Tax Issues with Decommissioning, Abandonment & Demolition EEI Taxation Committee Meeting November 15, 2011 Dallas, TX Carol NelsonPhil TingleMartha Pugh Progress Energy, Inc.McDermott Will &McDermott Will & Emery LLPEmery LLP

2 Agenda Introduction to Net Operating Losses and Specified Liability Losses Treatment of Nuclear Decommissioning Costs Carry back rules Recent IRS Guidance Demolition and Independent Spent Fuel Storage Installation (ISPFI) Deduction for abandonment Blue Ribbon Commission and Nuclear Waste Disposal Trust Accounts PPT

3 Net Operating Losses – § 172 Because of bonus depreciation, many energy companies now are (or will be) in a net operating loss (“NOL”) position. NOL is the excess of the deductions over gross income in a given tax year – § 172(c). Offsets income in past or future years (beginning with the earliest year). Carry back 2 years. Carry forward 20 years.

4 Specified Liability Losses Carry back 10 years – § 172(b)(1)(C). Defined in Section 172(f). Certain Product Liability Losses – § 172(f)(1)(A). Federal/State Law Liabilities – § 172(f)(1)(B). Reclamation of land Dismantling of a drilling platform Remediation of environmental contamination Workers compensation payments Decommissioning of Nuclear Power Plant (or unit)

5 Special Nuclear Power Plant Rule May carry back nuclear decommissioning specified liability losses to years beginning with the tax year the plant (or unit) was placed into service – § 172(f)(3). Not limited to 10 years. How far back? 1984.

6 Nuclear Decommissioning Costs Deductible expenses for the following: The entombment, decontamination, dismantlement, removal and disposal of the structures, systems and components of a nuclear power plant (regardless of whether the plant continues to produce electric energy). The preparation for decommissioning, such as engineering and other planning expenses. Costs after the actual decommissioning occurs, such as physical security and radiation monitoring expenses. Cost associated with the construction, operation, and ultimate decommissioning of a nuclear waste facility. Treas. Reg. § 1.468A-1(b)(6)

7 History of Specified Liability Loss Rule Separate carryback rules. Product Liability Costs. Deferred Statutory or Tort Liability Costs. Nuclear Decommissioning Costs treated as Deferred Statutory Liability Costs. Carry back to taxable year plant (or unit) was put in service – Former § 172(k)(2) (1989). Limitation on carry back of Deferred Statutory Liability Costs to taxable years beginning on or AFTER January 1, 1984 – Former § 172(k)(4) (1989).

8 Revenue Reconciliation Act of 1990 P.L § 11811(b)(2)(A) of the Act combined Deferred Statutory or Tort Liability losses with Product Liability Losses into single category of Specified Liability Losses. Rearranging of the code sections eliminated Former § 172(k)(4) from the Code (Limitation of carryback losses to years beginning on or after 1/1/1984).

9 Revenue Reconciliation Act of 1990 – Cont. P.L § 11811(b)(3)(B) - Enacting language: “The portion of any loss which is attributable to a deferred statutory or tort liability loss (as defined in section 172(k) of the Internal Revenue Code of 1986 as in effect on the day before the date of the enactment of [the 1990 Act]) may not be carried back to any taxable year beginning before January 1, 1984, by reason of the amendment made by [§ 11811(b)(2)(A)].”

10 Revenue Reconciliation Act of 1990 – Cont. Because Nuclear Decommissioning Costs were treated as Deferred Statutory Liability Costs under Former § 172(k), the carryback of NOLs attributable Nuclear Decommissioning Costs are limited to tax years beginning on or after Jan. 1, 1984.

11 Election to Relinquish Carryback NOL Under § 172(b)(3) – May relinquish the entire carryback period for an NOL for any taxable year. Election to relinquish must be made by the return filing deadline (including extensions). Once made, election is irrevocable. Is it possible to relinquish all NOLs except for Specified Liability Losses?

12 Election to Relinquish Carryback NOL – Cont. Treas. Reg (c)(4) (Aug. 26, 1986). “If a taxpayer sustains during the taxable year both a net operating loss not attributable to product liability and a product liability loss … [waiver election under § 172(b)(3)] does not preclude the product liability loss from being carried back 10 years under section...” Relates to Product Liability losses. Passed before revised statute defining specified liability losses.

13 IRS Guidance PLRs and Taxpayers were parents of consolidated groups with CNOLs that included Specified Liability Losses. Significant amounts of Specified Liability Losses were attributable to federal/state law liabilities described in § 172(f)(1)(B).

14 IRS Guidance – Cont. IRS summarized the history of specified liability loss carryback rule – Special carryback rule for products liabilities added to the code in 1978, effective for tax years beginning after September 30, Special carryback rule for deferred statutory or tort liabilities was added in 1984, effective for tax years beginning after Treas. Reg. § (c)(4) was proposed on March 25, 1983 and finalized on August 26, 1986 before the term “specified liability losses” was adopted in 1990.

15 IRS Guidance – Cont. The IRS applied Treas. Reg. § (c)(4) to all specified liability losses and concluded that an election to relinquish the carryback period for the CNOLs did not require the taxpayer to relinquish the carryback period for the specified liability losses, including the losses attributable to Federal/State Law Liabilities described in § 172(f)(1)(B). Portions of PLR were later revoked by PLR (relating to whether certain taxes were specified liability losses), but the carryback waiver ruling was left in effect.

