Read text of the seven-page letter ruling: PLR 201418024 [PDF 86 KB]
*Private letter rulings are taxpayer-specific rulings furnished by the IRS National Office in response to requests made by taxpayers and can only be relied upon by the taxpayer to whom issued. It is important to note that, pursuant to section 6110(k)(3), such items cannot be used or cited as precedent. Nonetheless, such rulings can provide useful information about how the IRS may view certain issues.
The taxpayer, a regulated public utility, had net operating loss carryforwards (NOLCs) over a period of five years.
During Year 3 and Year 5, the amount of accelerated depreciation claimed by the taxpayer exceeded the amount of NOLCs in those years. Also, in Year 4, the taxpayer produced regular taxable income as well as alternative minimum taxable income (AMTI). The regular taxable income was offset by NOLCs from Year 2 and Year 3, but could not offset the entire AMT liability under the limitation in section 56(d). As a result, the taxpayer paid AMT in Year 4 and had a minimum tax credit carryforward (MTCC) as of the end of Year 5.
On its regulatory books, the taxpayer normalized the difference between regulatory depreciation and tax depreciation—meaning that when accelerated tax depreciation reduces taxable income, the taxes that the taxpayer would have paid if regulatory depreciation (instead of tax depreciation) were claimed constitutes “cost-free capital” to the taxpayer.
Under the normalization rules, the taxpayer maintained a reserve account showing the amount of tax liability that is deferred as a result of the accelerated tax depreciation. This reserve is the accumulated deferred income tax (ADIT) account. Along with the ADIT account, the taxpayer maintained an offsetting series of entries that reflect that portion of those “tax losses” from accelerated tax depreciation that did not actually defer tax because of an NOLC. The taxpayer also carried the MTCC amount as an offset to the ADIT account.
The taxpayer filed a general rate case arguing that in establishing its rate base, the ADIT balance is reduced by the amounts that the taxpayer calculated as not actually deferring tax due to the presence of NOLCs or the MTCC. The public utility commission asserted that the reduction of the rate base by the full amount of its ADIT account, without regard to NOLC and MTCC offsets, was appropriate. The commission stated that, in setting rates it includes a provision for deferred taxes based on the entire difference between accelerated tax and regulatory depreciation, including situations in which a utility has, such as in this situation, an NOLC or AMT.
The IRS explained there is little IRS guidance on exactly how an NOLC or MTCC must be taken into account in calculating the ADIT—though both must be taken into account under the normalization requirements.
The IRS noted that, here, the commission asserted that in setting its rates, it included a provision for deferred taxes based on the entire difference between accelerated tax and regulatory depreciation, including situations in which a utility has an NOLC or MTCC.
The IRS stated that such a provision allows a utility to collect amounts from ratepayers equal to income taxes that would have been due absent the NOLC and MTCC, and therefore, the commission has already taken the NOLC and MTCC into account in setting rates.
The IRS therefore concluded that the reduction of a public utility's rate base by the full amount of its ADIT account—without regard to the balances in its NOLC and MTCC accounts—was consistent with the requirements of section 168(i)(9) and Reg. section 1.167(l)-1 and that this treatment does not violate normalization requirements when the rate-setting commission has already taken into account the NOLC and MTCC in setting rates.
The basis for the IRS conclusion in the letter ruling is somewhat unclear. Although the letter ruling states that the public utility commission took into account NOLC and MTCC in setting rates, the letter ruling does not describe the methodology for doing so, and the IRS analysis does not describe what an appropriate methodology would be, noting only that the NOLC and MTCC must be taken into account in calculating the ADIT account.
Note that there are a series of private letter rulings from the 1980s and 1990s that seem to indicate that NOLs are to be included in the calculation of the ADIT account (see PLR 8818040, PLR 8903080, PLR 9336010).
Without more developed facts and analysis, the recent letter ruling raises more questions than answers for taxpayers on this issue. In addition, this letter ruling draws attention to the issue of how much transparency utility commissions must use in setting rates.
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