The passage of The Tax Cuts and Jobs Act (“TCJA”) on December 22, 2017 brought about significant changes that affected many industries. As part of our quarterly newsletters, beginning with this one, we will discuss how the TCJA impacts various sectors of our M&D practice. This quarter’s newsletter will focus on Energy.
The Bipartisan Budget Act of 2018 signed into law on February 9, 2018 also affected the energy industry by extending many expired tax provisions that are applicable to the energy industry.
Provisions Under the TCJA That Could Impact the Energy Industry
Corporate Tax Rate
Many energy companies are C-Corporations, and could realize a substantial tax savings from the reduction of the corporate tax rate to 21% (from a top rate of 35%), which is effective January 1, 2018. Calendar year taxpayers with December 31, 2018 year end will utilize the full tax rate change benefit. Taxpayers whose fiscal year ends in 2018 will have to calculate their tax using a blended rate for the straddle year by applying each tax rate to the taxpayer’s income for the respective year.
Net Operating Losses (“NOLs”)
Losses arising in tax years beginning after 2017 are limited to 80% of taxable income and the carryback provisions are repealed. Additionally, an indefinite carryforward of NOLs is allowed.
First year bonus depreciation has increased from 50% to 100% for qualified property acquired and placed in service after Sept. 27, 2017 and before Jan. 1, 2023. In addition, Section 179 expensing increased from $500,000 to $1,000,000 for assets placed in service in 2018, with a phase-out beginning at $2,500,000. Equipment-intensive energy companies could gain significant tax benefits with these accelerated deductions.
The amended Section 163(j) limits the deduction of interest expense. For tax years beginning after Dec. 31, 2017, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income.
For tax years beginning after December 31, 2017 and before January 1, 2022, adjusted taxable income is computed without regard to NOLs, business interest income and expense, deductions allowable for depreciation, amortization, or depletion.
For taxable years beginning on or after January 1, 2022, adjusted taxable income will take into account a deduction for depreciation, amortization, and depletion but without regard to NOLs and business interest income and expense.
Repatriation of Foreign Earnings
Internal Revenue Code (IRC) Sec. 965, as newly enacted by the TCJA, imposes a transition tax on untaxed foreign earnings of foreign subsidiaries of U.S. companies by deeming those earnings to be repatriated. IRC Sec. 965(a) provides that, for the last tax year of a deferred foreign income corporation (“DFIC”) that begins before Jan. 1, 2018 (such year of the DFIC, the “inclusion year”), the subpart F income of the corporation (as otherwise determined for that tax year under IRC Sec. 952) is increased by the greater of (1) the accumulated post-’86 deferred foreign income of such corporation, determined as of November 2, 2017, or (2) the accumulated post-’86 deferred foreign income of such corporation determined as of December 31, 2017. This could have a significant impact, since many energy companies are global and own foreign subsidiaries.
Income Tax Accounting
As a result of the reduction of the corporate tax rate, companies must adjust the value of their deferred tax assets and deferred tax liabilities as of December 31, 2017. Cumulative temporary differences in book and tax assets and liabilities must be revalued to reflect what their benefit or tax burden will be upon their recognition or realization. Also, companies with an international presence must perform a detailed analysis to determine the effect of the many international tax changes.
Provisions Under the TCJA Affecting Specific Energy Sectors
Mining and Metals
Percentage depletion was retained. It enables a miner to claim depletion deductions equal to the lesser of 50% of net mining income or a fixed statutory percentage of gross income, which varies with the mineral being mined.
Oil and Gas
The deductibility of intangible drilling costs (“IDC”) was retained. This enables a company to deduct expenses that are incidental to, and necessary in, the drilling and preparation of wells for the production of oil and gas.
The Section 199 deduction was repealed, which may negatively affect certain oil and gas companies.
The TCJA did not repeal any conventional energy tax credits such as the enhanced oil recovery tax credit and the credit for producing oil and gas from marginal wells.
Power & Utilities
The TCJA modifies IRC Section 451 to require that accrual method taxpayers to recognize income items no later than the time they recognize the same items for financial accounting purposes. This has a potential impact on power purchase agreements (“PPAs”). Advance payments from PPAs must be taken into income on an accrual basis taxpayer when payment is received.
Many PPAs call for upfront payment but the seller takes the payment into income only as, and when, performance occurs and power is delivered. Under the new rule, advance payments must be accrued when received unless the taxpayer makes an election for a partial deferral of one year. The new income recognition provisions related to PPAs with pre-payments may alter pricing and structure of such agreements.
Cross-border sales are now to be sourced by location of production. The TCJA revises IRC Section 863(b) to provide that the source of income from the sale of inventory is based solely upon the location of the production activities with respect to the property.
This means that, for example, sales of electricity and oil or gas extracted in Mexico and sold in the US will no longer be partially sourced to the jurisdiction where title passes and, instead, will be sourced solely to Mexico.
Bipartisan Budget Act of 2018
The Bipartisan Budget Act of 2018 reinstated many tax provisions that had expired at the end of 2016. These provisions were reinstated retroactively to January 1, 2017. A full list is available in our previous Tax Alert.
Some of the highlights relating to the energy industry are as follows:
- Mine rescue team training credit
- Election to expense advanced mine safety equipment
- Empowerment zone tax incentives
- Alternative fuel vehicle refueling property credit
- Second generation biofuel producer credit
- Income tax credits for biodiesel fuel, biodiesel used to produce a qualified mixture, small agri-biodiesel producers, renewable diesel fuel and renewable diesel used to produce a qualified mixture
- Credit for construction of new energy efficient homes
- Extension of special rule for sales or dispositions to implement Federal Energy Regulatory Commission (“FERC”) or State electric restructuring policy for qualified electric utilities
- Extension of excise tax credits and outlay payments for alternative fuel, and excise tax credits for alternative fuel mixture
If you would like to discuss any of these topics in more depth, please contact our M&D tax department.