On March 6, 2020, the Internal Revenue Service (IRS) released PLR 202010002, which provided the appropriate normalization treatment of infrastructure surcharges in supplemental rate proceedings as well as the proper adjustments to the accumulated deferred income tax (ADIT) balance for a net operating loss carryforward (NOLC).  

Taxpayer is a waste and wastewater regulated public utility that charges rates set by a public utility commission (Commission) through periodic general rate cases (GRCs) and interim infrastructure surcharge proceedings (ISPs) that allow recovery of the costs to replace and relocate utility mains incurred between GRCs.  

Taxpayer requested a private letter ruling to determine whether the rates set pursuant to its ISP comply with the deferred tax normalization rules. Specifically, the taxpayer executed a consent agreement in connection with changes in its method of accounting for repair and maintenance of tangible property and for dispositions of tangible depreciable property. The change in accounting method for repairs and maintenance from capitalizing and depreciating such costs to deducting them as repairs created a net negative section 481 adjustment while the method change to adopt the functional interdependence test to determine the units of property for dispositions resulted in a net positive section 481 adjustment. Taken together, there was a net negative 481(a) adjustment.

The IRS ruled as follows:

1. Depreciable property included in rate base in an ISP is public utility property.
2. The ADIT amounts associated with such property must comply with normalization rules.
3. The normalization rules only apply to depreciation that continues to be claimed with respect to public utility property following the year of change in method of accounting. Since the taxpayer will be deducting repairs under section 162 rather than capitalizing and depreciating such costs as of the year of change, the ADIT attributable to tax years prior to the year of change is no longer subject to the normalization rules.
4. With respect to the change in method of accounting for dispositions, replacements and relocations will continue to be treated as retirements for regulatory accounting purposes, but will not be treated that way for federal income tax purposes. Since the tax basis of such assets is unaffected by the regulatory retirements and will continue to be depreciated following the year of change for federal income tax purposes, the property remains public utility property subject to normalization. 
5. Similarly, the ADIT restored by reason of the new method of accounting for dispositions remains subject to the normalization rules.
6. IRS reaffirmed that the use of the “with and without” method for determining the maximum reduction to rate base when the taxpayer incurs an NOLC – or an increase to its NOLC - provides certainty and prevents flow-through.¹ However, given the specific constraints of the ISP which is limited to costs incurred for certain public utility property between GRCs, the IRS concluded that changes to the ADIT attributable property governed by the immediately preceding GRC, did not have to be adjusted until the next GRC.  

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¹ When a regulated utility experiences an NOLC, the taxpayer does not receive the benefit of the depreciation-related ADIT, i.e., there is no interest free loan from the federal government.  Accordingly, the rate base reduction is deferred until the NOLC is utilized and the loan is extended.
² See PLR 201949002.

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