- March Madness: New Private Letter Rulings Address Tax Accounting Issues
- March 31, 2017 | Authors: Ellen McElroy; Michael D. Resnick; Bradley M. Seltzer; Amish M. Shah; H. Karl Zeswitz
- Law Firm: Eversheds Sutherland (US) LLP - Washington Office
- In the last few weeks, the Internal Revenue Service (the Service) issued several private letter rulings addressing a variety of tax accounting issues. From bonus depreciation elections to the correct unit of property for dispositions, among others, each of the rulings provides taxpayers with welcome clarification and analysis, especially given the recent Executive Order1 addressing federal regulations, which has slowed the release of Treasury Regulations.
PLR 201709007 (Mar. 3, 2017) – The Service allows a taxpayer to retroactively claim bonus depreciation
In PLR 201709007, a taxpayer was granted a 60-day extension to make the election under Section 168(k)(4)(I)(ii) not to apply Section 168(k)(4) to “round 2” property, and to revoke the election under Section 168(k)(4)(J)(iii) to apply Section 168(k)(4) to “round 3” property. The extension was granted assuming the taxpayer acted reasonably and in good faith, and because granting relief would not prejudice the government’s interests.
By way of background, dating back to 2001, Congress has provided additional first-year depreciation (bonus depreciation) for certain property. The rules have changed over the last 16 years, with various changes to rates, eligible basis and requirements regarding when the property is placed in service. Specifically, Section 168(k)(7) allows taxpayers to forego bonus depreciation by making an election for any class of property for a taxable year. Alternatively, Section 168(k)(4) allows taxpayers to elect to accelerate the use of alternative minimum tax (AMT) credits instead of claiming bonus depreciation.2 An election under Section 168(k)(4) remains in effect with respect to the class of property placed in service for that election year for future years until the election is revoked with the Service’s consent. When the Section 168(k)(4) election is made, no bonus depreciation is available, and the taxpayer must use the straight-line method of depreciation.
In its review of the facts, the Service noted that a former employee of the taxpayer did an incomplete analysis of the application of Section 168(k)(4). A subsequent review by outside counsel and current employees of the taxpayer revealed that applying Section 168(k)(4) to the years at issue was less beneficial than claiming bonus depreciation. Thus, the Service allowed the taxpayer to revoke its original election and to claim bonus depreciation for the years at issue.
PLR 201709007 confirms the Service’s standards for allowing late elections related to bonus depreciation, i.e., the taxpayer’s ability to demonstrate not only that it acted reasonably and in good faith, but also that the ultimate grant of relief will not prejudice the interests of the government. Consistent with prior rulings, the Service demonstrated a continuing willingness to grant relief regarding the election (and revocation of the election) under Section 168(k).3 The ruling provides an important reminder that even when a taxpayer makes an affirmative election not to claim bonus depreciation, it may be possible to retroactively change that determination and claim bonus depreciation.
PLR 201710006 (Mar. 10, 2017) – The Service determined that individual parts, not the assembled unit comprising the parts, are the appropriate units of property for disposition purposes
In PLR 201710006, the Service evaluated whether a taxpayer could apply the disposition rules of Treas. Reg. § 1.168(i)-8(c)(4) to race car parts, owned by the taxpayer, which were used in the assembly of a championship race car during a racing season. Because the taxpayer disassembled each race car entry into the various parts and permanently withdrew those parts as appropriate, the Service essentially viewed the parts, not the assembled race car, as the appropriate unit of property for purposes of applying Section 168, including the disposition provisions.
This ruling is interesting because the taxpayer’s business was viewed by the Service not as building or acquiring a complete automobile, but building or acquiring parts that the taxpayer then assembles and reassembles into “particular assemblages” for each racing event. After each event, the taxpayer disassembles the car, and inspects, repairs, refinishes and/or replaces the different parts used to create the racing car entry for the event. Due to the high stress and wear and tear the parts experience over the course of a season, many parts are damaged, obsolete and/or unusable at the end of the season. The taxpayer sought a ruling on whether, under Treas. Reg. § 1.168(i)-8(b)(2), a disposition occurred when the taxpayer disassembled the race car entry and permanently withdrew certain damaged, obsolete or unusable parts. Although the taxpayer used assembled cars in its business of owning and operating a championship race car, the Service agreed with the taxpayer and ruled that, provided the individual race car parts were not included in a general asset account, each part that the taxpayer owned and used to build its race cars for each specific event were the appropriate assets for disposition purposes under Treas. Reg. § 1.168(i)-8(c)(4).
This ruling is somewhat unexpected because the taxpayer used the race car exclusively in its assembled state, yet the Service agreed with the taxpayer’s position that the race car was not the correct unit of property for purposes of applying the disposition rules of Section 168.
This ruling should be considered when evaluating whether and how the disposition rules of Section 168 apply. Because the Service ruled that the taxpayer could apply the disposition rules to certain parts rather than the complete automobile, taxpayers should fully evaluate their treatment of machinery and equipment to ensure that the Section 168 disposition provisions are being applied correctly. Any taxpayer that routinely assembles or disassembles automobiles, trucks, machinery or other assets, which are historically treated as a single asset, could potentially benefit from this ruling by accelerating disposition deductions with respect to the various parts that are incorporated into each larger asset.
PLR 201709003 (Mar. 3, 2017) – The Service addresses the treatment of Section 197 intangibles following a restructuring
In PLR 201709003, the Service evaluated the treatment of Section 197 intangibles following a consolidation of partnership entities by a holding company and a subsequent agreement with a third party to combine those partnership operations into a new partnership. The Service ruled that as long as the lower-tier partnerships held two separate intangibles (both pre-1993 and post-1993 intangibles) at the time of the consolidation, then the new partnership would be viewed as receiving those two separate intangible assets and should continue to amortize the adjusted basis of the post-1993 intangibles.
As is common with many taxpayers, the holding company’s historic structure of owning numerous separate legal entities was the result of certain state law requirements and other business decisions made over the course of several years. Due to the age of the business (some cases involving partnerships formed prior to August 10, 1993), the acquired intangible assets of those entities were subject to the anti-churning rules of Section 197(f)(9). The anti-churning rules of Section 197(f)(9) prevent taxpayers from using the amortization rules of Section 197 for assets that were held (or traceable to assets held) prior to the effective dates of the provision. When Section 197 was enacted, there was concern that taxpayers would attempt to take advantage of the provision to secure amortization that was previously unavailable for certain assets (e.g., goodwill, going-concern value). Thus, the anti-churning rules were included to prevent taxpayers from claiming amortization for intangibles not amortizable under prior law when the purpose of the acquisition was to generate amortization under Section 197. These rules capture transfers occurring during the transition period; transfers from one who owned it during the transition period to another related party; and transfers in a series of related transactions designed to avoid the operation of Section 197.
To obtain a favorable ruling that allowed the taxpayer to amortize at least some of its intangibles, it is important to note that the taxpayer made several “material” representations, including that the lower-tier partnerships held two separate intangibles, that those separate intangibles were the pre-1993 and post-1993 intangibles, and that the consolidation transaction was subject to Sections 721 and 731.
This ruling is significant due to three key facts that the taxpayer in the ruling shares with so many taxpayers today: (i) a complex holding company structure that involves numerous lower-tier partnership entities; (ii) an attempt to consolidate the organizational structure, often by reducing the number of involved partnerships; and, (iii) the taxpayer’s ownership of both pre-1993 and post-1993 intangibles. In the event a taxpayer is interested in carrying out a similar consolidation and receiving similar favorable treatment with respect to its intangibles, this ruling shines a light on the representations and transaction structure that the Service considers helpful in obtaining such a result.
