The Latest on Federal Tax Policy
December 5, 2017 | Lynn Abramson, President, Clean Energy Business Network
This blog post compared major provisions in the original House and Senate proposals for the Tax Cuts and Jobs Act. For an analysis of the final agreement between the two chambers, click here.
As of early December, both the House of Representatives and Senate have passed their own versions of H.R. 1, the “Tax Cuts and Jobs Act,” legislation to provide corporate tax cuts and simplify the personal tax code. The House passed the measure on November 16 and the Senate on December 2, and the two chambers are working to go to conference and reconcile differences by December 15. The House legislation contains several changes to energy tax credits. The Senate bill does not include any provisions on energy-specific tax credits, but does include language on overseas earnings that could be detrimental to the tax equity market for renewable energy.
Corporate tax rate reduction: The House legislation would reduce corporate tax rates to 20%, down from 34-35% for most companies. For small businesses structured as pass-through entities (sole proprietorships, LLCs, and S-Corporations), it would establish a new maximum rate of 25% in place of the current practice of taxing owners at their individual income tax rates. The bill establishes a safeguard intended to help prevent abuse of this new structure: Owners can only claim 30% of their business income at this rate, and the remaining 70% would be subject to their individual tax rate. However, certain types of professional service providers (including engineering, legal, financing, and consulting firms) would not be eligible to utilize this new pass-through provision. The Senate legislation would also reduce corporate tax rates to 20%, but delay this change until 2019. It would create a new type of deduction for pass-through businesses allowing taxpayers to deduct 23% of domestic qualified business income from a partnership, S corporation, or sole proprietorship. As with the House proposal, certain types of professional service providers are excluded from this provision.
Base Erosion Anti-Abuse Tax: The House and Senate bills both include a stipulation called the Base Erosion Anti-Abuse Tax (BEAT) provision, a new tax which applies to banks, securities dealers, or large companies that conduct business both in the U.S. and abroad. Importantly, the way the Senate bill defines this provision, many tax credits would be devalued, including the Investment Tax Credit and the Production Tax Credit. The BEAT measure is intended to prevent “earnings stripping,” which is an accounting strategy whereby banks/large companies shift earnings from the U.S. to their foreign subsidiaries (with more favorable tax rates) to reduce tax liability. Under current law, multinational companies are able to defer paying U.S. taxes on their profits overseas until they bring the money home. The BEAT provision in the Senate Bill would require firms with overseas earnings to calculate their taxable income in two ways each year: 1) a new 10% tax (growing to 12.5% in 2026) calculated after adding all cross-border payments back into their U.S. earnings calculations, and 2) their regular tax liability on U.S. earnings only, EXCLUDING any tax credits (with the exception of R&D credits). If the second tax calculation is lower than the first, the company would be required to pay the difference. Renewable energy industry groups have expressed alarm that the BEAT tax would disrupt the tax equity market, which is the core financing tool for most solar and wind farms. Banks/equity investors would have to perform the BEAT calculations each year, and would therefore be unable to determine at the start of a deal whether or not they would be able to take advantage of federal tax credits for clean energy over the lifetime of the project. Furthermore, the BEAT provision would apply retroactively to existing as well as new projects. Therefore, many banks and investors would exit the equity financing market entirely. (Learn more about BEAT and see industry letter here.) Senator Cory Gardner (R-CO) and others worked unsuccessfully to revise the BEAT provision on the Senate floor to exempt renewable energy tax credits. This issue remains to be addressed in conference.
