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19 May 2017

Update on US Federal Tax Reform Proposals and Their Effect on the Renewable Energy Industry

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While tax reform has been a stated focus of the Trump administration and Congress, details remain elusive.  The administration has recently reaffirmed its desire to enact comprehensive corporate and individual tax reform, but so far has provided few concrete details of its plan, instead reaffirming several “core principles” that will drive its negotiations with Congress.  Due to the lack of detail in the most recent reform proposals and the uncertain prospects for passage in Congress, the precise impact of tax reform on the renewable energy industry is not yet known.

Summary of Tax Reform Proposals

While the Trump administration has not provided significant details on its tax reform plan, the broad contours of the plan have developed over the past several months (the “Trump Plan”) and are summarized below.

The Trump Plan proposes a 15 percent rate on the net income of corporations, small businesses and partnerships.  The Trump Plan, at least as it was proposed during the campaign, would permit companies engaged in manufacturing in the United States to elect to immediately expense capital investments. However, the administration’s most recent announcement was silent as to whether it would include full expensing of capital investments.

The Trump Plan also would lower individual income taxes by reducing the number of tax brackets from seven to three (with a maximum individual income tax rate of 35 percent), doubling the standard deduction and increasing certain child care tax benefits.  The plan would partially offset the decrease in revenue from these proposals by eliminating most itemized deductions, including the deduction for state and local taxes.  The home mortgage interest expense and charitable contribution deductions would be preserved.  The Trump Plan also would eliminate the alternative minimum tax and the 3.8 percent net investment income tax.

The House Republicans’ business tax plan, as set forth in their “Blueprint” released last summer, would reduce tax rates on the net income of corporations to 20 percent and on partnerships to 25 percent.  The Blueprint would provide immediate and automatic full expensing of all business investments other than land.  The Blueprint also would disallow deductions for net interest expense in order to equalize the tax treatment of debt and equity financing.  In addition, the Blueprint would introduce border adjustments to the taxation of products, services and intangibles that are imported into or exported from the United States.  Border adjustments would mean that income from goods exported from the United States would not be subject to tax while the cost of goods imported into the United States would not be deductible from income.  The border adjustment tax is not included in the Trump Plan, and the administration has indicated that it does not support it in its current form.

As to individuals, the Blueprint is similar to the Trump Plan in that it reduces the number of income tax brackets to three (but with a maximum individual income tax rate of 33 percent) and increases the standard deduction, but it goes further in reducing taxes on investment income (i.e., capital gains, dividends and interest) through a 50 percent exclusion of such income.

Both the Trump Plan and the Blueprint have as a stated goal the elimination of so-called special interest tax breaks, but few details have been provided as to which specific provisions would be eliminated.

Prospects for Comprehensive Tax Reform

Given the slim Republican majority in the Senate, any bill may require passage by simple majority through the reconciliation process.  Reconciliation allows the bill to pass with only a majority rather than 60 votes, but is only permitted for bills that do not add to the deficit beyond a 10-year window after passage.  Accordingly, the tax rate reductions, if enacted, may be temporary unless accompanied by substantial revenue offsets.

The administration has expressed confidence that tax reform can be completed by the end of 2017.  Nevertheless, given the differences between the administration and Congress, as well as within Congress, there is expected to be significant opposition to any comprehensive tax reform proposal.  Further, the current tax code is incredibly complex, and a comprehensive reworking of it will require a substantial amount of time, with significant input from affected parties and industries.  For these reasons, even if tax reform is ultimately passed, the process could continue well beyond this year.  In addition, as with any significant change in law, the effective date of such changes is expected to be prospective and, as was the case with the Bush tax cuts, could be phased in over time.  Accordingly, comprehensive tax reform, if passed, may not have its full effect for several years.

Effects of Proposed Tax Reform on Renewable Energy Investments

Although many of the core tax reform principles espoused by the Trump administration and the Congress could have a negative effect on renewable energy investments and financing, the extent of that effect is not entirely clear. Again, this is because the details of the administration’s and the House Republicans’ plans have not been fully fleshed out.

For example, it is not yet known what will happen with renewable energy tax credits in future tax reform.  Under current law, investments in solar and wind property generally are eligible for an investment tax credit, but the credit is scheduled to step down over the next several years and, in the case of wind property, the credit will phase out completely.  Similarly, the production tax credit available for wind properties will phase out entirely after 2019.  These incentives may be targeted as a means to pay for promised rate reductions, although because these credits phase out or will reduce significantly over the next few years, their power as a revenue offset for promised tax rate reductions is less substantial.  In addition, the Secretary of the Treasury has previously said that he intends the current renewable energy tax credit regime to remain unaltered. 

Even if renewable energy credits survive, however, the reduction in corporate and individual income tax rates, coupled with accelerated business expensing (which could increase materially in the short term after passage), would reduce the value of these credits for tax equity investors, as potential investors will have less overall tax to offset with credits.  This could reduce the number of investors and thus increase the before-tax yield demanded by remaining investors.  This reduction in value of energy tax credits would not be offset by immediate expensing of renewable energy investments.  While immediate expensing would accelerate the tax reduction available from the expense, the deduction would serve to reduce taxable income against which a lower tax rate now applies, reducing its overall effectiveness.

Furthermore, a border adjustment tax, if adopted, would eliminate expensing for renewable energy projects to the extent that the projects use imported goods.  While the border adjustment tax would exempt taxes on exports, energy projects generally do not produce anything for export. Further, if a border adjustment tax hampers imports generally, the tax could increase the cost of materials for renewable energy projects. Thus, on balance, a border adjustment tax would have a negative effect on renewable energy projects.

In sum, the broad contours of the tax reform proposals currently being considered by the Trump administration and the Congress potentially have negative effects on the renewable energy industry.  Because the details have not yet taken shape, there are open questions as to the likelihood that legislation resembling these proposals will be enacted, as well as the time period over which any enacted reform will take effect. In this regard, because tax reform may well be a slow process, tax law changes may have less of an effect on those contemplating renewable energy investments in the near future.  In order to determine the negative effect, if any, that such changes will have on their planned investments, potential investors will need to gauge the likelihood that tax reform will take this direction and, if it does, the time period over which such reform will take effect.

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