November 6, 2017 Many tax credits and incentives affected by House tax reform bill Formal tax committee action on long awaited tax reform kicked off with the November 2, 2017, release of a comprehensive tax reform bill, the Tax Cuts and Jobs Act (the House Bill). While tax reform is still evolving and provisions may be added, removed or altered, there are significant items that taxpayers should begin considering now. This is especially true for those considering construction or projects that rely on government incentives or tax credits. Most significantly, the following credits would be affected if the House Bill was enacted in its current form. Repeal of rehabilitation credit Current law Section 47(a) allows a rehabilitation credit of 20% of the qualified rehabilitation expenditures for any certified historic structure and 10% of expenditures for qualified buildings. This credit is taken into account in the year the rehabilitated building is placed in service. Provision The House Bill would repeal the rehabilitation credit. Repeal of the credit is expected to increase revenues by $9.3 billion over 10 years. Effective date The repeal would be effective immediately, but transitional relief would allow the credit for qualified expenditures incurred through the end of a 24-month period beginning no later than 180 days after enactment, provided that the building was in control of the taxpayer by the December 31, 2017. Implications Those taxpayers that are currently undertaking or are planning to undertake the rehabilitation of a certified historic structure should evaluate their time line to best take advantage of the transitional relief. It appears that the 60-month window for phased rehabilitations previously offered under the tax code would no longer be available. Further, this provision may affect projects currently under construction as many historic rehabilitation projects have a longer construction period than the 36-month window offered under the transition rules. Taxpayers who invest in or utilize these tax credits will want to review contracts to understand what protections are available to them in the event that project construction continues outside of the transition period. Termination of new markets tax credit (NMTC) Current law The NMTC Program allows individual and corporate taxpayers to receive a credit against federal income taxes for making qualified equity investments in community development entities (CDEs). The credit totals 39% of the investment and may be claimed by the investor over seven years. Substantially all of a taxpayer's investment must be used by a CDE to make qualified investments in low-income communities. The amount of credits available are determined annually and allocated on a competitive basis. To date, the CDFI Fund has made 1,032 awards, totaling $50.5b in tax credit allocation authority. Provision Under the House Bill, there would be no additional new rounds of credit allocation. The provision is expected to increase revenues by $1.7 billion over 10 years. Effective date Under the provision, 2017 would be the last allocation round of credits, but credits that would have already been allocated may be used over the course of up to seven years. Implications It is important to note that this does not affect the 2017 round for which applications have already been submitted. The announcement of the 2017 round expected in the first quarter of 2018 would be the last of the program. As such, entities that were planning on using the program to close financing gaps may need to look to other sources of funding. CDEs with business models based upon the receipt and deployment of a NMTC allocation should consider diversifying their business plans. Those taxpayers that invest in or otherwise take advantage of these credits as part of their community development efforts will likely have to find an alternative solution to avoid increases to effective tax rates. Repeal of the Work Opportunity tax credit (WOTC) Current law The WOTC is available to qualified employers that hire individuals who are members of targeted groups. The credit is equal to 40% of qualified first-year wages of employees belonging to certain targeted groups. The credit is subject to wage limits between $6,000 and $24,000 that vary by the specific targeted group. Provision The House Bill would repeal the WOTC. Repeal of the credit is expected to increase revenues by $3.6 billion over 10 years. Effective date The provision would be effective for wages incurred or paid to individuals who begin work after 2017. Implications Despite the proposed tax reform bill, employers should continue to target and hire WOTC-eligible individuals and submit IRS Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, to the designated State Workforce Agency on a timely basis. The proposed early repeal of the WOTC would not disqualify wages paid after December 31, 2017, to eligible employees who were hired on or before December 31, 2017. Accordingly, employers should plan to track wages paid to eligible employees throughout the 2018 and possibly 2019 (for eligible long-term family assistance recipients) tax years in order to calculate credit in future tax years. Repeal of the deduction for certain unused business credits Current law Section 196 allows a taxpayer to carry unused business credits back one year and forward 20 years. However, the ability to use those credits generally expires with the death of an individual taxpayer or the cessation of a business taxpayer. Provision The House Bill would repeal the deduction for unused business credits. The repeal is expected to have a negligible effect on revenues. Effective date The provision would be effective for tax years beginning after 2017. Implications Taxpayers that are currently carrying forward tax credits, or may end up carrying forward tax credits based upon other provisions of tax reform, should evaluate their ability to utilize the tax credits before the end of the tax credit carryforward period. Repeal of nonrefundable credits Current law Tax credits are available under current law for certain taxpayers or activities of the taxpayer. Taxpayers disabled or over 65 receive a tax credit of $7,500 for a couple or $5,000 for an individual. Taxpayers who adopt a child receive a credit of $13,570 per eligible child in 2017. Taxpayers who purchase government issued private activity bonds (PABs) receive a credit for the interest received from those bond. Taxpayers who purchase plug-in electric motor vehicles receive a credit of up to $7,500. Proposal The House Bill would end these nonrefundable credits, raising an estimated $4 billion in revenue over 10 years. Effective date The credits would be eliminated for tax years beginning after 2017. Implications While most of these programs are small in relation to other programs, taxpayers who utilize them should look for ways to accelerate their activity into 2017 so that they can benefit from the programs in case they are repealed. Production tax credit (PTC) Current law Section 45 allows a PTC for electricity produced from qualified energy resources (wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy) and sold to an unrelated person. The PTC is 1.5 cents (indexed annually for inflation) per kilowatt-hour of electricity produced. Proposals The House Bill would repeal the Section 45 production tax credit (PTC) inflation adjustment factor for electricity and refined coal, reverting the credit to 1.5 cents per kilowatt hour. It is uncertain if this applies only to facilities whose construction begins after November 2, 2017 or to existing facilities as well. The House Bill would also alter the current rules for when construction begins on a qualified facility, directing that the construction, modification, improvement or addition to any facility may not be treated as beginning before any date unless there is a continuous program of construction that begins before such date and ends on the date that such property is placed in service. Effective date This beginning of construction change would apply to tax years beginning before, on, or after November 2, 2017. Implications The provision contains two significant changes to the PTC. The first change lowers the credit level, effectively reducing the PTC amount 35% by reverting to the statutory 1.5 cents. The summary of the House Bill indicates that the repeal of the inflation adjustment factor may apply to all projects, even those that are already in service. That said, the language of the House Bill does not indicate that the repeal of the inflation adjustment factor would apply to all projects, but only those which begin construction after November 2, 2017. Given that there are no new refined coal production tax credits projects by statute (the statute allowing for the refined coal tax credit expired at the end of 2011) the inclusion of refined coal could be interpreted in favor of the retroactive nature included in the summary. While we expect the House Bill language to be the ultimate controlling language, it is important that interested taxpayers follow the mark-up process to see if any changes to the House Bill are made. Wind facilities eligible for the PTC would appear to continue to be eligible for a 30% investment tax credit in lieu of the PTC, which was not reduced under the House Bill. Given the reduction to the PTC, it is likely more important that taxpayers model their project to determine whether the PTC or the ITC is the most advantageous tax credit for their project. The second significant change is around the qualification for beginning of construction. This is an important qualification as under Section 45(b)(5), the PTC steps down 20% per year starting for projects "the construction of which begins" before January 1, 2018. Effectively, projects that begin construction in 2017 will receive only 80% of the PTC, projects that begin construction in 2018 will only receive 60% of the PTC, and projects that begin construction in 2019 will only receive 40% of the PTC. Under IRS Notice 2016-31 (see Tax Alert 2016-848), wind farms were permitted two different ways to meet the "begun construction" requirement; 1) a continuous program of physical construction test (i.e. physical work of a significant nature), or 2) incurring 5% of total project costs and making continuous efforts to advance towards completion of the facility. The Notice also provided a "Continuity Safe Harbor" which stated that a taxpayer satisfies the continuous efforts portion of the 5% test (and the continuous program of construction test) if the project was placed in service by December 31, 2020. Under the provision of the House Bill, it appears PTC projects could no longer begin construction by incurring 5% of project costs and could no longer avail themselves of the Continuity Safe Harbor. This would have a significant impact for taxpayers who are planning wind as PTC projects. For example, a project that began construction in 2016 by incurring 5% of project costs (but did not maintain a program of continuous construction) expected that they had qualified their project for 100% of the PTC. Under the proposed law, many of those projects would now need to start physical construction by the end of the year and continue physical construction until the project is complete in order to lock in only 80% of the PTC (which under the first significant change was also lowered from 2.4 cents per kilowatt hour to 1.5 cents). Investment Tax Credit (ITC) Current law Section 48(a) provides an investment tax credit (ITC) that is equal to 30% of the cost basis of qualifying energy property (eligible energy property consists of solar energy, fiber-optic solar energy, geothermal energy, qualified fuel cell, qualified microturbine, combined heat and power system, qualified small wind energy and thermal energy properties) for both residential and commercial property placed in service before January 1, 2017. Proposals The House Bill would generally harmonize the expiration dates and phase-out schedules for different types of qualifying energy property. The ITC would remain at 30% ITC for property where construction begins before 2020, phasing down to 26% for property with construction beginning before 2021, to 22% for projects beginning construction before 2022. Under the House Bill, the residential solar credit under Section 25D would expire at the end of 2021. The House Bill would terminate the 10% ITC for property with construction beginning after 2027. The House bill would also extend the ITC for residential energy efficient property, subject to the same phase-out schedule. The same continuous program of construction requirement for beginning of construction would apply to the ITC as previously proposed for the PTC. Implications This provision harmonizes the various ITC technologies. While solar is the most well-known ITC technology, Section 48 also includes qualified fuel cell property, qualified microturbine property, combined heat and power systems, and qualified small wind property. The ITC for these other technologies previously