On March 4, 2014, President Obama released his budget proposal for the 2015 fiscal year (Budget Proposal), which contains energy-related tax provisions that include a permanent extension of the production tax credit (PTC) and a provision making it refundable. Making the PTC refundable signals strong support for renewable energy. The Budget Proposal also affects several energy-related tax provisions, many of which were also proposed in the 2014 revenue proposal.
On February 26, 2014, House Ways and Means Committee Chairman Dave Camp (R-Mich.) released a discussion draft of the Tax Reform Act of 2014 (Camp Proposal) that also contains various energy-related tax provisions, including a phase-out and repeal of the PTC and a repeal of many other energy-related credits.
On December 18, 2013, former Senate Finance Committee Chairman Max Baucus (D-Mont.) released a discussion draft proposal that would streamline energy tax incentives to make them more predictable and technology-neutral (Baucus Energy Proposal). The Baucus Energy Proposal would consolidate various tax incentives for clean electricity into a PTC or an investment tax credit (ITC) for all types of power generation facilities. Click here for a discussion of the Baucus Energy Proposal. On November 21, 2013, former Chairman Baucus also released a discussion draft proposal related to cost recovery and tax accounting rules (Baucus Cost Recovery Proposal) that would modify and permanently extend expensing under section 179 of the Internal Revenue Code of 1986, as amended (Code), as well as other energy- related provisions. The Baucus Energy Proposal and the Baucus Cost Recovery Proposal are collectively referred to herein as the Baucus Proposal.
This Special Report offers a summary of the key energy- related tax provisions contained in the Budget Proposal, Camp Proposal and Baucus Proposal. The Budget Proposal provisions are explained further in the U.S. Department of Treasury’s general explanation of the Budget Proposal (Green Book), and the Camp Proposal provisions are explained further in the Joint Committee on Taxation’s Technical Explanation of the Camp Proposal (JCT Explanation) and the House Ways and Means Committee Tax Reform Act of 2014
Discussion Draft Section-by-Section Summary (W&M Section Summary).
There are some similarities but many differences between the three proposals. A comparison of the proposals’ key energy- related tax provisions follows. In addition, a chart comparing other energy-related provisions across the three proposals is provided at the end of this article.
Production Tax Credit
The PTC under section 45 of the Code expired for qualifying renewable energy facilities on December 31, 2013. Qualifying facilities include wind, closed-loop biomass, open-loop biomass, geothermal energy, landfill gas, municipal solid waste, hydroelectric, and marine and hydrokinetic facilities. To qualify for the PTC, construction of these qualified facilities must have begun before January 1, 2014.
The PTC is a credit per kilowatt-hour of electricity produced from qualified energy facilities. The base amount of the PTC is 1.5 cents per kilowatt-hour of electricity produced, which amount is indexed annually for inflation. For 2013, the amount of the credit was 2.3 cents per kilowatt-hour for wind, closed-loop biomass, geothermal energy and solar energy, and 1.1 cent per kilowatt-hour for open-loop biomass, small irrigation power, municipal solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy.
According to the Green Book, the Budget Proposal would extend the current PTC regime for one year for facilities on which construction begins before the end of 2014. For facilities on which construction begins after December 31, 2014, the Budget Proposal would permanently extend the PTC and make it refundable. By making the PTC refundable, taxpayers without a tax liability to offset with a tax credit, as is the case for some renewable energy developers and others, will be incentivized to produce renewable energy. Making the extension permanent is intended to provide certainty for business planning. In addition, the PTC would be extended to electricity produced from solar facilities, which was previously only eligible for the ITC, as discussed below.
