The United States allows a tax credit of $1.035 an mmBtu for producing unusual fuels. The credit was enacted in 1980 after the Arab oil embargo. The idea was to reduce the need to import oil from the Middle East by inducing Americans to look in unusual places for fuel.

One of the things the credit encourages is production of “synthetic fuel from coal.” Congress probably had in mind expensive and untested technologies like coal gasification or coal liquefaction. In the mid-1990’s, several companies developed binders for gluing together waste coal fines recovered from gob piles and silt ponds and making pellets that could be burned as fuel in power plants. All remaining projects had to be placed in service by June 1998 to qualify for tax credits. Fifty-two plants for binding together coal fines were operating by the deadline, with many rushing to get into service in the last week of June.

The binders have not worked as well as hoped. Meanwhile, the IRS said in private rulings that the facilities could be moved to new locations and could qualify for tax credits by applying the binders to “run-of-mine” coal. As a consequence, a number of these facilities have been moved near utility power plants and are adding binder to coal that would have been burned anyway in the power plants and without bothering to turn the output into pellets.

Kentucky Governor Paul Patton (D.) wrote US Treasury Secretary Lawrence Summers in late July that “the way this program is being used is an outrage” and said he would “seek to follow up personally” on the issue. Three congressmen from coal states sent the IRS and Treasury a similar letter in late July. Patton complained that the tax credits are depressing coal prices. Coal companies cannot afford to compete with synfuel producers whose tax subsidy is about $25 a ton.

The Treasury is now looking into the charges. It has asked the Department of Energy laboratory for its views on the chemical effects of adding binders. The IRS view is that material made from coal is a “synthetic fuel” if it differs significantly in chemical composition from the coal.

The IRS continues to issue private rulings in syncoal transactions in the meantime. However, the agency said it expects to ask more questions than in the past, and rulings may take a little longer than usual. Rulings had been taking four to six months.

Ruling requests will go to a different branch of the IRS starting October 1. This is a workload issue. The branch that had been fielding ruling requests on syncoal projects is overworked.

Meanwhile, the IRS released two interesting private letter rulings in late summer that bear on syncoal and landfill gas projects. In one, a partnership that owns a syncoal facility was sold to a buyer who paid the selling partners an amount in cash plus agreed to make contingent payments over time that are a percentage of section 29 tax credits. The partnership had an outstanding debt to the selling partners. The buyer agreed to make capital contributions to the partnership to pay off this debt, but not until – among other things – the project cleared an IRS audit without the IRS questioning whether the facility made it into service by the June 1998 deadline to qualify for credits. Under the deal with the sellers, the buyer could also reduce the contingent payments tied to tax credits for any reserve deposits to cover cleanup and operating costs as well as operating deficits and by “certain specified yearly amounts per ton.”

In the other ruling, the IRS said it would not allow section 29 credits to be claimed on landfill gas from expansion wells added to a landfill after June 1998.

Meanwhile, the American Petroleum Institute is arguing with the Treasury about whether a rule that section 29 credits cannot be used to offset alternative minimum taxes should be applied on a consolidated group basis or to each company separately. API argues the rule applies to the consolidated group. It sent Treasury a long memo on the subject at the end of July.