Legislation is currently pending before the House Ways and Means Committee which would provide a partial fix to a technical tax flaw that is limiting investment in the renewable energy sector, notwithstanding provisions enacted as part of the American Recovery and Reinvestment Act of 2009 (the "Recovery Act") to encourage such investment. This flaw, as well as a possible solution, was identified in a prior Reed Smith Alert ("Technical Tax Flaw May Be Preventing the Recovery Act From Accomplishing Its Objective in the Marketplace") distributed May 13, 2009 (the "Prior Alert").

Background

In order for a renewable energy project to be economically viable, investors have to be able to take advantage of certain tax incentives—viz., depreciation and tax credits. In general, depending upon the type of renewable energy involved, the current value of these tax incentives can be as high as 60 percent of the initial cost of the project. Approximately one-half of the value of such tax incentives is attributable to tax credits, and the other half is attributable to depreciation.

The problem is that in order to benefit from these tax incentives, an investor has to have taxable income. Unfortunately, many of the banks, insurance companies and other large financial institutions that have previously financed renewable energy projects now have substantial losses. Consequently, these entities are not able to utilize the tax benefits that are needed in order for a renewable energy project to be economically viable, and many of them have left the market.

The Recovery Act attempted to solve this problem by, among other things, permitting taxpayers to receive cash in lieu of tax credits for qualifying property placed in service during 2009 or 2010 (and for certain projects placed in service thereafter if construction begins in 2009 or 2010). However, the Recovery Act did not give investors the ability to convert depreciation into cash. Because depreciation represents approximately one-half of the available tax incentives (by value), and because investors have to be able to use the depreciation in order for their investment in a renewable energy project to be economically viable, the market, in large part, remains frozen.

As described in the Prior Alert, the best solution to this problem is to expand the investor pool beyond the banks, insurance companies and other financial institutions that have previously participated as investors in renewable energy projects. This would require amending the Internal Revenue Code to provide an exemption for renewable energy projects from the passive loss rules contained in Section 469. Under the passive loss rules, individuals and certain other types of taxpayers are not able to utilize losses and tax credits from so-called passive activities to offset income attributable to wages, income from portfolio investments or income from active businesses.1 Because most individual investors in renewable energy projects would be passive investors subject to the passive activity rules, they would not be able to utilize the tax losses and credits from renewable energy projects to offset their active business or portfolio income. The only reason that banks, insurance companies and other financial institutions have invested in renewable energy projects in the past is that these taxpayers are already exempt from the passive loss rules.

Proposed Legislation

H.R. 3135, introduced by Rep. Timothy J. Walz (D-Minn.), would provide a partial solution to the problem by providing an exemption from the passive loss rules to individuals with losses and credits attributable to investments in qualified wind facilities. Such an exemption would permit wealthy individuals to pool their resources through partnerships and other investment vehicles to provide financing in an economically viable manner, and thereby provide the capital required to expand the wind energy market. However, in order to attract capital investment in other types of renewable energy, Congress needs to expand the proposed legislation to include an exemption from the passive loss rules for investments in other types of renewable energy facilities.2

H.R. 3136 (also introduced by Rep. Timothy J. Walz), which is being considered by both the House Ways and Means Committee and the Energy and Commerce Committee, would extend the grant period for the cash in lieu of tax credits program pursuant to Section 1603 of the Recovery Act to include qualifying property placed in service before January 1, 2013. As noted above, the cash grant program enacted pursuant to the Recovery Act currently is only available to qualifying property placed in service during 2009 or 2010 (and for certain projects placed in service thereafter if construction begins in 2009 or 2010).

It is unclear whether H.R. 3135 or H.R. 3136 will be enacted into law.