In contrast to the Budget Proposal, the Camp Proposal would eliminate the inflation adjustments for the PTC for electricity produced and sold after December 31, 2014, and would repeal the PTC in its entirety for electricity produced and sold after December 31, 2024. Thus, for renewable electricity sold after December 31, 2014, the PTC would be 1.5 cents per kilowatt-hour, and the half-credit rate would be 0.75 cents per kilowatt-hour, for the remaining portion of the 10-year PTC period. The Camp Proposal also would clarify in the Code that for purposes of determining whether construction on a qualified facility is treated as beginning before January 1, 2014, there must be a continuous program of construction that begins before such date and ends on the date the facility is placed in service. This clarification would apply for taxable years beginning on or after the date of enactment of the proposal. This clarification in the proposal mirrors current law regarding when construction begins for purposes of the PTC and the ITC under Notice 2013-29, 2013-20 I.R.B. 1085, issued by the Internal Revenue Service (IRS) on April 15, 2013. Click here for a discussion of the Notice. The IRS issued additional guidance on when construction begins for purposes of the PTC and the ITC on September 20, 2013, in Notice 2013-60, 2013-44 I.R.B. 431. Click here for a discussion of this additional guidance.
The Baucus Proposal would consolidate various tax incentives for clean electricity into a new PTC and ITC regime. The Baucus Proposal would extend these new PTC and ITC regimes to facilities placed in service through December 31, 2016, and the PTC regime would provide for a rate that decreases in inverse proportion to the greenhouse gas emissions of a technology. Click here for a discussion of this proposal.
Changes to the Investment Tax Credits
The ITC for qualified energy property is a permanent, non- refundable, 10 percent credit allowed for property that does one of the following:
Uses solar energy to generate electricity, to heat or cool a structure, or to provide solar process heat
Is used to produce, distribute or use energy derived from a geothermal deposit
The credit for solar energy property was temporarily increased to 30 percent for solar and fuel cell facilities placed in service prior to January 1, 2017.
In addition, energy ITCs are available for qualifying geothermal heat pump property, small wind property, combined heat and power property, and microturbines placed in service prior to January 1, 2017.
The 10 percent investment credit for solar and geothermal property would be repealed for property placed in service after December 31, 2016. The temporary 30 percent credit for solar investments and the temporary credits for qualifying geothermal heat pump property, small wind property, combined heat and power property fuel cells, and microturbines would be allowed to expire.
The Camp Proposal also would repeal the ITC, effective for property placed in service after 2016.
As described above, the Baucus Proposal would consolidate various tax incentives for clean electricity into a new PTC and ITC regime. The Baucus Proposal would extend the ITC to facilities placed in service through December 31, 2016, and would impose a maximum ITC amount of 20 percent. Click here for a discussion of this proposal.
Enhancement of the Research and Experimentation Tax Credit
The research and experimentation (R&E) credit pursuant to section 41 of the Code expired on December 31, 2013. The credit equaled 20 percent of eligible costs for qualified research expenses above a base amount. The base amount was generally computed by looking at the ratio of the taxpayer’s research expenses to its gross receipts for past
periods. The base amount could not be less than 50 percent of the taxpayer’s qualified research expenses for the taxable year. Taxpayers also could elect the alternative simplified research credit (ASC), which equaled 14 percent of qualified research expenses that exceeded 50 percent of the average qualified research expenses for the three preceding taxable years. An election to use the ASC applied to all succeeding taxable years unless revoked with the consent of the Secretary.
As explained in the Green Book, the Budget Proposal would make the R&E credit permanent for expenditures paid or incurred after December 31, 2013, and would increase the rate of the ASC from 14 percent to 17 percent, effective after December 31, 2014. Raising the ASC rate provides an improved incentive to increase research and makes the ASC a more attractive option.
Similarly, the Camp Proposal would make the R&E credit permanent for expenditures paid or incurred after December 31, 2013, and would increase the rate of the ASC to 15 percent. However, under the Camp Proposal, the ASC rate would be reduced to 10 percent if a taxpayer had no qualified research expenses in any one of the three preceding taxable years. The Camp Proposal also would repeal the traditional 20 percent research credit calculation method.
