I.      Introduction

On Monday, the Treasury Department released the Obama Administration’s Fiscal Year 2012 Revenue Proposals (the “Greenbook”), which includes several significant energy-related tax proposals.1 The proposals are all substantially similar to the energy-related tax proposals in last year’s Greenbook, except for a new proposal to provide a tax credit in lieu of a deduction for energy-efficient commercial buildings, which is discussed below in Part III.

In short, the Greenbook’s proposals would, if enacted:

  • Repeal a number of energy-related tax preferences, including tax credits and accelerated deductions.  
  • More than triple the aggregate amount of “qualifying advanced energy project” tax credits (from $2.3 billion to $7.3 billion) that the IRS may award for property used to re-equip, expand, or establish certain manufacturing facilities for the production of renewable and advanced energy property. Taxpayers would be able to apply for tax credits up to 30% of their basis in qualifying property during the two-year period following enactment.  
  • Provide a tax credit in lieu of the deduction that is currently available for certain costs relating to the retrofitting of commercial buildings to increase their energy efficiency.
  • Extend the availability of the cash grant in lieu of an investment tax credit with respect to certain renewable energy projects whose construction begins in 2012.2  
  • Reinstate the pre-1996 “Superfund” excise tax on crude oil, certain other petroleum products, and certain hazardous chemicals.  

The balance of this memorandum discusses the Greenbook’s key energy proposals.  

II. Eliminate Fossil Fuel Tax Preferences

The Greenbook reproposes last year’s proposal to eliminate several tax preferences relating to oil, gas, and coal. The following is a summary of the significant fossil fuel preferences that the Greenbook proposes to eliminate.

  • Repeal the enhanced oil recovery credit. The Greenbook proposes to repeal the 15% tax credit for certain costs attributable to a “qualified enhanced oil recovery project.”3 (This credit has never been effective because its availability is based on energy prices and energy prices have exceeded the applicable threshold for the years in which the credit has been in place.)  
  • Repeal the credit for oil and gas produced from marginal wells. The Greenbook proposes to repeal the existing tax credit equal to $3.00 per barrel of domestic crude oil or $0.50 per 1,000 cubic feet of natural gas produced from qualifying domestic wells.4 (This credit has never been effective because its availability is based on energy prices and energy prices have exceeded the applicable threshold for the years in which the credit has been in place.)  
  • Repeal the current deduction for intangible drilling costs. The Greenbook would generally deny holders of working interests in domestic oil or gas properties current deductions for wages, the cost of fuel, repairs, hauling, supplies that do not have a salvage value, and certain other costs that are incident to and necessary for the preparation or drilling of wells. Current law generally permits these holders to either deduct these costs in the first year in which they are incurred, or amortize them over five years.5 The proposal would require any of these costs paid or incurred after 2011 to be capitalized.
  • Repeal the current deduction for the costs of tertiary injectants. The Greenbook proposes to repeal the currently available deduction for the costs of certain tertiary injectants that are used as part of a tertiary recovery method to increase the recovery of crude oil.6 The proposal would require any of these costs paid or incurred after 2011 to be capitalized.  
  • Repeal the current deduction for exploration and development costs. The Greenbook proposes to repeal the currently available deduction for the costs of ascertaining the existence, location, extent, or quality of a domestic ore or other mineral deposit (including coal or other hard mineral fossil fuel deposits), and of developing mines to exploit these deposits.7 The proposal would require any of these costs paid or incurred after 2011 to be capitalized.  
  • Repeal the percentage depletion method for oil and gas wells and hardmineral fossil fuel mines. The Greenbook proposes to disallow the percentage depletion method with respect to oil and natural gas wells and hard-mineral fossil fuel deposits (e.g., coal and certain lignite and oil shale mines), and would require taxpayers to use the cost depletion method with respect to these properties.8 (Under current law, taxpayers may choose between the two methods.9) The proposal would be effective for taxable years beginning after 2011.  
  • Require seven-year amortization for geological and geophysical expenditures of independent producers. The Greenbook proposes to require seven-year amortization of all geological and geophysical expenditures paid or incurred in connection with the domestic exploration for, or development of, oil or gas. Current law generally requires seven-year amortization only for “major integrated oil companies,” and permits two-year amortization for other producers.10 The proposal would be effective for geological and geophysical expenditures paid or incurred after 2011.
  • Repeal the domestic manufacturing deduction for oil and gas companies. The Greenbook proposes to repeal the domestic production activities deduction for producers, refiners, processors, transporters and distributors of oil, natural gas, hard-mineral fossil fuels (e.g., coal and certain lignite and oil shale), and “primary products” of these fuels. Very generally, current law permits a deduction of 9% (or 6% for oil and gas activities) of the lesser of (i) gross receipts derived from the disposition of these fossil fuels, reduced by the cost of goods sold and other expenses allocable to the receipts and (ii) taxable income, but not in excess of 50% of W-2 wages paid.11 The proposal would be effective for taxable years beginning after 2011.  
  • Subject working interests in oil and gas properties to the passive activity loss rules. The Greenbook proposes to repeal the exception to the “passive activity loss rules” that currently applies to any working or operating mineral interest in an oil or natural gas property that a taxpayer holds either directly or through an entity that does not limit the taxpayer’s liability.12 Under the proposal, the passive activity loss rules would apply to prevent passive holders of oil or gas properties from using losses generated by these properties to offset gains from non-passive activities until the holders dispose of their interests in the oil or gas properties. The proposal would be effective for taxable years beginning after 2011.  
  • Tax coal and lignite royalties as ordinary income. The Greenbook proposes to tax any gain or loss from the sale of coal (including lignite) as ordinary income or loss. Under current law, this gain or loss is generally treated as long-term capital gain or loss to a domestic coal mine lessor that is a passive recipient of royalties under the lease and owns the coal for more than one year before the coal is mined.13 The proposal would be effective for royalties realized in taxable years beginning after 2011.