16 IRS Guidance – Cont. FSA 5199 (December 16, 1996). Taxpayer had CNOLs that included specified liability losses (state and federal income tax deficiency payments). Made § 172(b)(3) election to relinquish carryback of CNOLs when it filed its return. Taxpayer later claimed the election did not apply to the specified liability losses. IRS took the position that the § 172(b)(3) election applied to all NOLs. IRS stated: “Finally, the taxpayer’s election is an unambiguous and all encompassing election. The taxpayer could have specified that the election applied only to the three year carryback and not the ten year carryback net operating losses, by the taxpayer did not.”

17 IRS Guidance – Cont. ILM (July 26, 2011) Issue: Whether taxpayer making 172(b)(3) election can carryback losses with extended carryback periods, including specified liability losses. Conclusion: 172(b)(3) election applies to ALL losses, including special liability losses. – Arguably inconsistent with regulations and prior PLR. Reasoning: No more than one NOL exists per tax year. Election to relinquish the entire carryback period applies to the entire NOL and not just a portion. Treas. Reg. § (c)(4) is limited to product liability losses only.

18 Demolition § 280B generally does not allow for the deduction of expenses or losses incurred in the demolition of a structure. Exception – Expenses for the demolition of a nuclear power plant are treated as Nuclear Decommissioning Costs and are deductible without regard to § 280B – Treas. Reg. § 1.468A-1(b)(6).

19 ISFSI Treatment Certain costs associate with independent spent fuel storage installation (ISFSI) may be decommissioning costs. ISFI consists of canisters, casks, and the concrete pad where the canisters are placed. PLR characterizes costs as Code section 162 and 165 costs. Starting in 1998, nuclear utilities began filing suits against DOE for the failure to remove spent nuclear fuel from reactor sites pursuant to the terms of the standard contract and the Nuclear Waste Policy Act.

20 Abandonment § 165(a) – Deduction for loss sustained during the taxable year and not compensated for by insurance or otherwise. § 165(b) – Loss is equal to the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property. Section (c) of the Income Tax Regulations provides for allowance under section 165(a) of losses arising from the permanent withdrawal of depreciable property from use in the trade or business or in the production of income, see section 1.167(a)-8.

21 Abandonment. § 1.167(a)-8(a)(4)--In order to qualify for the recognition of loss from physical abandonment, the intent of the taxpayer must be irrevocably to discard the asset so that it will neither be used again by him nor retrieved by him for sale, exchange, or other disposition. "A mere intention to abandon is ineffectual unless coupled with a voluntary relinquishment of possession and control. To abandon real property there must be a concurrence of the act of leaving the premises vacant and unoccupied with the intention of not returning. There must be some clear and unmistakable affirmative act indicating a purpose to repudiate ownership." Helvering v. Jones, 120 F.2d 828, 830 (8th Cir.), cert. denied, 314 U.S. 661 (1941).

22 Demonstrating Abandonment Dismantle and remove components necessary for the operation of the Facility. Issue a press releases concerning the abandonment of the Facility. Reflect the abandonment in its financial statements. Ensure expenses are not inconsistent with abandonment – expenses incurred to insure the Facility, expenses incurred to insure it is safe and secure, expenses to meet environmental or community laws, expenses incurred to maintain the Facility for aesthetic reasons (to the extent needed for the protection of business reputation or to comply with local laws), and; any other expenses that are not inconsistent with the act of abandonment, like paying property tax, licenses (as long as not operating licenses), etc. While certain maintenance may be done for aesthetic/business protection reasons, no other maintenance should be performed with respect to the Facility. Thus, the interior of the Facility and all operational components should be allowed to deteriorate.

23 Treas. Reg. § (d) (2)(i) Whether a reasonable prospect of recovery exists with respect to a claim for reimbursement of a loss is a question of fact to be determined upon an examination of all facts and circumstances. Whether or not such reimbursement will be received may be ascertained with reasonable certainty for example, by a settlement of the claim, by an adjudication of the claim, or by an abandonment of the claim.

24 Blue Ribbon Commission Proposal Tasked by the Secretary of Energy to recommend a plan for managing nuclear waste. Draft report proposed changing the collection of 1 mill/kwh fees. DOE would amend contracts with utilities to allow them to retain the portion of the fee that exceeded the annual appropriations level for nuclear waste management activities. Utilities would place fees in an irrevocable trust account – similar to decommissioning funds. No new legislation required.

25 Summary Decommissioning Costs are specified liability losses and have a special 10 year carryback rule (or to the date the plant or unit is placed in service). Special losses can only be carried back to years beginning on or after 1/1/1984. According to a recent IRS memorandum, election to relinquish carryback period for all NOLs applies to specified liability losses. Reverses position of previous PLRs. Demolition Costs are deductible as Nuclear Decommissioning Costs Consider how suits against DOE for failure to take spent fuel may impact ability to deduct abandonment costs. Blue Ribbon Commission and Nuclear Waste Disposal Fees PPT