The Baucus Proposal has no provision relating to the R&E credit.
Tax Credits for Investment in Qualified Property Used in a Qualifying Advanced Energy Manufacturing Project
Section 48C of the Code provides for a 30 percent tax credit for investments in eligible property used in a “qualifying advanced energy project.” However, the credit is currently unavailable, because total credits were capped at $2.3 billion under the American Recovery and Reinvestment Act of 2009. All credits were allocated in the 2009–2010 allocation round
and the reallocation of credits from projects that failed to meet certain certification requirements occurred in 2013.
A qualifying advanced energy project is a project that re- equips, expands or establishes a manufacturing facility for the production of the following:
Property designed to produce energy from renewable resources
Fuel cells, microturbines or an energy storage system for use with electric or hybrid-electric vehicles
Electric grids to support the transmission, including storage, of intermittent sources of renewable energy
Property designed to capture and sequester carbon dioxide emissions
Property designed to refine or blend renewable fuels or to produce energy conservation technologies
Electric drive motor vehicles that qualify for tax credits, or components designed for use with such vehicles
Other advanced energy property designed to reduce greenhouse gas emissions
The Budget Proposal would authorize an additional $2.5 billion of credits for investments in eligible property used in a qualifying advanced energy manufacturing project. Taxpayers would be able to apply for a credit with respect to part or all of their qualified investment. If a taxpayer applied for a credit with respect to only part of the qualified investment in the project, the taxpayer’s increased cost sharing and the project’s reduced revenue cost to the government would be taken into account in determining whether to allocate credits to the project.
Applications for the additional credits would be made during the two-year period beginning on the date on which the additional authorization is enacted. Applicants allocated additional credits must demonstrate that the requirements of the certification have been met within one year of the date of acceptance of the application and must place the property in service within three years from the date that the certification is
issued. This change would be effective as of the date of enactment.
In contrast to the Budget Proposal, the Camp Proposal would repeal the tax credit for property used in a qualified advanced energy manufacturing project. The repeal would be effective for allocations and reallocations occurring after December 31, 2014.
Like the Camp Proposal, the Baucus Proposal also would repeal the credit. However, the credit would be terminated for periods after December 31, 2016.
Modifications to the New Markets Tax Credit
The new markets tax credit (NMTC) program was a 39 percent credit for qualified equity investments made to acquire stock in a corporation, or capital interest in a partnership, that is a qualified community development entity. Such acquired stock or partnership interest must be held for a period of seven years. The program was conducted pursuant to section 45D of the Code. The credit could be taken over seven years and generally equaled 5 percent of the amount of the taxpayer’s qualified investment for the first three years, and 6 percent of such investment for the last four years. The NMTC expired on December 31, 2013.
The Budget Proposal would extend the NMTC permanently, with an allocation amount of $5 billion for each round. The Budget Proposal also would permit NMTC amounts resulting from qualified investments made after December 31, 2013, to offset a taxpayer’s alternative minimum tax liability. This proposal would be effective upon enactment.
CAMP AND BAUCUS PROPOSALS
Neither the Camp Proposal nor the Baucus Proposal has a provision making any changes to the NMTC.
New Manufacturing Communities Tax Credit
As described in the Green Book, there is currently no tax incentive directly targeted to investments in communities that have suffered or expect to suffer an economic disruption as a result of a major job loss event, but which do not necessarily qualify as low-income communities. The Budget Proposal includes a new allocated tax credit to support investments in communities that have suffered a major job loss event. For this purpose, a major job loss event occurs when a military base closes or a major employer closes or substantially reduces a facility or operating unit, resulting in a long-term mass layoff. Applicants for the credit would be required to consult with relevant state or local economic development agencies (or similar entities) in selecting those investments that qualify for the credit. This credit could be structured similarly to the NMTC or as an allocated investment credit similar to the qualifying advanced energy project credit. This proposal would provide about $2 billion in credits for qualified investments approved in each of three years, 2015 through 2017.
