Editor: Please describe your practice.
Burton: My practice area is focused on federal income tax and, in particular, the tax aspects of renewable energy. I also work on matters outside the renewable energy industry. I have an interest in tax credits generally and am a member of both the firm’s tax practice group and its project finance group. I also edit the firm's blog, www.TaxEquityTelegraph.com, which addresses the intersection of tax and energy policy. I do some non-tax-related project finance work as well. I am in the New York office of the firm.
Editor: What is a “tax extender"? Why does the Congressional Budget Office treat tax extenders as poor tax policy?
Burton: Tax extenders are tax breaks and incentives that have sunset dates. So, rather than saying we will permanently add a tax credit to the Internal Revenue Code, Congress has said we will add it for one or two years, and then if it is not extended it will end. The tax extender is supposed to be a temporary incentive that addresses a specific problem, but many of them have become close to being permanent in nature.
Another reason for tax extenders is because Congress imposed on itself a rule that any tax benefit or spending has to be offset by a revenue source or a reduction in spending. In the case of tax extenders, Congress in effect is saying that because we cannot figure out how to pay for such tax relief permanently, we will only extend it for a year or two. Many of these tax extender provisions have been extended multiple times.
The Congressional Research Service feels that this is arguably a manipulation of the revenue estimating process because Congress says these tax extenders will only be for a year or two, but then it repeatedly extends them. If the Obama administration's proposal to make the renewable energy credits, such as the production tax credit (PTC), permanent were adopted, these policy concerns would be eliminated. Unfortunately, it is not clear that proposal has the votes to pass. I would rather see the PTC extended on a temporary basis than have it remain lapsed.
Editor: Why is the Baucus Proposal (Proposal) with respect to energy tax incentives important?
Burton: The Proposal, if enacted, provides long-term stability. It provides incentives for clean electricity production until the pollution output from the country's power plants shows that the tax incentives for new clean power plants are no longer needed. The other thing it does is that it is technology-neutral. Currently, if a client comes to me with a new technology that produces clean energy, I have to try to shoehorn that into the definitions in the Internal Revenue Code. The great thing about the Proposal is that it says your tax credit is based on how clean your energy is versus a neutral standard. Therefore, if you develop a new widget that produces cleaner energy, you get a tax credit for this even if that widget does not fit a definition that is currently in the Internal Revenue Code. Let’s say you have a means of making natural gas-fired plants 10 percent cleaner. Under the Proposal, you get a fraction of a tax credit for that 10 percent improvement. It is not an on-off switch – it’s a gradient tax credit system.
Editor: Describe the treatment of solar energy in the Proposal.
Burton: The Proposal permanently reduces the solar investment tax credit (ITC) from 30 percent to 20 percent. Right now, the solar ITC has a sunset date that requires a solar facility to be operational by the end of 2016 or be eligible for only a 10 percent ITC. Whether Baucus's proposal is an improvement on current law depends on your perspective. If you view current law as a 30 percent investment tax credit (which decreases to 10 percent after 2016), the proposal is a one-third reduction. In contrast, if you view current law as the 10 percent post-2016 percentage, then the proposal doubles the tax credit.
Editor: How is wind energy treated in the Proposal?
Burton: Under the Proposal, wind did a little better than solar energy. Currently, the PTC for wind is 2.3 cents per kilowatt hour, and that is what the Proposal gives it. The Proposal appears to include an annual inflation adjustment. I think the wind industry is happier than the solar industry with the Proposal.
Editor: When do the tax credits provided for in the Proposal come to an end?
Burton: Once American electricity production achieves a target of an average of 372 grams of carbon emissions per kilowatt hour of electricity generated, then the tax credits start to ratchet down over a three-year period. But the phase-out only applies to new projects placed in service after the announcement has been made that the nation has achieved that goal. It doesn’t apply to projects placed in service prior to the announcement.
Editor: Why would the ITC be reduced to 20 percent?
Burton: As I said, the solar industry would see its ITC decline from 30 percent to 20 percent, while wind keeps its 2.3 cent per kilowatt hour production tax credit. This is because the staff of the Senate Finance Committee tried to roughly calculate what ITC is comparable to a 2.3 cent per kilowatt hour production tax credit. The PTC is a 10-year credit, and if your project performs well, you will get more, and if your project doesn’t do so well, you get less. The ITC is different because it is based on your tax basis, which is effectively cost. You get a 30 percent ITC upon completion of the project and it becomes operational. As long as you don’t sell or tear the project down, you do not have to pay that ITC back. The ITC is an upfront all-at-once tax credit versus a 10-year stream for the PTC. The Senate finance staff determined that, if the 10-year PTC is 2.3 cents per kilowatt hour, that would be equivalent to a 20 percent ITC paid up front. We don’t know what their math was, and there were a lot of assumptions and rough justice in the staff’s approach to this.
Editor: Senator Coons is lead sponsor of the Master Limited Partnership Parity Act. Describe its purpose.
Burton: A master limited partnership (MLP) is a publicly traded vehicle listed on the NYSE or NASDAQ. But unlike most publicly traded vehicles, it is subject to a single layer of tax. The entity itself pays no tax, and the investors pay the tax on dividends and capital gains – so it is one level of tax versus two levels of tax in the case of the typical investment in corporate stock. To have this advantage, 90 percent of your income must be from certain types of activities. The primary users of this exception are generally businesses involved in the production of fossil fuels. The businesses engaged in the exploration, production, refining and transport of fossil fuels can also qualify as MLPs.
Most people familiar with the area acknowledge that MLPs reflect a political compromise during consideration of the 1986 Tax Reform Act. The MLP Parity Act says, okay, if we are giving fossil fuel this nice one level of taxation tax break, we should also give it to renewable energy. So, the MLP Parity Act extends those rules to include renewable energy. It would allow you to form a publicly traded company, raise capital from retail investors and operate a renewable energy business and qualify for this benefit.
Editor: Does the MLP Parity Act deserve support? What is the glitch in the MLP Parity Act for the solar industry?
Burton: I support the MLP Parity Act, but it is not a good trade for the tax credits because the PTC and the ITC are a bigger economic benefit than a single layer of tax. Trading tax credits for MLP status is not a trade most participants in the renewable energy industry are prepared to make. The MLP Parity Act does not address the lack of supply of investors prepared to pay for and use these tax credits. They are usually publicly traded corporations that are sophisticated enough to invest in renewable energy and who have substantial tax liabilities – which basically comes down to banks and non-bank players such as insurance companies, Google and General Electric.
Finally, the glitch that you refer to in terms of solar power is with residential solar. One of the most common financing techniques in residential solar is leasing, and although income from solar counts, leasing income from solar power does not count. The MLP Parity Act would leave a big portion of the residential solar finance business outside of its rules. We as a nation should encourage residential solar power. I would hope that the Act is revised to include solar power leasing income as well.
Editor: Are there any proposals that you think our readers should be aware of?
Burton: Senator Baucus has also proposed depreciation reform that would greatly simplify the current extremely complex depreciation system. He proposes simplifying the rules we have for calculating depreciation. Unfortunately, for renewable energy, it has been put into a depreciation basket where it has a much longer life than the five-year depreciation life currently provided for renewable energy.
The tax credits are important to renewable energy, as is the accelerated depreciation, which is a challenge that the renewable energy industry faces if these tax reform proposals move forward. Senator Baucus has left the Senate to be ambassador to China. Senator Wyden is his successor. Wyden appears to support tax reform, but also appears to be taking the pragmatic approach of prioritizing the passage of the extenders ahead of tax reform. I agree with Wyden's prioritization, as tax reform is quite difficult to accomplish, and passage of the extenders would support American job creation, which recent economic reports suggest is lagging.