• IRS Rules That a Method of Reflecting a Federal Income Tax Settlement in Ratemaking Violated the Consistency Rule of Normalization
  • July 27, 2018 | Authors: Ram C. Sunkara; Ellen McElroy; Karl H. Zeswitz; Mary E. Monahan
  • Law Firms: Eversheds Sutherland (US) LLP - Atlanta Office ; Eversheds Sutherland (US) LLP - Washington Office
  • In PLR 201828010, the Internal Revenue Service (IRS) considered the proper ratemaking treatment for reflecting the results of a federal income tax settlement. The taxpayer was a member of an affiliated group filing consolidated returns reflecting accumulated net operating losses (NOLs). Accordingly, it had recorded the yet-unused NOLs in a deferred tax asset (DTA) account and took that DTA into account in computing the accumulated deferred federal income taxes (ADFIT) used to reduce rate base.1 For ratemaking purposes the public utility commissions employed a historic test year and, in computing ADFIT used to reduce rate base, used a 13-month average commonly adopted in ratemaking. Because the IRS settlement adjusting taxable income was recorded on the last month of the test period, only 1/13th of the effect of the settlement was reflected as an adjustment to the ADFIT balance.

    Intervenors proposed that the ADFIT balance reflect the entire amount of the IRS settlement as of the end of the test year, not merely 1/13th of such amount. The IRS properly observed that the normalization rules require consistent conventions in calculating depreciation expense, tax expense, rate base and the ADFIT used to reduce rate base. Accordingly, it concluded that the use of the 13-month average convention to compute depreciation, tax expense and rate base, but an end-of-test year convention to compute the ADFIT in reflecting the IRS settlement, would violate the consistency requirement of the normalization provisions of the Internal Revenue Code.