Corporate Alternative Minimum Tax: Similarly, there is a complication involving the Alternative Minimum Tax (AMT). Under current law, taxpayers must compute their income for purposes of both the regular income tax and a separate calculation—the alternative minimum tax (AMT)— and their tax liability is equal to the greater of the two. Many lawmakers have decried the AMT as needlessly complicated, and both chambers sought to repeal it. However, the Senate had to add the AMT back into its proposal at the last minute in order to meet the chamber’s deficit requirements—but since the AMT level (20%) was not reduced, it is now the same as the corporate tax rate (also 20%). Firms would be forced to use the AMT in this scenario. Under the AMT provision, companies can only utilize tax credits for four years before they apply to their overall tax liability. Since the Production Tax Credit is paid out over 10 years, this would reduce the length of time wind energy projects would generate the credit by 6 years. There is speculation that this could cause wind developers to abandon the PTC and utilize the Investment Tax Credit instead. It is important to note that the corporate tax rate does not drop to 20% until 2019 under the Senate version of the bill. The AMT issue will likely need to be addressed in conference due to its broad implications for many industries.
Personal tax rate changes: The House legislation would reduce the number of individual income tax brackets from 7 down to 4. It would preserve the current top rate of 39.6%, but raise the income threshold for this level to $500,000 for individuals or $1,000,000 for couples filing jointly. Other income tiers would be taxed at 35% (for individual income of $200,001-$500,000), 25% (for $45,001-$200,000), and 12% (for up to $45,000). The standard deduction would be doubled to $12,000 for individuals and $24,000 for families. The ability to deduct state and local income taxes on a federal tax return would be capped at $10,000, and the home mortgage interest deduction would be capped at $500,000 for new homes purchased after enactment. Numerous other individual tax deductions would be eliminated. The Senate legislation would keep the total number of brackets at 7, but reduce rates for several of these brackets, including lowering the top rate to 38.5% and raising the income threshold for this level to $500,000 for an individual or $1,000,000 for couples filing jointly. Other income tiers would be taxed at 35% (for individual income of $200,000-$500,000), 32.5% (for $170,000-$200,000), 25% ($60,000-$170,000), 22.5% ($37,870-$60,000), 12% ($9,525-$38,700), and 10% (up to $9,525). The Senate bill also includes a repeal of the individual health insurance mandate created under the Affordable Care Act. Notably, the individual tax cuts and change in the estate tax all expire at the end of 2025 in order to comply with a Senate rule prohibiting legislation from adding to the deficit beyond a 10-year window (the Byrd rule).
Energy provisions: The House legislation would make significant adjustments to the production, investment, and residential tax credits (Sec. 45, 48, and 25D), in addition to other energy tax provisions. The base Senate bill does not contain ANY language on energy-specific tax credits, but the BEAT provision discussed above could impact the usefulness of existing credits. Additionally on the energy front, the Senate bill contains provisions sought by Senator Lisa Murkowski (R-AK) allowing drilling in a portion of the Arctic National Wildlife Refuge (ANWR). Several amendments on specific energy credits were filed during committee consideration, but the committee elected not to include these and expressed the possibility of moving a separate tax extenders package after, coupled with appropriations/funding bills for federal agencies. If you are interested in any of these provisions, you should contact your legislators now while conference negotiations are underway:
- 45 Production Tax Credit: The House bill would continue to provide a wind PTC through the end of 2019 but with significant modifications. The bill would NOT reinstate the other, expired Sec. 45 technologies. It would repeal the inflation adjustment for the credit effective immediately for all new projects starting immediately—essentially reverting to a credit of 1.5 ¢/kWh from the current rate of 2.3 ¢/kWh for wind projects. The legislation would change the terms defining the start of construction requirements for meeting the deadline, altering previous safe harbor guidelines set forth by the Treasury Department outlining minimum capital expenditures of 5% or other construction requirements to instead require “continuous construction” from start to finish. Industry leaders had hoped that provisions from H.R. 4137—Representative Stefanik’s (R-NY-21) legislation to reinstate and extend expired PTC credits—would be included, but they were not addressed in the House proposal.
As noted previously, the Base Erosion Anti-abuse Tax provision in the Senate proposal would not allow firms to use the PTC in the calculation of the BEAT portion of their tax liability should it fall under a certain threshold (a tax liability calculation of 10% that includes cross-border payments). This could create a large degree of uncertainty in tax equity markets and potentially steer many large firms away from utilizing the Production Tax Credit. Additionally, under the Senate version, firms would be forced to use the Alternative Minimum Tax, which would limit the use of the PTC from 10 to 4 years (thought the AMT is one area that might see an alteration in conference between the Senate and House).
