To tap into available federal tax credits, biogas projects in development should examine steps they might need to take before December 31, 2016.
BioCycle November 2016
With the end of 2016 in plain view, anaerobic digestion (AD) projects in the development phase should examine what has to happen by December 31 in order to tap into available federal tax credits. Under current law, Section 45 of the federal tax code makes AD projects eligible for a Production Tax Credit (PTC), which can be converted into an Investment Tax Credit (ITC), if the projects are used to produce electricity. In 2004, Congress passed the American Jobs Creation Act, which included expansion of the PTC to apply to renewable energy. For AD projects, Section 45 is set to expire at the end of 2016. In 2016, Congress put in place two options that would allow projects to obtain the tax credits. These options are the Physical Work Test and the Five Percent Safe Harbor test.
The Physical Work Test means the project must physically begin construction by December 31, 2016 and must have continuous construction throughout the project. The Five Percent Safe Harbor Test requires the project to incur 5 percent of the total cost of the project before December 31, 2016 and have continuous construction.
In June 2016, the Internal Revenue Service (IRS) issued Notice 2016-31, which clarified and expanded Safe Harbor for biomass facilities — including AD — to begin construction by December 31, 2016. In order to satisfy the IRS, a biomass project must meet the Continuity Safe Harbor requirement, so as to qualify for the PTC or ITC for a Biomass Project.
If the project begins construction and meets the Physical Work Test, or meets the Five Percent Safe Harbor test, then the project will deem to make the Safe Harbor Continuity Requirement, providing the project is placed into service no later than four years after the year during which construction began or December 31, 2016. For example, if the project “begun construction” is January 15, 2016 and it is placed in service by December 31, 2020, then the project satisfies the Continuity Safe Harbor.
There are specific requirements for Safe Harbor, which go beyond simply meeting the project’s begun construction date of December 31, 2016. At the outset, there must be a binding written contract established prior to construction, and physical work of a significant nature, which may include integral site improvements such as filling or compacting soil or installing stack piling, must have begun. Be aware that preliminary activities such as planning, designing, site clearing, surveying and a number of other processes are not considered physical work of a significant nature.
Continual progress towards completion must be made once construction has begun. However, the IRS has an allowance for disruptions such as natural disasters, severe weather conditions and the presence of endangered species. Other allowable disruptions include: delays in obtaining permits or licenses from federal, state, local, or Indian tribal governments, including, but not limited to, delays in obtaining permits or licenses from the Federal Energy Regulatory Commission (FERC), the Environmental Protection Agency (EPA), the Bureau of Land Management (BLM), and the Federal Aviation Agency (FAA); interconnection-related delays; delays in the manufacture of custom components; labor stoppages; the inability to obtain specialized equipment of limited availability; financing delays of less than six months; and supply shortages.
5% Of Total Cost Option
If construction has not begun, the project must incur at least 5 percent of the total cost of the project before December 31, 2016. If 5 percent of the cost has been incurred, the project must still have continuous construction.
The total cost of the project does not include the cost of land or any property not integral to the facility. The taxpayer must make a continuous effort to advance toward the project’s completion, which will be determined by relevant facts and circumstances, such as: paying or incurring additional amounts included in the total cost of the facility; entering into binding written contracts; obtaining permits; and performing physical work of a significant nature.
It is important to note that cost overruns will be a factor in determining the 5 percent. If overruns increase the cost, and the safe harbor amount is less than 5 percent of the total cost of the facility at the time the project is placed in service, then the taxpayer will not satisfy the Safe Harbor with respect to the project.
For taxpayers using the Physical Work Test and the Five Percent Safe Harbor for Continuity Safe Harbor, these may not be relied upon in alternating calendar years to satisfy the beginning of construction requirement or the Continuity Requirement. For example, if physical work of a significant nature is begun in 2015, and the taxpayer pays or incurs 5 percent or more of the total cost of the facility in 2016, the Continuity Safe Harbor will be applied beginning in 2015, not in 2016.
Passive Income, Bonus Depreciation
In order to take advantage of the ITC against other ordinary taxable income the owner of the project (taxpayer) must be active in the business. If the taxpayer is passive, i.e. just an investor that does not materially participate, then the tax credits can only offset other passive income, not active income. This area is very tricky and consulting a tax advisor is strongly recommended.
Along with the ITC, AD projects are also eligible to take advantage of the bonus deprecation. Bonus deprecation allows a project to take 50 percent depreciation in the year the project is placed in service. The 50 percent bonus deprecation is set to expire at the end of 2017. In 2018, the bonus depreciation is 40 percent, and decreases to 30 percent for 2019. In 2020, the bonus depreciation will no longer exist.
Tax laws are constantly changing and can be challenging to navigate. This article outlines the current tax laws as they stand today. There are rumors that AD projects could be receiving tax extenders, for which we are hopeful. Being on top of the tax law and understanding the rules are critical when considering the tax advantages of a project.
Kathy Parker, CPA, MST, is a Partner at Rodman CPAs in Waltham, MA (www.rodmancpa.com). She is an active leader of the firm’s “Green Team” specialty practice.