III. Expand the Qualifying Advanced Energy Projects Credit Program

The Greenbook reproposes last year’s proposal to expand the “qualifying advanced energy project credit program” by increasing the aggregate amount of tax credits that the IRS can award from $2.3 billion to $7.3 billion.14 Under this program, the IRS may award credits equal to 30% of a taxpayer’s basis in certain property that is used in a project that re-equips, expands, or establishes a qualifying manufacturing facility for the production of certain renewable and advanced energy property.15

Under the proposal, applications for credits could be made during the two-year period following enactment. In addition, the proposal would modify the existing rules to permit taxpayers to apply for credits with respect to only a portion of the applicable property’s cost (rather than the property’s entire cost), and the IRS could take into account the fact that a taxpayer is requesting only a partial credit in determining whether to allocate credits to the project.

IV. Credit in Lieu of Deduction for Energy-Efficient Commercial Buildings

The Greenbook proposes to provide taxpayers with a tax credit in lieu of a deduction for certain costs associated with retrofitting commercial buildings to increase their energy efficiency.

Under current law, a taxpayer is generally entitled to expense the cost of any depreciable property installed before 2014 as part of a building’s heating, cooling, ventilation, hot water or interior lighting system, or the building envelope, if the installation is made pursuant to a plan to increase the building’s energy efficiency by 50% in accordance with IRS guidance.16 The deduction is subject to a cap of $1.80 per square foot of the building. In addition, a current deduction of up to $0.60 per square foot is permitted for the cost of certain property that does not increase a building’s overall energy efficiency by 50% but satisfies energy savings targets established by the IRS in published guidance.17

The Greenbook proposes to replace the current deductions with a tax credit of up to $1.80 per square foot for the cost of property that increases a building’s energy efficiency by at least 50%, $0.90 per square foot for property that increases a building’s energy efficiency by at least 30%, and $0.60 per square foot for property that increases a building’s energy efficiency by at least 20%, and would also treat certain property as satisfying the 50%, 30%, or 20% energy savings requirements if the property satisfies certain standards based on building types and climate zones.18 In addition, the proposal would provide special rules for REITs and their shareholders.

V. Extend the Section 1603 Renewable Energy Grant Program

The Greenbook proposes to extend through the end of 2012 the cash grant that is available in lieu of an investment tax credit with respect to the construction of certain renewable energy projects. The cash grant program was introduced under section 1603 of the American Recovery and Reinvestment Act of 2009 and, if not extended, will expire at the end of 2011.19

VI. Reinstate Superfund Taxes

The Greenbook proposes to reinstate pre-1996 “Superfund” excise taxes. In general, the excise taxes would consist of (i) a $0.097-per-barrel excise tax imposed on crude oil received by certain domestic exporters or refiners, and on certain imported petroleum products,20 and (ii) a $0.22- to $4.87-per-ton excise tax on certain hazardous chemicals sold or used by manufacturers, producers, or importers, and on imported substances whose manufacture or production involved the use of these chemicals.21 The proposal would be effective for taxable years beginning after 2011 and before 2022.