The IRS ruled in PLR 202417002 that a ratemaking formula with attrition methodology, which was required by the regulating commission of a public utility, conflicts with the normalization rules. Taxpayer can, however, avail itself of safe harbor relief for inadvertent errors because it is using a "tracker memorandum account" to track the difference between the attrition methodology and its proposed methodology.


Taxpayer is the common parent of an affiliated group of corporations and serves as an agent of Subsidiary. Subsidiary is a regulated public utility subject to the ratemaking jurisdiction of Commission. Following a ratemaking proceeding, Subsidiary adjusted rates using the attrition methodology, which provides for rate base additions in year 3 by adding the difference between the year 1 and year 2 rate base to the year 2 rate base. Depreciation expense is handled the same way.

Subsidiary is subject to normalization requirements under IRC Section 168(i)(9).

The specific ratemaking adjustment in question pertains to the calculation of rate base for year 3 (the attrition year) and the relationship of that calculation to the normalization requirements.

Subsidiary has used the attrition methodology before when required by Commission. Subsidiary observed for first time, however, that the attrition methodology was "fundamentally inconsistent with the deferred-tax-account computational rules of [Treas. Reg. Section] 1.167(l)-1(h), as well as the normalization consistency rules of [IRC Section] 168(i)(9)." Because the earlier use could not be changed, Subsidiary requested "inadvertent error" relief for prior years.

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 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.

Treas. Reg. Section 168(i)(9)(A)(i) requires a taxpayer, in computing its tax expense for establishing its cost of service for rate-making purposes and reflecting operating results in its regulated books of account, to use a method of depreciation with respect to public utility property that is the same as, and a depreciation period for such property that is no shorter than, the method and period used to compute its depreciation expense for such purposes.

Under the consistency rule in IRC Section 168(i)(9)(B)(i), a taxpayer complies with IRC Section 168(i)(9)(A), for ratemaking purposes, by using the same estimate or procedure for its tax expense, depreciation expense and reserve for deferred taxes.

Revenue Procedure 2017-47 permits taxpayers with normalization violations from "inadvertent error" to claim safe-harbor treatment excusing the violation if the error, once identified, is corrected at the "first available opportunity."

The attrition-year methodology is inconsistent with the deferred-tax-account computational rules of Treas. Reg. Section 1.167(l)-1(h), as it decouples cost-of-service "depreciation-expense" calculations from the year 3 rate base. This decoupling from the additions to the "deferred-tax reserve" (and ultimately, rate base) is inconsistent with the express terms for making permissible additions or reversals of the deferred-tax reserve under the deferred-tax-account computational rules of Treas. Reg. Section 1.167(l)-1(h). The net effect is that the deferred-tax reserve does not represent the deferral of taxes attributable to the use of different methods of depreciation for ratemaking and tax purposes on the same rate base.


The IRS made three rulings:

  • The final rate order mandating the continued use of the third-year attrition adjustment would violate the deferred-tax-account computational rules of Treas. Reg. Section 1.167(l)-1(h)(1) because it would decouple reserve depreciation expense and reserve deferred-tax expense, both of which are included in rate base, from cost-of-service depreciation expense and deferred-tax expense.
  • The final order mandating the continued use of the third-year attrition adjustment would violate the consistency rules of IRC Section 168(i)(9)(B).
  • Subsidiary may claim safe-harbor treatment based on inadvertent error.


In this PLR, year 1 and year 2 have normal ratemaking principles and the addition to rate base in year 3 derives from referring to the rate base of the prior two years. This causes a disconnect between the book accumulated depreciation reserve and the depreciation expense that is being computed in year 3, which has a corresponding impact on the calculation of accumulated deferred income taxes (ADIT).

The PLR references tables showing the computational approach, but they were not included in the published ruling, so it is hard to determine the overall impact to the rate. It is clear, however, that year 3 was computed using derived numbers from the averages of years 1 and 2, which inherently would lead to some inconsistencies between the various elements under the normalization rules. This ruling is a cautionary tale that showcases why reviewing the approach for a given rate case is important, even if it appears to follow a previous format, to confirm compliance with the normalization rules.

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Contact Information

For additional information concerning this Alert, please contact:

Americas Power & Utilities Tax Group

Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor