Energy Provisions in the Tax Bill

tax briefEnergy Provisions in the Tax BillWhat energy industries are discovering in both the House and Senate tax bills.

Budget & Tax, Energy & Natural Resources  | Research & Analysis
Dec 7, 2017  | 17 min read

The accountants, lawyers, and lobbyists for every industry or sector are poring over the tax bills passed by the House and Senate.

We’re doing the same to see what the bills did, whom they will benefit, and what it will cost taxpayers.

Here are some of the provisions that will be of particular interest to the energy sector:

(Click on the links for longer descriptions. More links will posted as they become available.)

  • 45J: Nuclear production tax credit (PTC)Extended & Expanded in House
    • Credit was created in 2005 and is available to qualifying nuclear plants for each kilowatt hour (kWh) they produce. To currently qualify, plants must be placed in service before 2021.
    • The House provision effectively gets rid of the current placed-in-service deadline of Dec. 31, 2020. I.e. it’ll be available to the next couple of new nuclear power plants whenever they come online.
    • The new provision also allows cooperatives and municipal utilities to get the credit (even though they have no tax liability to use it against) and transfer it to project partners (aka Southern Company in the case of the Plant Vogtle reactors)
    • The JCT scores the PTC modifications as costing $0.4 billion over the next 10 years
      • That seems low in the 10-yr. window if Vogtle finishes. And if so, the Vogtle project partners could claim up to $278 million per year.
      • Lifetime cost to taxpayers: $6 billion.

 

  • 199: Domestic Production Activities DeductionRepealed in both House & Senate
    • In 2013 (most recent year available) oil and gas extraction and refinery corporations together claimed more than $2 billion in Section 199 deductions, according to IRS statistics.
    • The House bill repeals the deduction starting in 2018. The Senate does the same for individuals who want to claim the credit, but allows corporations to take the deduction until 2019.
    • According to the JCT’s score of the House bill, the repeal of Section 199 would increase tax revenues by $95.2 billion.

 

  • 45I: Credit for Oil & Gas from Marginal Wellsrepealed in House
    • JCT says the repeal will have “no revenue effect” because no companies are claiming it anyway (in part due to high gas prices).
    • Repealing the provision removes a special interest carve-out in the tax code, but one that is little used.

 

  • 43: Enhanced oil recovery creditrepealed in House
    • Repeal has very little effect because current oil prices are high enough to reduce the credit amount that would be taken anyway
    • JCT scores repeal will increase revenue by $0.2 billion over 10 years
    • Another case where repealing the provision removes a special interest carve-out in the tax code, but one that is little used.

 

  • Deduction for income from Master Limited Partnerships (MLPs) added in Senate
    • MLP income was included at the last minute as qualifying for the 23 percent deduction for income from pass-through entities
    • These are already tax-advantaged entities – MLPs can share more of their profits with investors because they avoid corporate taxation, but have access to capital markets that other pass-through entities do not.
    • The majority of MLPs are oil and gas companies – they and their investors would be the biggest beneficiaries of the change.
    • JCT says making MLP income eligible for the deduction will reduce revenue by $700 million over 10 years.

 

  • Production tax credit (PTC) and investment tax credit (ITC) for renewablescut back in House
    • The House bill eliminates the inflation adjustment for the PTC for eligible projects that start construction after the tax bill is enacted.
    • The bill also changes the qualifying rules for the PTC to require continuous construction of an eligible project until its placed-in-service date.
    • The ITC is extended for “fiber optic solar, fuel cell, microturbine, geothermal heat pump, small wind, and combined heat and power property.”
      • Supporters of these industries say the extension was “left out” of the last tax extenders package, and have been lobbying for one ever since.

    • The ITC is ended for solar and geothermal after 2027

 

The Tax Breaks in Detail:

Section 199 – Domestic Manufacturing Deduction

  • Repealed by both House and Senate

The Section 199 deduction allows companies to deduct nine percent of their income derived from qualifying property produced in the U.S. from their total taxable income. It was created in 2004, largely to replace a subsidy for manufacturing exporters that was deemed a violation of World Trade Organization rules. It was written so broadly, however, that more than one-third of all corporate income has qualified for the deduction in recent years. For companies whose entire income qualifies, it reduces the topline corporate tax rate of 35 percent by 3.15 percent. As a result, it has been one of the most expensive tax expenditures for taxpayers. The JCT estimated in January 2017 that it would reduce federal tax receipts by more than $100 billion in the five years 2016-2020.

Income from oil and gas production is included in what qualifies for the deduction. Since 2010, the allowable deduction has been reduced by one-third for oil and gas companies, meaning that they can reduce their topline tax rate by 2.1 percent. In 2013, oil and gas extraction and refinery corporations together claimed more than $2 billion in Section 199 deductions, according to IRS statistics.

The tax bills in both the House and Senate eliminate the Section 199 deduction altogether, including for oil and gas companies. The House bill repeals the deduction starting in 2018. The Senate does the same for individuals who want to claim the credit, but allows corporations to take the deduction until 2019.

According to the JCT’s score of the House bill, the repeal of Section 199 would increase tax revenues by $95.2 billion.

Marginal Well Production Credit

  • Repealed by House, untouched by Senate

Oil and gas producers can claim a credit for every barrel of oil or thousand cubic feet (mcf) of natural gas produced from a marginal well. Marginal wells are defined as those that produce 25 barrels of oil (or oil-equivalent) per day or less. Producers can claim a credit of $3 per barrel of oil or $0.50 per mcf (adjusted for inflation, and reduced by high oil and gas prices) produced from such wells, up to 1,095 barrels of oil or oil-equivalent per year.

