PLR: Proper application of excess deferred income tax “normalization consistency rules” for public utilities

The “normalization consistency rules” for public utilities must be applied in a variety of circumstances.

“Normalization consistency rules” for public utilities

The IRS publicly released a private letter ruling* in which the IRS ruled that the “normalization consistency rules” for public utilities must be applied in a variety of circumstances. The ruling validated that the consistency rules are an important and operative component of the pre-existing deferred tax normalization rules as referenced in prior IRS guidance, specifically Rev. Proc. 2020-39.

Read PLR 202142002 [PDF 113 KB] (released October 22, 2021, and dated July 26, 2021)

* Private letter rulings are taxpayer-specific rulings furnished by the IRS Office of Chief Counsel in response to requests made by taxpayers and can only be relied upon by the taxpayer to whom issued. Pursuant to section 6110(k)(3), written determinations such as private letter rulings are not intended to be relied upon by third parties and may not be cited as precedent. These written determinations may, however, offer an indication of the IRS’s position on the issues addressed.

Summary

In general terms, the normalization consistency rules require regulators to adjust rate base, accumulated deferred income tax (ADIT) balance, book depreciation expense, and tax expense whenever and at the same time refunds of excess deferred income taxes are adjusted in rates.

In Rev. Proc. 2020-39, the IRS provided guidance on the application of the normalization rules in connection with the 2017 tax reform law commonly referred to as the “Tax Cuts and Job Act” (TCJA), and stated that the TCJA normalization requirements for excess deferred taxes are part of the overall pre-existing deferred tax normalization rules and those rules essentially remain in effect. Read TaxNewsFlash

The IRS in PLR 202142002 validated that the consistency rules are an important and operative component of the pre-existing deferred tax normalization rules it referenced in Rev. Proc. 2020-39. In the letter ruling, the IRS stated: “The Normalization Rules of section 168(i)(9), former section 167(l), and section 13001(d) of the TCJA do not permit taxpayer to:” [emphasis added]

  • Adjust its excess deferred income taxes (EDIT) average rate assumption method (ARAM) amortization annually based on the test year to the EDIT ARAM based on one or more subsequent years without making similar adjustments to rate base, ADIT, book depreciation, and tax expense
  • Adjust its EDIT ARAM amortization annually without making similar adjustments to rate base, ADIT, book depreciation, and tax expense
  • Provide a true-up to EDIT ARAM amortization in the year following the rate year based on volume variances between the test year and the rate year without making similar adjustments to rate base, ADIT, book depreciation, and tax expense

The IRS concluded by stating that “…Taxpayer will not be considered to be in violation of the normalization rules if it follows the corrective actions described in its letter.”

KPMG observation

The implications of the PLR for public utilities include the following:

  • There is broad disparity in how state regulators have implemented and ordered the refunding of excess deferred income taxes resulting from TCJA, and in particular the application of the normalization consistency rules.  Based on the combined guidance from the IRS provided by Rev. Proc. 2020-39 and PLR 202142002, public utilities need to consider reviewing their separate circumstances to determine compliance with the rules.
  • In connection with 2021 year-end audits, public utilities need to consider proper compliance with IRS normalization consistency rules to avoid any potential for an uncertain tax position in 2021 audits—i.e., if the normalization consistency rules have not been properly applied and there is no activity or intent to correct such inconsistency in rates to secure an inadvertent violation of the normalization rules, the use of accelerated depreciation for tax purposes could be called into question and create an uncertain tax position.
  • To the extent Congress enacts tax reform in the near term and such reform increases the corporate tax rate from the current rate of 21% (as has been proposed in certain pending bills), public utilities would be required to restate the level of excess deferred income taxes on their books, adjust the amortization of excess deferred income taxes prospectively, and incorporate that prospective amortization in rates in conformity with the normalization consistency rules.  This effort could become extremely complex to the extent that the normalization consistency rules were not properly implemented in connection with refunding excess deferred income taxes in connection with TCJA, and in certain circumstances could have negative earning implications.


For more information, contact KPMG’s Power & Utilities Tax Industry Leader:

Glenn Todd | +1 412 232 1642 | gtodd@kpmg.com


Or contact these KPMG tax professionals:

Richard Marcos | +1 213 817 3188 | rmarcos@kpmg.com

Kim Sucha | +1 402 661 5220 | ksucha@kpmg.com

 

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