CAMP AND BAUCUS PROPOSALS
Neither the Camp Proposal nor the Baucus Proposal has a provision for a new manufacturing communities tax credit.
Permanent Extension of Section 179 Expensing
Section 179 of the Code provides that taxpayers may elect to deduct a limited amount of the cost of qualifying depreciable property placed in service during the taxable year, rather than capitalizing and depreciating it. The deduction limit is reduced by the amount by which the cost of qualifying property placed in service during the year exceeds a threshold amount. The amount allowed as a deduction under section 179 cannot exceed the taxable income of the taxpayer that is derived from the active conduct of a trade or business.
Qualifying property generally is depreciable tangible property that is purchased for use in the active conduct of a trade or
business. The definition of qualifying property currently includes real property and temporarily includes off-the-shelf computer software.
Beginning in 2007, the maximum deduction amount was
$125,000, but this deduction amount was reduced by the amount that a taxpayer’s investment exceeded $500,000. For 2008 and 2009, these thresholds were changed to $250,000 and $800,000, respectively, and for 2010 and 2011, these thresholds were $500,000 and $2 million, respectively. The American Taxpayer Relief Act of 2012 extended the threshold amounts for 2011 through 2013. However, for qualifying property placed in service after 2013, the thresholds reverted to pre-2003 limits, i.e., $25,000 and $200,000, respectively, with no indexing for inflation.
The Budget Proposal would permanently extend the section 179 expensing and investment threshold limits for 2013—i.e., a maximum deduction of $500,000, with an investment threshold limit of $2 million. These thresholds would be indexed for inflation for all taxable years beginning after 2013. The definition of qualifying property would permanently include off-the-shelf computer software but would not include real property. This proposal would be effective for qualifying property placed in service in taxable years beginning after December 31, 2013.
Like the Budget Proposal, the Camp Proposal also would permanently extend section 179 expensing and would permanently include off-the-shelf computer software as qualifying property. However, the Camp Proposal would set the threshold limits at the 2008 and 2009 levels—i.e., a maximum deduction of $250,000, with a threshold limit of
$800,000. These thresholds would be effective for taxable years beginning after 2013 and would be indexed for inflation for taxable years beginning after 2014. In addition, unlike the Budget Proposal, the Camp Proposal also would permanently treat qualified real property as eligible section 179 property, and would allow investments in air conditioning and heating units to qualify for section 179 expensing. These proposals would be effective for taxable years beginning after 2013.
The Baucus Proposal would extend for one year the current treatment of Code section 179 expensing. For taxable years beginning after December 31, 2014, Code section 179 expensing under the Baucus Proposal would be permanently extended with a maximum expense amount of $1 million. This
$1 million maximum would be reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in the taxable year exceeds $2 million. These threshold amounts would be indexed for inflation beginning after December 31, 2015. The Baucus Proposal also would broaden the scope of Code section 179 expensing to include not just Code section 179 expenditures, but also the cost of Code section 179 property. The proposal also would expand the definition of qualifying property to include Code section 50(b) property (property used outside the United States, property used for lodging, property used by certain tax-exempt organizations, and property used by governmental units or foreign persons or entities) and air conditioning and heating units.
Changes to the Deduction for Domestic Production Activities
Section 199 of the Code currently provides a deduction from taxable income attributable to domestic production activities (manufacturing deduction). For taxable years beginning after 2009, this deduction is generally equal to 9 percent of the lesser of the taxpayer’s qualified production activities income or taxable income for the taxable year. In the case of oil- related qualified production activities income, the deduction is equal to 6 percent. The amount of the manufacturing deduction for any taxable year is limited to 50 percent of the taxpayer’s W-2 wages for the taxable year that are properly allocable to qualifying domestic production gross receipts.
