Wind, geothermal, biomass, landfill gas, incremental hydroelectric and ocean energy projects in the United States will qualify for tax credits if they are under construction by year end under a bill that cleared Congress on January 1.

This is expected to lead to a rush to start construction of projects later this year.

The owners of such projects will have a choice between two tax credits: production tax credits of 2.2¢ a kilowatt hour on the electricity output for 10 years for wind and geothermal and 1.1¢ for other projects or an investment tax credit for 30% of the project cost. The production tax credit is adjusted each year for inflation. Any investment tax credit is taken fully in the year a project is completed, with the exception that it can be taken on contractor payments during construction for projects that are expected to take at least two years to build.

There is no deadline to complete the projects.

It will be up to the Internal Revenue Service to decide what it means for a project to be under construction.

Congressional sources say the intention was for the IRS to follow the same rules as under the Treasury cash grant program for renewable energy projects. Under that program, a project is under construction when the developer has either started “physical work of a significant nature” or “incurred” more than 5% of the project cost.

IRS and Treasury sources confirm that use of the Treasury cash grant definition is likely, but caution that no final decision has been made.

Guidance is expected to take several months.

A meeting among Treasury and IRS and Hill staff is expected shortly to make sure everyone is on the same page.

The IRS will have to decide whether to test when construction has started at wind farms on a turbine-by-turbine basis or by looking at the entire project. The IRS treats each wind turbine, pad and tower as a separate “facility” for production tax credit purposes. Under the Treasury cash grant program, a developer could choose to treat multiple units of property on a single site that will be operated as a larger unit as a single unit of property for testing when construction started, making it easier to treat an entire project as under construction.

The same bill that extended tax credits also extended a 50% depreciation bonus for another year for all new equipment placed in service in 2013. Thus, solar and fuel cell projects would also qualify. The bonus is the ability to deduct 50% of the equipment cost immediately. The other 50% is depreciated normally.

Assets like thermal power plants and transmission lines that would normally be depreciated over 15 or 20 years will have an extra year through 2014 to be completed and qualify for the bonus. However, the bonus can only be claimed on the share of depreciable basis built up through December 2013.

Among other changes, the bill allows projects on Indian reservations to be depreciated more rapidly — for example, for wind and solar facilities over three years instead of five years — for projects placed in service by December 2013.

It authorizes the Treasury to allocate another $3.5 billion in new markets tax credits for each of 2012 and 2013. New markets tax credits are credits of 39% claimed over seven years on investments in low-income areas.

Companies do not have to pay corporate income taxes on 9% of income from their manufacturing operations in the United States. Generating electricity is considered manufacturing. This has the effect of reducing the corporate income tax rate on income from such manufacturing to slightly less than 32%. Companies manufacturing in Puerto Rico qualified for the exclusion through 2011. The bill extends the exclusion for Puerto Rican manufacturing for another two years through 2013.

The bill gives electric utilities another year to sell transmission assets to independent transmission companies and receive an 8-year “spread” on the gain. A utility would normally be taxed fully on the gain in the year of sale. A special rule allows the gain to be reported over eight years. The special rule expired for asset sales after 2011. The bill extends it through December 2013. Congress wants to encourage regulated utilities to divest their transmission assets.

Wind and geothermal lobbyists say they will try to extend production tax credits again as part of any corporate tax reform bill that is taken up in 2013 or 2014 by Congress.

The American Wind Energy Association told Congress in December that it can accept a phase out of production tax credits for wind farms over six years. Under its proposed phase out, projects put in service in 2014 would qualify for 90% of the normal credit, in 2015 for 80%, in 2016 for 70%, in 2017 or 2018 for 60%, and there would be no tax credits for projects completed after that.

Projects that start construction by 2013 would not be affected.

Senator Charles Grassley (R-Iowa), one of the original authors of the production tax credit statute, responded that the credits should phase out over three years.

by Keith Martin