US utilities that start reporting customer connection fees as income must treat the change as a “change in method of accounting,” the IRS said.

That makes the change more costly.

US utilities usually charge new customers for electricity, gas, water, sewage, telephone and cable television service a “connection fee” to cover the cost of running a line or gas main to the customer’s property. These fees must be reported as taxable income.

Some utilities have been slow to do so.

Normally when a company changes the way it calculates its income, the change is considered a change in accounting method, meaning it requires prior approval from the IRS and the company must not only report future amounts correctly but also make an adjustment on account of having done things differently in the past. This is called a “section 481 adjustment.” Ordinarily, the extra income tied to past-year reporting can be spread over four years.

The US Tax Court told Saline Sewer Co. in 1992 that it was not a change in accounting method when the utility started reporting customer connection fees as income. A federal district court in Florida told Florida Progress Corp., an electric utility, the same thing in 1999.

The IRS said in June that it disagrees.

Changing how a company calculates its income is a change in accounting method if it affects the timing of when income is reported, but not if it leads to a permanent increase or decrease in income. Thus, for example, it is a change in accounting method for a company to change how it depreciates assets. It is not such a change to switch to reporting certain payments to shareholders as dividends rather than interest.

The IRS said that a utility that starts reporting customer connection fees as income is merely changing the timing of its income and not the absolute amount. The utility would have reported no income before the change and it could not depreciate the line or gas main on the customer’s property because the customer paid the cost; the utility paid nothing for it. The IRS said the net income of the utility after the change is still zero. That’s because it has income but it can also deduct the amount as depreciation over the life of the line or gas main that was installed to connect the customer.

This is a little too metaphysical. It is hard to see how there is a change in the timing of income when the amount was zero both before and after. The utility will pay more in taxes after the change; this is consistent with its having more income to report in time value terms. The IRS explained its position in Revenue Ruling 2008-30.

Keith Martin