August 08, 2005 | By Keith Martin in Washington, DC

SYNFUEL plant owners won a round in the IRS national office in June.

Another round is expected. 

IRS agents in the field are moving on audit to disallow section 29 tax credits claimed on synfuel plants. Credits do not appear to have been disallowed in audits handled by the West Virginia district office, but credits have been disallowed elsewhere. 

The plants produce synthetic fuel by putting crushed coal in a mixer and adding a chemical regent. The plant owners claim tax credits of $1.13 an mmBtu on the output. The credits are intended as a reward for anyone making synthetic fuel from coal. 

The IRS field agents are arguing in some of the audits that the plants were not put into service in time to qualify for tax credits. They had to be in service by June 1998. Many plants were hurriedly built close to the deadline and then produced little output for months afterward. It was the middle of 1999 before most plants had appreciable sales.

In order to be in service for tax purposes, a plant must be in a “condition or state of readiness for its intended purpose.” The IRS is arguing on audit that the fact the plants made few sales is an indication that they were not yet in a position to make a usable product and it was only after tinkering with equipment, the chemical reagent or the feedstock fed into the plants late in 1998 or in 1999 that the plants were able to make marketable synfuel.

The IRS national office rejected this argument in the first case to be heard in June. The plants at issue in that case had measurable output and better operating histories than most such plants had in 1998, but they were shut down by the fall and remained shuttered until mid-1999. The owner had a fulltime sales staff that tried throughout 1998 and 1999 to make sales. All of the output produced during 1998 was eventually sold. The taxpayer argued that it took time to overcome initial market resistance to the product and this — rather than any problems with the equipment — explained the period when the plants were idle. 

The IRS national office agreed and said so in a “technical advice memorandum,” or a ruling to settle a dispute stemming from an audit. It was helpful that there was a pattern of steadily increasingly output during the four to five months the plants operated in 1998 before they were shut down. The national office has at least one other case in front of it. A decision in expected in September or October.

The field appears to be refusing to let any other cases be heard in Washington. Meanwhile, plant owners are keeping a wary eye on rising oil prices. The tax credits phase out if oil prices return to levels reached during the Arab oil embargo in the 1970’s. Credits would have phased out during 2004 if the average wellhead price for domestic crude oil in the United States had moved across a range of $51.35 to $64.46 a barrel. The average price that year was $36.75. The range is adjusted each year for inflation. 

NYMEX futures prices reached $65 a barrel in early August. NYMEX prices have generally been more than $3 a barrel higher than the reference oil price used by the IRS for its phaseout calculation, but the gap is increasing according to Meridian Investments, which studied the historic price link. The reference price was about 85% of the NYMEX futures price at the start of this year. Meridian calculated in late March that NYMEX futures prices would have to average $64.02 for the rest of 2005 in order for the reference price to reach the bottom of the phaseout range. 

Separately, House and Senate negotiators working on the energy bill wrote the following in the “conference report” on the final bill:“The conferees understand that the Internal Revenue Service has stopped issuing private letter rulings and other taxpayer-specific guidance regarding the section 29 credit. The conferees believe that the Internal Revenue Service should consider issuing such rulings and guidance on an expedited basis to those taxpayers who had pending ruling requests at the time the moratorium was implemented.”

IRS officials in Washington say they are not aware of any moratorium. They speculate that the conferees may be referring to a policy that the IRS has had in effect for at least the last year and a half of not ruling on plants that use processes for making synthetic fuel that the IRS has not already blessed in prior rulings.