IRS Rules 3 Utilities Cannot Reduce NOL Carryforwards For Tax Allocation Payments

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The IRS recently issued three related private letter rulings (PLRs) determining that a utility's net operating loss carryforward (NOLC) cannot be reduced by intercompany tax allocation payments under the normalization rules.

United States Tax

Highlights

The IRS recently issued three related private letter rulings (PLRs) determining that a utility's net operating loss carryforward (NOLC) cannot be reduced by intercompany tax allocation payments under the normalization rules.
The rulings involved three affiliated utilities that had incurred net operating losses attributable to the use of accelerated depreciation for federal income tax purposes.
The IRS reasoned that the tax allocation payments received from profitable affiliates that utilized the NOLCs did not represent interest-free loans from the federal government, which it described as the sine qua non of depreciation normalization.

Following the initial public release of private letter ruling (PLR) 20242002 as part of a state rate proceeding, on June 28, 2024, the IRS publicly released that ruling, as well as two companion rulings obtained by other affiliates subject to the jurisdiction of different state public utility commissions, PLRs 20242003 and 20242004 (all dated March 8, 2024). (See Holland & Knight's previous alert, "IRS Rules Utility's NOL Carryforward Cannot Be Reduced by Tax Allocation Payments," May 8, 2024.)

In general, the PLRs ruled that the normalization mechanical deferred tax computational rules of Treasury Regulation Section 1.167(l)-1(h) and the consistency rules of Section 168(i)(9) precluded the reduction of a regulated utility's net operating loss (NOL) by intercompany tax allocation payments received from profitable members of the consolidated group that were able to use the NOLs.

The rulings provided that because the mechanical deferred tax reserve computational rules are based exclusively on the difference between book and tax depreciation multiplied by the statutory tax rate, the introduction of another variable into the calculation (i.e., the profits of the affiliates who used the net operating loss carryforward (NOLC) to offset tax liability) would violate those rules. Further, the consistency rules under Section 168 required that any projections or adjustments to any one of the four normalization consistency elements (tax expense, depreciation expense, the reserve for deferred taxes and rate base) mandated consistent adjustments to the other elements. Because the adjustment made by the utilities was solely with respect to rate base, the remaining three elements were unadjusted and thus "out of sync" under the consistency rules.

Holland & Knight Insight

Despite minor differences of fact in the respective rulings, the fundamental conclusions and analysis in all three rulings were identical. Importantly, the rulings confirmed that, under Rev. Proc. 2017-47, if the utility takes corrective action at the "next available opportunity," the utility will avoid the loss of the right to claim accelerated depreciation on all of the taxpayer's public utility property, subject to the jurisdiction of the commission.

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