The Budget Proposal would retain the overall section 199 manufacturing deduction, but would exclude from the definition of domestic production gross receipts all gross receipts derived from the sale, exchange or other disposition of oil, natural gas, and coal and other hard-mineral fossil fuels for taxable years beginning after December 31, 2014.
In contrast, the Camp Proposal would repeal the section 199 manufacturing deduction for taxable years beginning after December 31, 2016. Under this proposal, the repeal would be phased in, with the manufacturing deduction reduced to 6 percent for taxable years beginning after December 31, 2014, and a further reduction to 3 percent for taxable years beginning after December 31, 2015. Furthermore, during the phase-in years, the limitation with respect to oil-related qualified production activities income would be the same as the general rule.
The Baucus Proposal has no provision relating to the section 199 manufacturing deduction.
Requirement for Derivative Contracts to Be Marked to Market with Resulting Gain or Loss Treated as Ordinary Gain
Currently, many derivative contracts are not subject to the marked to market rules.
The Budget Proposal would require that derivative contracts be “marked to market”—i.e., that gain or loss from a derivative contract be reported on an annual basis as if the contract were sold for its fair market value—no later than the last business day of the taxpayer’s taxable year. Gain or loss from such contract would be treated as ordinary and attributable to the taxpayer’s trade or business. The source of income associated with the derivative contract would continue to be determined under current law. However, transactions that qualify as business hedging transactions would not be required to be marked to market.
The Budget Proposal would broadly define a derivative contract to include any contract, the value of which is determined, directly or indirectly, in whole or in part, by the value of actively traded property, and any contract with respect to a contract previously described. Thus, the Green Book notes that marked to market treatment would apply to contingent debt and structured notes linked to actively traded
property. The Budget Proposal also would eliminate or amend Code sections 475, 1256 (regarding marked to market treatment as 60 percent long-term capital gain or loss and 40 percent short-term capital gain or loss) and 1092 (tax straddles), and would significantly curtail the application of Code sections 1233 (short sales), 1234 (gain or loss from an option), 1234A (gain or loss from certain terminations), 1258 (conversion transactions), 1259 (constructive sales transactions) and 1260 (constructive ownership transactions).
The Budget Proposal would apply to derivative contracts entered into after December 31, 2014.
Like the Budget Proposal, the Camp Proposal would require that derivative contracts be “marked to market” on the last business day of the taxpayer’s taxable year, and that such gain or loss would be treated as ordinary income or loss attributable to the taxpayer’s trade or business. Similarly, transactions qualifying as hedging transactions for tax purposes would not be required to be marked to market. In addition, the Camp Proposal would not require that stocks or bonds be marked to market.
The Camp Proposal also would broadly define a derivative contract as including any contract the value of which, or any payment or other transfer with respect to which, is directly or indirectly determined by reference to one or more of the following:
Stock in a corporation
Any partnership or beneficial ownership interest in a partnership or trust
Any note, bond, debenture or other evidence of indebtedness
Any real property (other than any excluded real property)
Any actively traded commodity within the meaning of section 1092(d)(1)
Any rate, price, amount, index, formula or algorithm
Any other item prescribed by the Secretary
The JCT Explanation notes that a derivative also would include an embedded derivative component such that if a contract has derivative and non-derivative components, each derivative component would be treated as a separate derivative.
However, the Camp Proposal provides a number of exclusions. For example, derivatives with respect to a tract of real property within the meaning of Code section 1237(c), or real property that would be inventory if held directly by the taxpayer, would be excluded from the proposal’s timing and character rules. In addition, the Camp Proposal would exclude from the definition of a derivative (i) financing transactions, such as securities lending, sale-repurchase and similar financing transactions; (ii) a Code section 83(e)(3) option received in connection with the performance of services; and (iii) an insurance, annuity or endowment contract issued by an insurance company.
