Instead, Oncor’s parent, the financially beleaguered Energy Future Holdings (EFH), can pocket most of the money. Since 2008, these phantom taxes have totaled at least a half billion dollars. And because EFH faces the possibility of bankruptcy or restructuring in the near future, it is likely that this money will never be remitted to the federal treasury.
The practice is not illegal, although it should be reformed. The Legislature should ensure that money utilities collect from its customers for federal income taxes should be used for that purpose. Otherwise, the utilities should not collect the money at all.
However, Texas lawmakers adopted legislation in 2013 that will exacerbate this phantom tax problem.
These are the findings of this new snapshot report from The Texas Coalition for Affordable Power (TCAP), which has found that EFH’s financial problems already are placing a multi-million dollar burden on north Texas electricity customers.
In compiling this report, TCAP has reviewed Securities and Exchange Commission filings, regulatory filings at the Public Utility Commission, and journalistic accounts. It also has analyzed new legislation at the state Capitol.
Although much of the state’s electricity market has been deregulated, transmission and distribution utilities remain regulated. This is because transmission and distribution utilities are natural monopolies. These utilities do not face competition so it is left to the Public Utility Commission (PUC) to ensure they do not overcharge for their services. Rates set by the PUC are paid by Retail Electric Providers, which collect the money though charges included in bills that go to residential and business customers.
When setting rates, the PUC allows monopoly transmission and distribution utilities to collect from customers sufficient money to recover the utility’s reasonable expenses. Under Texas law, these reasonable expenses can include an amount for a utility’s federal income taxes.
However, utilities that are subsidiaries of holding companies (or utilities that are subsidiaries of parent companies that own the utility and other unregulated affiliates) typically do not make direct tax payments to the federal treasury. Instead, the utility’s parent company files a tax return for the utility and any affiliated companies. The parent company consolidates the revenues and losses of all its holdings — including those of its regulated transmission and distribution utility — and files a single return with the Internal Revenue Service.
This arrangement provides a significant financial benefit to the parent company. For instance, when the parent company owes nothing to the IRS, it simply gets to pocket the tax payments it receives from its captive utility customers. When a utility’s customers pay more for federal income taxes than the parent company owes to the IRS, the parent company gets to pocket the excess.
This practice is not illegal. However, if not closely monitored and controlled by regulators, it can lead to extremely unfair outcomes. Keep in mind that transmission and distribution utilities are monopolies. Utility customers have no choice but to pay rates charged by the utility — even when those rates include assessments for a non-existent tax bill. A utility customer cannot quit the utility and go elsewhere for service.
All customers in deregulated areas of the state — regardless of the retail electric provider that serves them — receive service from a regulated transmission and distribution utility. In North Texas, that utility is Oncor. Around Houston, the utility is CenterPoint Energy.
Residential electricity bills generated by retail electric providers typically include a charge to reflect pass-through payments made to the transmission and distribution utility. However, customers may not find a separate line item to reflect collections by the utility for federal income taxes. In this way, these phantom tax payments go unnoticed by consumers.
Energy Future Holdings is the majority owner of Oncor. It acquired Oncor and other holdings of the former TXU Corporation in a 2007 leveraged buyout, the largest in history. But now EFH faces a crushing debt burden and declining revenues. According to reports, EFH spent half its revenues in 2012 on interest payments alone. Analysts believe bankruptcy or restructuring is not far off, perhaps by the end of summer or early next year.
Filings at the federal Securities and Exchange Commission show that EFH is not paying federal income taxes. This is not surprising, given its mounting losses. EFH paid no federal income taxes in 2010, 2011 and 2012, according to the company’s 10-K filings with the Securities and Exchange Commission.
Those filings also indicate EFH received refunds in 2009 and 2008, and its last federal income tax payment may have been made in 2007.
EFH owns 80 percent of Oncor, which does not directly pay taxes to the federal government. Instead, Oncor collects money from its ratepayers for federal income taxes and then remits a share of that money to EFH. The 2012 SEC filings describe the major aspects of Energy Future Holding’s tax sharing agreement with Oncor.
Oncor collected more than $230 million from its customers for taxes in 2012, according to PUC regulatory filings. It appears Oncor collected slightly less from its customers in 2011 and 2010. EFH had access to eighty percent of that money — even though EFH did not owe federal income taxes. Since 2008, Oncor collected more than $500 million from its ratepayers for federal income taxes that neither Oncor nor Energy Future Holdings likely will ever pay to the federal government.
Because EFH faces almost certain restructuring or bankruptcy, it appears likely that this money will never make it to the federal treasury. That is, the hundreds of millions of dollars collected annually from Oncor ratepayers for federal income taxes may be lost both to ratepayers and taxpayers. Instead, EFH has been able to access and use this money for debt service to temporarily stave off its creditors.
The Public Utility Commission has the discretion to consider these tax overpayments during utility rate cases, and can take action to mitigate them. In a recent case involving CenterPoint Electric, for instance, the PUC reduced the consumer tax payments imbedded in rates by about $10 million annually.
But in a 2009 Oncor rate case the PUC declined to exercise that discretion. If the PUC had applied what’s known as a “consolidated tax savings adjustment,” the value of the lost phantom taxes paid by Oncor customers would have been reduced by about $100 million per year.
This is not a new issue. A 2006 examination of the phantom tax phenomena by the New York Times found that CenterPoint Energy, the Houston based utility, collected about $150 million in taxes from ratepayers between 2002 and 2004. CenterPoint did not pay federal taxes during those years, but rather received a $350 million tax refund, according to the newspaper.
Although the PUC has not applied an adjustment to mitigate the phantom taxes in the Oncor case, it has done so in other instances. This is because, under a previous prevision of Texas law, the PUC has the discretion to apply a “consolidated tax savings adjustment” when setting utility rates.
However, a new law adopted in 2013 by the Texas Legislature — Senate Bill 1364 — deprived the PUC of this authority. The statutory change was a top priority of the CenterPoint utility, based in Houston.