IRS provides additional guidance on cost of removal, salvage and normalization 

Eversheds Sutherland (US) LLPIn PLR 202141001 (July 15, 2021) the IRS expanded upon the guidance it provided in PLR 202033002 (Aug. 14, 2020) regarding the proper ratemaking treatment of cost of removal (COR) and salvage under the normalization rules. As explained more fully below, the IRS:

  • Reaffirmed that COR is not subject to the normalization rules, but salvage must be normalized.
  • The computation of the reversal of the excess tax reserve created by the rate Tax Cuts and Jobs Act (TCJA)1 by taking into account the COR component of depreciation is inconsistent with the normalization rules.
  • Conversely, the computation of the reversal of the excess tax reserve created by the TCJA taking into account the salvage value component of depreciation, but not COR, complies with the normalization rules.

Not surprisingly, the IRS reaffirmed that although estimated COR may be treated as a component of book depreciation, the reversal of the estimate when the COR is actually incurred for tax purposes is an ordinary and necessary business expense under IRC §162 in the year incurred, not a depreciation deduction under IRC §168. Thus, COR is not a depreciation "method and life" difference in book and tax depreciation and thus is not subject to the normalization rules. Salvage, however, is a component of depreciation and thus is subject to the normalization rules.

Similarly, the reversal of the excess tax reserve created by the TCJA tax rate reductions must be calculated independently from the COR deferred tax asset in order to comply with normalization. Conversely, computing the reversal of the excess tax reserve to account for salvage, but not COR, will comply with the normalization rules.

Eversheds Sutherland Observation:  The ruling is helpful, but not surprising, in distinguishing the treatment of COR and salvage for normalization purposes. The former does not reflect method and life depreciation timing differences, whereas the latter does. In this ruling, however, the taxpayer kept separate records enabling it to isolate and track the amounts reflected in cost of removal and salvage. It is not entirely clear how the taxpayer would comply with the normalization rules if it does not have that tracking capability to “unbundle” the COR and salvage components of depreciation.

 

P.L. 115-97.

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