Rev. Proc. 2003-33: Safe Harbor for Utility Contributions
Explore Rev. Proc. 2003-33, which defines the conditions under which certain payments to water and sewerage utilities are treated as non-taxable capital.
The Internal Revenue Code clarifies the tax treatment of payments made to regulated public water and sewerage disposal utilities. This guidance determines when a payment from a customer or developer for new infrastructure is a non-taxable contribution to the utility’s capital, rather than taxable income.
Initially, these contributions were non-taxable. This treatment was temporarily repealed by the Tax Cuts and Jobs Act of 2017 but was later reinstated by the Infrastructure Investment and Jobs Act. As a result, non-taxable treatment is again the standard for these utilities, provided certain conditions are met.
Eligibility Requirements
The utility receiving the payment must be a “regulated public utility,” which means its rates for water or sewerage disposal services are established or approved by a state or local government agency, a public service or public utility commission, or a similar body.
The payment must qualify as a “contribution in aid of construction.” This means the funds are not for general corporate use but are tied directly to a specific construction project, such as extending a water main or connecting a new development to the sewer system. The payment must be made by the person who will benefit from the services, which could be a developer building a new subdivision or a commercial entity constructing a new facility.
Key Conditions for Non-Taxable Treatment
A central requirement is that the contribution must not be included in the utility’s rate base for ratemaking purposes. This means the utility cannot use the value of the contributed asset to justify higher rates charged to its customers.
For the payment to qualify, it must be used for the construction of property that will be owned and operated by the utility. The utility must have full ownership and control over the asset once it is placed in service. The transaction must be clearly intended as a contribution to the capital of the utility.
Resulting Tax Consequences
For the utility, the payment is treated as a non-taxable contribution to capital under Internal Revenue Code Section 118. This means the utility does not recognize the payment as gross income and, therefore, does not owe federal income tax on the funds received for the construction project.
A significant consequence for the utility is that the property constructed with these funds has a tax basis of zero. Because the utility did not expend its own capital to acquire the asset, it cannot claim depreciation deductions on it for tax purposes. This prevents the utility from receiving a double benefit of non-taxable receipt of funds and future tax deductions.
For the party making the payment, the contribution is treated as a capital expenditure, not a deductible expense. This expenditure increases the tax basis of the property owned by the payer that benefits from the utility service. For example, if a developer makes the payment to extend water lines to a new housing development, the cost of that payment is added to the developer’s basis in the lots or homes being sold.