The W&M Section Summary states that the changes in the Camp Proposal would update antiquated tax rules to create a more uniform and transparent tax treatment of financial products. To implement these changes, the Camp Proposal would repeal Code sections 1233, 1234, 1234A, 1234B (gains or sales from securities futures contracts), 1236 (dealers in securities), 1256, 1258, 1259 and 1260.
The Camp Proposal would be effective for taxable years ending after December 31, 2014, with respect to property acquired and positions established after December 31, 2014. With respect to any other property or position, the proposal would be effective for taxable years ending after December 31, 2019.
The Baucus Proposal has no provision relating to derivative contracts.
Cellulosic Biofuels Tax Credit
Section 40 of the Code contains four income tax credits relating to alcohol (including ethanol) and cellulosic biofuels used as fuel. These credits are the alcohol mixture credit, the alcohol credit, the eligible small producer credit and the
cellulosic biofuels producer credit. Other than the cellulosic biofuels producer credit, the credits expired on December 31, 2011. The cellulosic biofuels producer credit expired on December 31, 2013.
The cellulosic biofuels producer credit was a non-refundable credit equal to $1.01 for each gallon of qualified cellulosic biofuel produced in a taxable year.
The Green Book explains that retroactively extending this credit would support the reduction of petroleum consumption and greenhouse gas emissions. The Green Book also noted that the credit could be phased out in the future if cellulosic biofuel becomes cost-competitive. This proposal would retroactively extend the cellulosic biofuels credit for blending cellulosic fuel at $1.01 per gallon through December 31, 2020, with a 20.2-cent reduction per gallon each subsequent year, so that the credit would expire after December 31, 2024.
In contrast, the Camp Proposal would repeal all of section 40 of the Code. The repeal would be effective for fuels sold or used after 2013.
The Baucus Proposal would extend the current credits related to biofuels through December 31, 2016. However, the Baucus Proposal also would create a PTC for clean biofuels, or a producer could elect to take an ITC for clean biofuels. The PTC for clean biofuels would be the PTC rate multiplied by the total gallons of transportation fuels produced by the taxpayer at a qualified facility and sold or used by the taxpayer (i) to produce a transportation fuel mixture, (ii) as transportation fuel in a trade or business, or (iii) for sale at retail to another person. This proposed PTC for clean biofuels is dependent on the British thermal unit (BTU) content of the fuel as compared to gasoline, and the emissions factor as compared to conventional ethanol. The ITC for clean biofuels would be equal to the product of 20 percent, the BTU factor for the transportation fuel produced, and the emissions factor for such fuel. The proposed clean fuel PTC would be effective for fuel sold or used after December 31, 2016, while the proposed
clean fuel ITC would be effective for facilities placed in service after December 31, 2016.
Reduction of Excise Tax on Liquefied Natural Gas
An excise tax of 24.3 cents per gallon is imposed on liquefied natural gas (LNG) used as highway motor fuels to fund the Highway Trust Fund. An additional 0.1-cent-per-gallon tax is imposed to fund the Leaking Underground Storage Tank Trust Fund. These taxes are set to expire after September 30, 2016.
Because vehicles fueled with LNG emit significantly lower levels of carbon dioxide, nitrogen oxide and sulfur dioxide compared to diesel-fueled vehicles, using LNG would help to reduce petroleum consumption, according to the Green Book, and reducing the excise tax on LNG so that it is at parity with diesel fuel would promote the use of natural gas vehicles. The Budget Proposal would lower the 24.3-cents-per-gallon excise tax on LNG to 14.1 cents per gallon beginning after December 31, 2014.
CAMP AND BAUCUS PROPOSALS
Neither the Camp Proposal nor the Baucus Proposal has a provision making any changes to the LNG excise tax.
Other Changes in the Proposals
The three proposals also provide for additional changes to other energy-related tax provisions in the Code. The table below illustrates the similarities and differences between the Budget Proposal, the Camp Proposal and the Baucus Proposal on these remaining issues