By Mary Burke Baker, Cindy L. O’Malley, Nicholas A. Leibham,Karishma Shah Page, Ryan J. Severson, Andrés Gil, David A. Walker, Published by K&L Gates
In late 2013, the Senate Finance Committee released a tax reform staff discussion draft on energy (the “energy draft”) as part of a series of tax reform proposals. According to Committee staff, the energy draft “proposes a dramatically simpler set of long-term energy tax incentives that are technology-neutral and promote cleaner energy that is made in the United States.”
Although the departure of former Chairman Max Baucus (D-MT) from the U.S. Senate has thrown the fate of energy tax reform into doubt, there is ample reason to believe that his energy draft has gas left in the tank. This alert describes the energy draft and offers insights on the possible next steps for the proposal.
Key Components of the Energy Draft
The energy draft would create two new sets of tax incentives for clean electricity and clean transportation fuels. In order to give the business community and administrative agencies time to plan for and implement these provisions, the energy draft includes a transition period for certain existing tax incentives.
In particular, the draft extends the production tax credit (PTC) and investment tax credit (ITC) for electricity from renewable sources under sections 45 and 48 of the Tax Code, as well as the credit for residential renewable electricity investments under section 25D, through the end of 2016. The energy draft also extends the PTCs for various transportation fuels under sections 40 (second generation biofuels), 40A (biodiesel, renewable diesel), and 6426 (alternative fuels, alternative fuel mixtures) of the Tax Code through the end of 2016.
Tax Incentives for Clean Electricity and Clean Transportation Fuel
Beginning in 2017, when the existing tax incentives expire, the energy draft implements a new system of tax incentives for “clean electricity” and “clean transportation fuels.” This system is designed to be technology-neutral (i.e., not arbitrarily favoring one specific technology over another) and based on the environmental impact of the energy source involved.
The incentives for clean electricity and clean transportation fuels are designed to help the United States reduce by 25% the greenhouse gas emissions (GHGs) associated with our country’s overall electricity generation and transportation fuel supply.
For clean electricity, the energy draft allows a taxpayer to elect either a PTC of up to $0.023/kilowatt hour (adjusted for inflation) for 10 years or an ITC of up to 20% for electricity generation that has GHG emissions at least 25% below the average of the current electricity fleet.
The proposal adjusts the PTC and ITC levels depending on the GHG emissions of the electricity generation. Under this system, electricity generation that is just over 25% below the average of the current electricity fleet would receive minimal credits, but these credits would gradually increase so that electricity generation with zero GHG emissions would be entitled to the full amount of the credits.
The proposal phases out the credits once the GHG emissions of the overall electricity fleet decline by 25% below 2013 levels. Taxpayers who place facilities in service during the first, second, and third years of the phase-out would receive 75%, 50%, 25%, respectively, of the credit to which they would otherwise be entitled, and taxpayers would be eligible for 10 years of tax credits at the applicable level. Taxpayers would be unable to claim the credit for facilities placed in service after the third year of the phase-out.
Additionally, the proposal includes an ITC of 20% for carbon capture and sequestration equipment that: (1) is installed in a facility that was placed in service before 2017; and (2) results in a reduction of carbon dioxide emissions rate of 50% or greater.
Clean Transportation Fuel
Similar to the tax incentives for clean electricity, beginning in 2017 the energy draft allows the taxpayer to elect a PTC of up to $1/gallon for 10 years or an ITC of up to 20% for transportation fuels that have GHG emissions at least 25% below conventional gasoline. The GHG levels of transportation fuels would be measured by the EPA through a life-cycle analysis.
The energy draft adjusts the PTC and ITC levels depending on the GHG emissions and energy content of the taxpayer’s fuel. Under this system, fuels with lower GHG emissions and/or higher energy content would be entitled to larger tax credits.
Additionally, the proposal phases out the credits once the GHG emissions of the overall transportation fuel supply decline by 25% below 2013 levels. Taxpayers who place facilities in service during the first, second, and third years of the phase-out would receive 75%, 50%, 25%, respectively, of the credit to which they would otherwise be entitled, and taxpayers would be eligible for 10 years of tax credits at the applicable level. Taxpayers would be unable to claim the credit for facilities placed in service after the third year of the phase-out.
Repeal Efficiency Credits and Other Provisions
In addition to the new system of tax incentives for clean electricity and clean transportation fuels, the energy draft would repeal, or allow to expire, the following 11 existing energy tax provisions:
- Section 25C credit for residential energy efficiency
- Section 30B credits for fuel cell motor vehicles
- Section 30D credits for electric plug-in vehicles
- Section 43 credit for enhanced oil recovery costs
- Section 45I marginal well production credit
- Section 45N mine rescue training credit
- Section 45Q carbon dioxide sequestration credit
- Section 45L credit for construction of energy-efficient new homes
- Section 45M credit for energy efficient appliances
- Section 48C credit for investment in advanced energy property
- Treatment of gain resulting from Federal Energy Regulatory Commission restructuring
The impact of comprehensive tax reform on the energy sector could be even more significant when viewed in light of the Senate Finance Committee’s other tax reform staff discussion drafts. In particular, the Committee’s staff discussion draft on cost recovery and accounting proposed to repeal 11 current energy-related incentives that the staff determined “are not targeted on domestic production of electricity or fuels,” including percentage depletion and the deduction for intangible drilling costs. Further, the cost recovery and accounting draft would repeal provisions that apply to renewable energy, such as accelerated depreciation for second generation biofuel plant property.
How Much Gas is Left in the Tank?
With Chairman Baucus’ departure from the Senate, it is natural to wonder whether the energy draft will remain relevant as the debate over comprehensive tax reform continues. However, the energy draft is likely to stay significant for a few reasons.
- Wyden and energy policy. First, new Senate Finance Committee Chairman Ron Wyden (D-OR) has a keen interest in energy policy, as reflected by his tenure as Chairman of the Committee on Energy and Natural Resources. In addition, Senator Wyden’s office reportedly had a hand in drafting the proposal with Chairman Baucus’ Finance Committee staff, and Senator Wyden also praised the energy draft after its release.
- “Big ideas” in energy tax reform. Second, the energy draft embodies certain bipartisan principles that are seen as being on the cutting edge of energy tax policy. Members of Congress—including Chairman Wyden— have called for a “technology-neutral” system of energy tax incentives, but the energy draft is one of the first legislative proposals to actually flesh out this idea in great detail. Although some sectors of the energy industry have expressed dissatisfaction over aspects of the proposal (e.g., the elimination of all credits for energy efficiency), the fact that comprehensive tax reform is not imminent means that the Committee will have time to fine-tune the energy draft under Chairman Wyden rather than abandon it completely.
- Appetite for a new regime. Third, dissatisfaction and uncertainty in the business community relating to the tax extenders process will likely help build momentum for a long-term system of energy tax incentives like the one proposed in the energy draft.
Taken together, these factors mean that the energy draft is likely to remain a prominent part of the energy tax debate under Chairman Wyden. Stakeholders should not miss the opportunity to weigh in with the Committee on this legislation, which could dramatically alter the tax treatment of the energy sector.