PLR 201709008 (Mar. 3, 2017) – The Service addresses the applicability of normalization requirements in the context of net operating loss carryforwards
In PLR 201709008, the Service addressed whether an electric utility complied with normalization requirements under Section 168 following the settlement of a regulatory commission rate case. The Service determined that an accumulated deferred income tax (ADIT) asset resulting from the net operating loss (NOL) carryforward must be included in the rate base because the ADIT liability resulting from accelerated tax depreciation was included. The Service ruled that the normalization requirements would have been violated if the entire ADIT asset was excluded or a portion of the ADIT less than that attributable to accelerated tax depreciation had been included.
Although the taxpayer was directed by its regulatory commission to file this ruling, the ruling is significant for the clarification that it provides with respect to the Service’s view and application of Section 168’s normalization requirements. At the heart of these requirements is Treas. Reg. § 1.167(l)-1(h), which requires a utility to maintain a reserve reflecting the total amount of the deferral of federal tax liability resulting from a taxpayer’s use of different depreciation methods for tax and ratemaking purposes.4
Under these regulations, the reserve established for public utility property should reflect the total amount of the deferred federal tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes. If the use of accelerated depreciation results in an NOL carryforward, then the amount and timing of the deferral of tax liability shall be taken into account as prescribed by the district director. Because the taxpayer was, in fact, seeking to include in its rate base the ADIT asset resulting from the NOL carryforward, given the inclusion in the rate base of the full amount of the ADIT liability resulting from accelerated tax depreciation, the Service was able to rule that the taxpayer’s method had satisfied the normalization requirements of Treas. Reg. § 1.167(l)-1(h) and Section 168.
This ruling is consistent with the determinations in previous rulings regarding NOL carryforwards, where the Service has generally ruled that a utility satisfies the normalization requirements of Treas. Reg. § 1.167(1)-1(h) as long as the method used by the utility ensures that the rate base is not reduced by the ADIT deductions that produced the NOL.5
1 See Executive Order No. 13771, Reducing Regulation and Controlling Regulatory Costs, 82 Fed. Reg. 9339 (Jan. 30, 2017).
2 The AMT rules impose an additional tax, which is allowed as a credit against the taxpayer’s regular income tax for future years, but for a particular year, this credit is usually limited to the amount by which the regular tax exceeds the tentative minimum tax. Under the election provided in Section 168(k)(4), that limitation is increased by a “bonus depreciation amount,” which is greater than the amount otherwise allowable. If the enhanced minimum tax credit exceeds the taxpayer’s tax liability for the year, the excess is refunded to the taxpayer.
3 See PLR 201603009 (Jan. 15, 2016).
4 Treas. Reg. § 1.167(l)-1(h) provides that a taxpayer uses a normalization method of regulated accounting with respect to public utility property: (a) if the same method of depreciation (whether or not a subsection (l) method) is used to compute both its tax expense and its depreciation expense for purposes of establishing cost of service for ratemaking purposes and for reflecting operating results in its regulated books of account, and (b) if to compute its allowance for depreciation under Section 167 it uses a method of depreciation other than the method it used for purposes described in (a) of this subdivision, and the taxpayer makes adjustments consistent with subparagraph (2) of this paragraph to a reserve to reflect the total amount of the deferral of Federal income tax liability resulting from the use with respect to all of its public utility property of such different methods of depreciation.
5 See generally PLR 201418024 (May 2, 2014) (in which the Service ruled the reduction of a utility's rate base by the full amount of its ADIT without regard to balances in its NOL carryforward account and its minimum tax credit carryforward account was consistent with the normalization requirements of Treas. Reg. §1.167(1)-1(h)), PLR 201436037 and 201436038 (Sept. 5, 2014) (in which the Service ruled the reduction of a utility's rate base by the full amount of its ADIT account balances offset by the portion of its NOL carryforward-related account that is less than the amount attributable to AD computed on a “with or without” basis would be inconsistent with the normalization requirements of Treas. Reg. §1.167(l)-1).