Effects of Tax Reform on the Renewable Energy Sector
On December 22, 2017, the tax reform bill known as the Tax Cuts and Jobs Act (H.R. 1) (the "Tax Reform Act") was signed into law. Prior to its enactment, the renewable energy industry was deeply concerned about proposals in the House of Representatives (the "House Bill") and the Senate (the "Senate Bill") that, if enacted, would have had significant adverse effects on the utility of both the renewable energy investment tax credit (ITC) and energy production tax credit (PTC).
Most of these unfavorable proposals were withdrawn, and the Tax Reform Act largely preserves the benefits of the ITCs and PTCs. The final version of the Tax Reform Act also partially alleviated the negative effect that the so-called base erosion anti-abuse tax (the BEAT) would have had on the ITC and PTC, but only on a temporary basis, creating significant uncertainty for certain taxpayers considering tax equity investments. This article describes the (i) general business provisions relevant to the renewable energy sector and (ii) renewable energy credit specific provisions.
Business Tax Reform Effects on the Renewable Energy Sector
Corporate Tax Reform
The corporate tax rate was reduced from 35 percent to 21 percent. Unlike many other provisions of the Tax Reform Act, the new corporate tax rate does not expire. However, going forward, net operating losses (NOLs) can only be used to offset 80 percent of taxable income. Furthermore, such NOLs cannot be carried back but can be carried forward indefinitely (the prior law allowed NOLs to be carried back two years or carried forward 20 years). The new rules only apply to NOLs generated in taxable years beginning after December 31, 2017. As a result, NOLs generated before that time can continue to be used to offset 100 percent of taxable income and may be carried back.
The Tax Reform Act also provides that (i) contributions to a corporation in aid of construction or any other contribution as a customer or potential customer and (ii) any contribution by a government entity or civic group (other than contributions made as a shareholder) are taxable income to the corporation. Thus, utilities and other corporations receiving state assistance in the form of contributions must treat such contributions as taxable income.
Deduction for Pass-Through Income
The Tax Reform Act provides a new deduction for individuals, estates and trusts equal to 20 percent of the taxpayer's "qualified business income," which results in an effective top tax rate of 29.6 percent (based on a new maximum individual rate of 37 percent). The deduction does not apply to investment-related income.
For taxpayers with income over a certain threshold, (i) the deduction phases out for income from so-called specified services businesses in which the principal asset is the reputation or skill of the employees or owners, and (ii) is limited to 50 percent of the taxpayer's allocation of the W-2 wages paid by the business, or (iii) the sum of 25 percent of the W-2 wages plus 2.5 percent of the unadjusted basis in certain tangible, depreciable property used in a trade or business for the production of qualified business income. The phase-out begins for taxpayers with taxable income over $315,000 (for married taxpayers filing jointly) or
$157,500 (for individuals) and phases out completely for taxpayers with an additional $100,000 of income (for married taxpayers filing jointly) or $50,000 (for individuals).
Non-corporate taxpayers owning interests in partnerships engaged in operations in the renewable energy sector may be eligible for the 20 percent deduction on allocations of partnership income.
The rules expand and extend bonus depreciation. Under the new rules, "qualified property" acquired and placed in service after September 27, 2017 is eligible for 100 percent depreciation in the year such property is placed in service. The 100 percent bonus depreciation begins to phase down in 2023 for most qualified property (2024 for certain long- production-period property) and phases down 20 percent per year until it is eliminated entirely in 2027 (2028 for certain long-production-period property). In the taxpayer's first taxable year ending after September 27, 2017, the taxpayer can elect to apply a 50 percent bonus depreciation rate instead of 100 percent.
"Qualified property" eligible for 100 percent bonus depreciation includes depreciable property with a recovery period of 20 years or less as well as property with a recovery period of at least 10 years if such property has an estimated production period of at least one year and a cost of at least $1 million. The new rule also expands the definition of "qualified property" to include used property that is newly acquired by the taxpayer. However, it excludes property used primarily in "regulated public utilities businesses." A regulated public utilities business includes trades or businesses that furnish or sell (1) electrical energy, water or sewage disposal services, (2) gas or steam through a local distribution system, or (3) transportation of gas or steam by pipeline, if the rates for the furnishing or sale have been established or approved by the United States or any state government, political subdivision, or any agency or commission thereof.
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