- 48 Investment Tax Credit: The House bill would reinstate and extend the ITC for non-solar technologies. It would reinstate the 30% initial credit for fuel cells, small wind, and fiber-optic solar and gradually phase the credit out through the end of 2021, on the same schedule as solar. It would also reinstate and extend through 2021 the 10% credit for microturbines, combined heat and power, and geothermal heat pumps. The bill would repeal the permanent 10% solar and geothermal tax credits for projects that start construction after 2027. Just as with the PTC, the bill alters requirements for meeting the “commence construction” threshold a project must satisfy to qualify for the credit. Several Senators filed amendments during committee consideration relating to the ITC, including one by Senators Heller (R-NV) and Portman (R-OH) that would reinstate the expired ITC and residential credits, increase the commercial geothermal credit to 30%, and add waste heat to power as an eligible technology for the 10% credit. However, these were not included in the final Senate bill.
The Base Erosion Anti-abuse Tax provision in the Senate proposal would not allow firms to use the Investment Tax Credit in the calculation of the BEAT portion of their tax liability should it fall under a certain threshold (a tax liability calculation of 10% that includes cross-border payments). This could create a large degree of uncertainty in tax equity markets and potentially steer many large firms away from utilizing the Investment Tax Credit.
- 25D Residential Tax Credit: The House tax plan would reinstate and extend the residential tax credit for all non-solar technologies eligible for the residential tax credit (essentially the same as the Sec. 48 technologies described above), on the same schedule as solar. For projects placed in service by the end of 2021, the credit would be 30% initially, gradually phased out over this time.
- Nuclear production tax credit: In the House legislation, if any portion of the 6,000-megawatt nationwide cap on the nuclear PTC remains unallocated after the current deadline (end of 2020), the unused portion could be reallocated to additional facilities. Senators Isakson (R-GA), Scott (R-SC), and Crapo (R-ID) introduced an amendment during committee consideration comparable to the House language on the nuclear PTC, but it was not included in the final Senate bill.
- Fossil energy credits: The House bill would repeal the (currently) permanent enhanced oil recovery and marginal oil and gas well credits.
- Electric vehicles: The House legislation would repeal the existing $7,500 credit for electric vehicles placed in service, which under current law is capped at a total of 200,000 vehicles per automaker with a phase-out triggered once this threshold is met. No firm has surpassed the 200,000 vehicle threshold, but some auto manufacturers have higher EV sales than others. This change would disproportionately impact those firms that have sold fewer EVs and any future entrants to the market.
- Other: Both the House and Senate bills include some adjustments to the Section 179 property expensing to allow certain types of nonresidential energy efficiency improvements to qualify. The House and Senate plans would not extend any other expired energy tax incentives, such as those for commercial and residential energy efficiency, or alternative fuels. Neither bill would include changes to existing credits sought by the carbon capture and sequestration, commercial geothermal, waste heat to power, and energy storage industries. Finally, neither bill includes provisions sought by the clean energy industry to expand eligibility for Master Limited Partnerships, a low-cost financing tool currently available to fossil energy projects.
Summary Table of Proposed Tax Code Changes
This summary discusses only a handful of the provisions in these bills, which would adjust many other corporate and individual tax credits. Read more about the House bill as introduced, see changes during the amendment process, and the Senate bill as introduced. Follow @l_abramson on Twitter to hear more from Lynn. Follow the CEBN on Twitter, Facebook and LinkedIn to stay connected.
The Clean Energy Business Network (CEBN) works to advance the clean energy economy through policy, public education, and business support for small- and medium-size energy companies. Started in 2009 by The Pew Charitable Trusts, the CEBN is now a small business division of the Business Council for Sustainable Energy. The CEBN represents 3,000+ business leaders across all 50 U.S. states working with a broad range of clean energy and transportation technologies.