A New Tax Bill

A New Tax Bill

January 01, 2006

A new tax bill signed by President Bush on December 21 will reward companies making investments in sections of Louisiana, Mississippi and Alabama that were damaged by Hurricane Katrina.  It also affects paper mills and companies that produce synthetic fuel from coal.

The bill allows a 50% “depreciation bonus” on new plant and equipment put into service in the hurricane zone in Louisiana, Mississippi and Alabama by December 2007.  The deadline for completing new office buildings is a year later.  The bonus can also be claimed on improvements to existing facilities.

It is an acceleration of tax depreciation to which the owner of a project would be entitled anyway.

The owner gets a much larger depreciation deduction the first year and smaller ones later.  His depreciation allowance in the year the project is put into service is 50% of his “tax basis” in the project (basically what the project cost), plus depreciation for the year calculated in the regular manner on the remaining 50% of basis.  The remaining 50% of basis is depreciated normally.

The faster writeoff can be a significant benefit.  The benefit is greater the longer the normal depreciation period for an asset.  A 50% bonus reduces the cost of assets that are depreciated over 20 years — for example, transmission lines and coal- and combined-cycle gas-fired power plants — by 8.98%.  It reduces the cost of gas pipelines and other gas-fired power plants that are depreciated over 15 years by 7.54%.  The cost of a power plant that burns waste would be reduced by 3.61%.  Wind farms and biomass projects would cost 2.61% less.  These are the federal tax savings from the depreciation bonus using a 10% discount rate.  There may be additional state tax savings.

The bonus cannot be claimed on a project if tax-exempt financing is used to pay part of the cost.  It only applies to projects on which construction starts on or after August 28, 2005.

The United States already allowed a 30% or 50% depreciation bonus on infrastructure projects with at least two-year construction periods built during the period September 11, 2001 through December 2005.  The bill gives the IRS the authority to extend the December 2005 deadline for selected projects that companies can show were delayed because of Hurricanes Katrina, Rita or Wilma.  Thus, this relief extends also to projects in Florida and Texas.

The bill also allows each of the three Katrina states to issue tax-exempt bonds in an amount up to $2,500 times the original population of the hurricane zone to pay for renovating or rebuilding existing facilities belonging to regulated utilities or constructing new ones.  The potential beneficiaries are electric, gas, water, steam and sewage utilities and gas pipeline and telephone companies.  The bonds must be issued by December 2010.  The facilities must be used to provide services at rates that are regulated on a rate-of-return basis.

The same utilities have also been given the right to carry casualty losses caused by Katrina back as many as 10 years.  That could open the door to refunds of federal income taxes paid during the past 10 years.  Such losses can usually only be carried back two years.

Congress also attached a series of “technical corrections” to recent tax legislation to the Katrina-relief measure.

Among the technical corrections is one that makes clear that “lignin” — a wood residue that is a byproduct from making paper — is “biomass” so that paper companies can burn it to generate electricity and qualify potentially for production tax credits of 0.9¢ a kilowatt hour on the electricity.  Paper companies were worried that the IRS would rule out the credits on grounds that the material is not “waste” or that it is hazardous because of chemicals that are used in the papermaking process.  Only electricity sold to third parties qualifies for credits.

Another technical change affects companies with plants that make synthetic fuel from coal.  A JOBS bill in October 2004 authorized section 45 tax credits to be claimed on new plants for making “refined coal.” The new plants must be put into service during a window period that runs from October 23, 2004 through December 2008.  The credits are $4.375 a ton.  They run for 10 years after a plant is put into service.  The product must have a market value at least 50% higher than the raw coal used to produce it.  It must also reduce nitrogen oxide emissions and either sulfur dioxide or mercury emissions, when burned, by at least 20% compared to the raw coal.

The technical change clarifies that anyone making refined coal in the future does not also have to show that the output is a “synthetic” fuel.  In other words, there is no need to prove that it differs chemically from the raw coal.

The credits phase out as coal prices move across a range of $8.75 above the 2002 coal price.  Both the $8.75 range and the 2002 coal price are adjusted for inflation.

Owners of existing synfuel plants may be able to qualify for another 10 years of tax credits by rebuilding their plants enough to have them considered “new” for tax purposes.  The IRS treats a rebuilt plant as new if the amount spent on upgrades is more than 80% of the value of the rebuilt plant.

Keith Martin