With the 2017 Tax Cuts and Jobs Act (“TCJA”), developers and water and wastewater companies see the return of a tax policy that has significant consequences for both groups. This is the first post in a two-post series discussing the history of “Advances” and “CIAC” and the practical effect of the TCJA on construction, dedication and utilization of water lines in Pennsylvania. In short, the cost of doing business just increased for developers, while water companies once again are saddled with additional work. This post provides background and history while a second post will provide insight on working through the issues.
Most private companies require a developer to “advance” fund (an “Advance”) the cost of pipe or other upgrades – in the form of funds or contributed property – needed to connect a new development to an existing water system. As customers connect to the water system, the water company receives revenue and the Advance is refunded on a per customer basis. Contributions in Aid of Construction (“CIAC”) are similar to Advances, with two main differences being CIAC are permanent while Advances are refunded and CIAC may be reimbursements from the government for the relocation of facilities. Advances not refunded by the end of the contract term are booked as CIAC. The purpose of Advances and CIAC is to shield existing customers from the cost of growth. If a development fully builds out, the developer receives a full refund of the Advance, but if the build-out is less than anticipated, existing customers are protected from footing the bill.
For many years, the Internal Revenue Code, 26 USCS § 1 et seq. (“IRC”), treated Advances and CIAC as taxable income to water companies. Under the Tax Reform Act of 1986, 99 P.L. 514, 100 Stat. 2085 (“TRA”), most public utility commissions authorized water companies to gross up Advances and CIAC to cover the taxable income recognized due to Advances and CIAC. See 1987 Pa. PUC LEXIS 323, 63 Pa. PUC 447 (Pa. P.U.C. April 09, 1987); 1988 Pa. PUC LEXIS 469, 67 Pa. PUC 439 (Pa. P.U.C. June 10, 1988). Taxing Advances and CIAC created issues for developers and water companies, alike. It created animosity between developers and water companies because developers had to pay an extra 66% over the cost of installing the water line to cover the water company’s taxes. At the same time, it created significant accounting issues, so water companies hated it. Moreover, because Advances are based on estimated costs, the actual cost could be significantly different due to unforeseen construction conditions, such as hitting rock during construction. Consequently, water companies had to go back and determine the actual cost of construction plus taxes after the project was complete. Worse, they then had to return to developers to either ask for additional costs plus taxes or issue a refund.
In 1996, the tax on Advances and CIAC was repealed and the two no longer had to be grossed up. SMALL BUSINESS JOB PROTECTION ACT OF 1996, Enacted H.R. 3448, 104 P.L. 188, 110 Stat. 1755. Developers were pleased because they did not have to pay a 66% mark-up and water companies enjoyed relief from the heavy record keeping burden. Unfortunately, the TCJA brings back the tax on Advances and CIAC, so all involved must determine how best to approach the issues discussed above. The next post in this two-post series discusses just that.
Please feel free to contact any member of the McNees Wallace & Nurick Land Use Group for assistance with any land use or development issues and/or if you have any questions regarding this post.