lapsed at the end of 2016. Under this provision, those technologies would be extended and the phase-out timing would be the same as that for solar. This provision also ends the previously permanent 10% ITC for solar after 2027. It's worth noting that the solar industry has not yet received their "begun construction" guidance that would have presumably allowed for a 5% incurred and continuity safe harbor similar to what was provided to the wind industry under IRS Notice 2016-31. However, the fact that the ITC credit phase-out for solar does not start until 2020 means this leaves the solar industry with time to adjust their plans and qualify for the full 30% ITC, unlike the wind industry where that ship appears to have sailed under this guidance. Other provisions of interest Maximum tax rate for individual's business income Under current law, businesses organized as sole proprietorships, partnerships, limited liability companies, and S corporations are generally treated as "pass-through" entities subject to tax at the individual owner or shareholder level. Net income earned by owners of these entities is reported on their individual income tax returns subject to ordinary income tax rates. The House Bill would create a new income tax rate of 25% for individuals who are partners in partnerships (the passthrough rate). In general, to the extent that, after exclusion of net capital gain, an individual has taxable income that would otherwise be subject to a rate higher than 25%, any qualified business income (QBI) would be taxed at 25%. QBI is, generally, 100% of "net business income" derived from a "passive business activity" and 30% of any "net business income" derived from any "active business activity." The proposal is expected to reduce revenues by $448.0 billion over 10 years. Repeal of individual deduction for other taxes paid The House Bill would repeal the deduction for state and local taxes, other than taxes on trade or business income, and $10,000 of real estate taxes. Repeal of the Alternative Minimum Tax (AMT) The House Bill would repeal the AMT. The individual AMT affected about 4.5 million American families in 2017. Repeal of this tax is estimated to reduce revenues by $695.5 billion over 10 years. Repeal of the corporate AMT is estimated to reduce revenues by $40.3 billion over 10 years. Any AMT credit carryforwards could be claimed as a refund of 50% of the remaining credits (to the extent the credits exceed regular tax for the year), beginning in tax years 2019, 2020, and 2021. All remaining credits may be claimed in the tax year beginning in 2022. Reduction in corporate tax rate The House Bill would reduce the corporate tax rate to 20% rate without a phase-in or phase-out, effective for tax years beginning after 2017. Increased expensing The House Bill would allow taxpayers to expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023 (with an additional year for certain qualified property with a longer production period). Qualified property would not include any property used by a regulated public utility company or any property used in a real property trade or business. Changes to accounting methods for small businesses The House Bill would increase to $25 million (indexed for inflation) the $5 million annual gross receipts threshold for the use of the cash method of accounting for corporations and partnerships with a corporate partner, including farms. The cash method of accounting would apply even if the business has inventories, and these businesses would be completely exempt from the uniform capitalization (UNICAP) rules and the percentage-of-completion accounting method for long-term contracts. Interest limitation The House Bill would place multiple limitations on interest through revisions to Section 163, with an exception for small business with gross receipts under $25 million. Revision of treatment of contributions to capital The House Bill would treat contributions of capital that exceed the fair-market value of the stock received as taxable income. This provision is intended to remove the Federal tax subsidy of state and local incentives to locate businesses. Repeal of partnership technical terminations Under Section 708(b)(1)(B) of current law, a sale or exchange of 50% or more of interests in partnership capital and profits within 12 months causes a "technical termination" of the partnership. The bill would repeal Section 708(b)(1)(B) for partnership tax years beginning after December 31, 2017. Repeal of employer-provided child care credit. The House Bill would repeal the tax credit for employer-provided childcare. The credit is equal to 25% of qualified expenses for employee child care and 10% of qualified expenses for child-care resource and referral services. The credit is capped at $150,000 per tax year. Tax-exempt bonds The House Bill would repeal the exclusion from gross income for interest on qualified private activity bonds and for interest on any bond issued to advance refund a tax-exempt bond, effective for bonds issued after December 31, 2017. Next steps The House Ways and Means Committee will begin deliberation on the bill this week. Separately, a Senate Republican version of a tax reform bill will be released. Final thoughts Proposals in the House Bill would significantly affect a number of Federal Tax Credit programs. It proposes to repeal a number of significant programs that were previously considered to have bipartisan support such as the Work Opportunity Tax Credit and the New Markets Tax Credit. Additionally, it would repeal a number of smaller tax credit programs, such as the employer-provided child care credit, the historic rehabilitation tax credit, and the plug-in electric vehicle tax credit. While not slated for repeal, the House Bill would significantly alter the way the PTC program would work going forward. There were a number of other provisions, listed here, but not discussed in detail, that would significantly affect existing tax credit programs. The elimination of private activity bonds would almost certainly lower the amount of low-income housing tax credit units built going forward. Interestingly, it is not all bad news as a number of previously expired Section 48 technologies would be extended as part of the proposal. Taxpayers that use general business tax credits as part of their business should pay close attention to the mark-up of the House bill, the Senate version of tax reform and the ultimate progression of these bills. ———————————————
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