The House bill eliminates the credit. The Senate version does not. Removing the tax break, however, will have little effect. The amount of the marginal well credit claimed by producers is so small the JCT has scored the provision as having a de minimis effect on revenue in past years. Repealing the provision, furthermore, would have “no revenue effect,” according to the JCT.

 

Enhanced Oil Recovery (EOR) Credit

  • Repealed by House, untouched by Senate

The credit for EOR, which was first enacted in 1990, allows oil and gas producers to reduce their tax bills by up to 15 percent of qualified costs incurred or paid for an EOR project. Those can include the cost for tangible property, intangible drilling costs, tertiary injectants, or a gas treatment plant in Alaska preparing gas for transport by pipeline. The amount of the credit is reduced or phased out entirely when crude oil prices are high.

That has been the case in recent years, reducing the credit amount that can be claimed. Repealing the credit would increase revenue by $200 million over ten years, according to the JCT.

 

Pass-Through Deduction for MLP Income

  • Added by Senate

In the horse-trading leading up to the final vote on the Senate’s version of the tax bill, the newly-created deduction for income from pass-through businesses was increased from 17.4 percent to 23 percent. These businesses, as their name suggests, pass-through their profits (and losses, tax deductions, tax credits, etc.) to their owners, which are then taxed once on the individual side of the tax code. This differs from corporate profits, which are subject to corporate taxation, and then to individual taxation once the after-tax profits are distributed to shareholders via dividends.

If pass-through income would normally be subject to the top individual tax rate – 38.5 percent in the Senate bill – by claiming the new deduction, pass-through owners could lower the tax rate on the income to 29.65 percent. It would be a boon to current and future pass-through owners. The JCT estimates the new deduction would reduce tax receipts by more than $470 billion over ten years.

By avoiding corporate taxation, pass-through businesses can share more of their profits with their owners, which makes them more attractive to investors. Most pass-through businesses, however, are not traded on financial exchanges. The exceptions are what are referred to as “publicly traded partnerships.”

In the 1980s, the partnership structure was increasingly adopted as a way to access capital markets while avoiding corporate taxation, thereby eroding the corporate tax base. The Tax Reform Act of 1986 ended the practice, but left an exception for partnerships that derive at least 90 percent of their income from certain sources. Those include rent from real property, financial transactions, and notably, development of natural resources. In fact, the majority of qualifying partnerships today, referred to as Master Limited Partnerhips (MLPs), are oil and gas companies. In addition to the exemption from corporate taxation, net income for MLPs owners, or “unitholders,” is increased by their ability to defer tax on quarterly cash distributions, which is not available to stockholders for quarterly dividends.

The deduction for pass-through businesses created by the Senate bill originally excluded MLP income. But that changed at the last-minute thanks to an amendment from Sen. John Cornyn (R-TX). The JCT estimated that the applicability of the deduction to MLP income would reduce tax receipts by $700 million over ten years.

That makes its impact on revenue an order of magnitude smaller than the overall shift in how pass-through businesses are taxed, but the narrow benefit will mostly accrue to unitholders of oil and gas MLPs.

 

Nuclear production tax credit (PTC)

  • Extended and expanded by the House

The House tax bill expands and extends the credit for production of electricity from “advanced” nuclear power facilities. The credit allows qualifying nuclear power plants to earn 1.8 cents for every kilowatt hour of electricity it produces and sells to an unaffiliated buyer in its first eight years of operation. When the nuclear production tax credit (PTC) was first passed in the Energy Policy Act of 2005 (EPAct), the goal was to promote the construction of “advanced”* nuclear power plants in the near term. Accordingly, the provision as enacted only allows plants to claim the credit if they come online before 2021.

The so-called “nuclear renaissance” never materialized and by the start of this year, only two nuclear projects were under way with an expected completion date before the 2021 deadline.

After the lead contractor for both, Westinghouse Electric Co., filed for bankruptcy in March, owners of one of the projects at the V.C. Summer Plant in South Carolina announced they were abandoning construction. The owners of the other project at Plant Vogtle in Georgia have since reported their two reactors are roughly $12 billion over budget and at least five years behind schedule. As a result, it’s now clear that no facility will qualify for the PTC as enacted.

Thanks to powerful lobbying from the Georgia and South Carolina delegations, and their industry allies, the House passed H.R. 1551 in June to expand and extend the PTC. The Senate hasn’t taken up the measure, but Section 3506 in the tax bill is a word-for-word copy of H.R. 1551.

The proposed provision makes two changes to the PTC.

First, it eliminates the 2021 deadline. Thus, what was an incentive for near-term economic activity would become a blank check to any nuclear plant that is ever constructed in the future.

Second, it allows entities that don’t pay federal taxes to claim the tax credit, and then transfer it to taxable project partners.

Three owners of Plant Vogtle fit in that category, and would be able to transfer the credit to another project partner, say the construction manager – Southern Nuclear – or another plant owner – Georgia Power – which are both owned by Southern Company.

The JCT scores the PTC modifications as costing $0.4 billion over the next 10 years. That seems unlikely.

If Vogtle comes online in 2022 and 2023 as currently expected, its owners could potentially claim $278 million in the credit every year, all of which could funnel to Southern Company, which could end up pocketing more than $2 billion from the credit.

Regardless, if the credit becomes immortal, taxpayers will eventually have to subsidize the nuclear industry to the tune of $6 billion, in or out of the budget window.

And of that, more than $2 billion could end up in the pockets of Southern Company for their nuclear construction debacle.