This is the second post in a two-post series on the 2017 Tax Cuts and Jobs Act (“TCJA”), with which developers and water companies see the return of a tax policy with negative consequences for development.  Effective this year, advances for construction (“Advances”) and Contributions in Aid of Construction (“CIAC”) for water systems are treated as taxable income.  Essentially, water companies must include in taxable income the contributed property or cash needed to connect a development to a water system.  This tax adds significant costs to developers when water companies pass the tax to developers.  At the same time, more work is created for water companies which must gross up Advances and CIAC (together, “A/CIAC”) and later recalculate those costs based on the actual cost of construction and gross up refunds.  This post provides insight on ways to mitigate the negative effects of the TCJA on development in Pennsylvania.

Unfortunately, avoiding the extra accounting work for water companies is not possible unless reforms are made.  However, water companies have two choices with respect to tax impact: (1) absorb the tax in revenue requirement and spread the cost to all customers or (2) charge the tax to developers.  In the past, the Pennsylvania Public Utility Commission (“PUC”) has preferred the latter approach because it follows cost causation principles used for structuring rates.  While some water companies, including Aqua Pennsylvania, have decided to pay the tax and spread it to all customers, knowing the tax often will be passed to developers, the query becomes: how can developers lessen the blow?

Developers have several options, none of which are a complete solution.

  1. Pay the tax and request a calculation of the gross up factor to confirm it is accurate.
  2. Discuss with the water company the importance of economic development generally and explain that since the revenue generated by a development will benefit all customers, all customers should pay the tax resulting from this benefit.
  3. If there is no active docket on this issue pending before the PUC, developers may meet with PUC Commissioners to explain the negative impact of the tax on economic development, so the Commissioners can make more informed decisions
  4. Intervene in open PUC dockets related to this issue to explain why the tax expense should follow the economic benefits of the revenue generated by the development. Pennsylvania American Water’s PUC case is docketed at R-2018-3002502.
  5. File a complaint with the PUC against a water company which is grossing up A/CIAC without approval in its tariff. While there may be merit to this approach, it could take months to submit testimony, secure a decision and have the PUC act on that decision.
  6. Ensure the gross up payment to the water company is deferred until the taxable event occurs. If the developer is constructing the facilities and then transferring them to the water company, no gross up should be paid until the facilities are transferred because that is when the taxable event occurs.

The goals of developers and the water company are aligned – neither want to pay federal income taxes on A/CIAC.  By utilizing the approaches above, the effects of the tax can be reduced.  Please 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.