Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

Phantom Taxes: The Big Paycheck

Fortnightly Magazine - July 1 1996

payback will prove most difficult for those companies that, by virtue of their disproportionate investment in nuclear plant, have argued most vociferously for stranded-cost recovery. Indeed, stranded nuclear investment stands as a primary legacy of tax normalization.

Consider the extreme example of the Long Island Lighting Co. (LILCO) and its Shoreham nuclear plant.

LILCO abandoned Shoreham in 1989 after it was fully constructed at a cost of $5.4 billion and ready for operation. During construction, LILCO capitalized virtually all Shoreham-related costs for rate purposes, including financing and overhead costs. However, on its income tax books, LILCO had also expensed most of Shoreham's construction-related financing expenses and some of Shoreham's overhead costs. Moreover, LILCO never recognized the equity component of AFUDC (allowance for funds used during construction) as income for tax purposes. Finally, LILCO took investment tax credits for its Shoreham investment, without passing them along to ratepayers. Thus, Shoreham generated huge losses for tax purposes while generating income for ratemaking purposes. It took reimbursement for over $100 million in average annual imputed federal income-tax costs, even though its actual federal income tax costs were virtually nonexistent (see Table).

The disparity between the tax and book treatment of Shoreham-related expenses and income (yielding $875 million in excess tax reimbursements over seven years) caused a growing disparity between Shoreham's tax basis and its rate-base value. By 1989, when Shoreham was abandoned, its tax basis was only $1.8 billion, only a third of its $5.4-billion unadjusted rate base. When LILCO wrote off Shoreham, the net balance of ratepayer Shoreham-related ADFIT advances exceeded $1 billion.4 In other words, LILCO had collected more than $1 billion in federal tax-expense reimbursements over and above actual tax expenses.

The Argument for Ratepayer Recovery

Had Shoreham gone into service in the 1980s, its tax basis would now be depreciated close to zero. LILCO would be looking at a 20-year, $50-million annual after-tax cash crunch to reimburse ratepayers for their earlier ADFIT advances (see Chart).5

Other utilities with similarly disproportionate investment in nuclear plant have experienced similar reversals, or will in the future.6 In other words, they must now begin to pay back the tax advances they have been receiving from ratepayers.

First of all, this obligation to pay back prior deferrals must take center stage in the stranded-cost debate. Some treat this obligation as a liability that utilities owe to the Internal Revenue Service (IRS). But utilities have operated as a cost-plus industry; to the extent that they have been reimbursed by ratepayers above incurred costs they should owe restitution to their customers.

Second, utilities should not be permitted to retain ADFITs for their own benefit without an appropriate quid pro quo. Much of the restructuring debate has focused on moving generation assets out of rate base, into unregulated subsidiaries or divisions of utility companies. Unchecked, this shifting of assets could inequitably deny ratepayers recovery of their ADFIT advances.

When the telephone industry restructured, telephone carriers procured IRS private letter rulings that ADFITs could accompany assets transferred to unregulated operations instead of being refunded to the ratepayers who had advanced