MERCHANT PLANT DEVELOPERS can probably avoid having to pay tax grossups on their electric interties by using a grantor trust structure.

The owner of a new power plant must pay the cost of connecting his power plant to the grid. The local utility usually builds the intertie; the generator reimburses it for the cost. Utilities have not reported these cost reimbursements as income since 1988. However, the IRS said earlier this year that it is studying the issue. A ruling is expected sometime next year. If the IRS decides that the cost reimbursements must be reported as income, then utilities will insist on a tax grossup, making interconnection more expensive.

There are ways to structure the interconnection arrangements to avoid this problem – no matter what the IRS decides. The key is the generator should arrange directly with a contractor to have the intertie built. It would then contribute the intertie to a grantor trust with itself as beneficiary and the utility as the trustee. This would give the utility the control it requires over the intertie. It should also not have to report the intertie as income. At the end of the interconnection agreement, the trust would liquidate and the intertie would be returned to the generator.

This approach works with radial lines and other dedicated equipment. It is hard to make work for system upgrades.