|Tax Aspects of Greenhouse Gas Legislation
While the focus on H.R. 2454 (111th Congress) — the American Clean Energy and Security Act (ACES) — has been on its cap-and-trade program for greenhouse gas (GHG) emissions, it also includes tax provisions and raises several tax issues.
August 13, 2009
In less than two months, on June 26, 2009 the House of Representatives passed ACES by a vote of 219 to 212. This bill — over 1,400 pages long — is designed to enable the U.S. to reduce its GHG emissions in order to address climate change concerns. Although just as effective (and probably requiring far less than 1,400 pages), a carbon tax was not seriously discussed. However, taxes do play a part in the ACES. For example, the tax system is used to alleviate costs of the legislation for lower-income workers. Tax issues are also associated with the ACES because the cap-and-trade system involves assets for which various tax questions exist. This article provides an overview to the ACES and some of the tax issues of the proposed cap-and-trade system.
Energy Basics of the ACES
The House Committee on Energy and Commerce believes that the ACES "will create millions of new clean energy jobs, enhance America's energy independence and protect the environment" (ACES summary (PDF), July 2009). It is intended to reduce GHG emissions such that by 2050, they do not exceed 17 percent of the 2005 U.S. levels (Act §702). Key provisions include the following:
Specific ACES tax provisions include:
Emission allowances and offsets are not new. In the 1990s, the Environmental Protection Agency (EPA) distributed sulfur dioxide (SO2) emission allowances to utility companies. In 2005, 10 states in the northeast and mid-Atlantic area established a carbon emissions trading system through the Regional Greenhouse Gas Initiative. The European Union began a carbon emissions trading system in 2005 to help meet its obligations under the Kyoto Protocol.
For several years, businesses and individuals have been able to purchase carbon offsets from various sources to reduce their carbon footprint. Such offsets might, for example, represent investment in a renewable energy project. A voluntary carbon offset trading system has existed in the U.S. since 2003 (see information from the Chicago Climate Exchange).
Limited tax guidance exists on allowances. New and updated guidance will be needed for the proposed cap-and-trade system. Key tax issues are described below along with some of the existing guidance.
Gross income: The distribution method for allowances (sale or giveaway) affects the tax treatment. If sold for market value, there would be no income effect to purchasers. If given away (as in ACES), the answer is less clear.
Rev. Rul. 92-16 provided that the SO2 allowances issued by the EPA without charge were not taxable income to the recipient. No rationale was provided (also see PLR 9231033). It is unclear whether the Internal Revenue Service (IRS) would rule the same way today for a program in which allowances are issued to over 7,000 entities compared to less than 120 recipients in the SO2 program (Senator Max Baucus, D-MT, June 16, 2009 testimony (PDF)). The Senate Finance Committee held a hearing on this topic in June 2009 with no clear answer produced.
The allowances are different from other tax-free government benefits because they are transferable. Yet, treating them as income seems harsh in that the allowances are a government mandate. When untaxed, the allowances have a zero basis. Thus, if sold by the recipient, they are fully taxable and if used, produce no deduction.
Sales and exchanges: Under the ACES, allowances can be sold, exchanged, transferred, retired or used by the holder. Allowances might also expire. Per Act §721(c) and §732(e), allowances and offsets do not constitute property rights.
Rev. Proc. 92-91 provided guidance on capitalization, depreciation, sales and exchanges of SO2 allowances. Much of this guidance needs updating because subsequent to its issuance, IRC §197 on amortization of intangibles was enacted as was §1221(a)(8) that treats supplies as noncapital assets (PLR 200728032 held that SO2 allowances were not a supply under §1221(a)(8) primarily because they are not tangible personal property). Also, Reg. §1.167(a)-3 on the amortizable life of certain intangibles was modified.
Issues in need of guidance include the relevance of allowances not constituting property rights under the ACES, deductibility, character of allowances and offsets (capital or ordinary), amortization and application of §197, application of like-kind and involuntary conversion rules and the treatment of retirements, expirations and transaction costs.
Charitable activities: Guidance is needed on donations of allowances and offsets to charitable organizations. Also, are purchases from a charity of offsets to reduce one's carbon footprint a charitable donation even though the "donor" derived a benefit? Guidance is needed on when sales of allowances and offsets might constitute unrelated business taxable income (UBTI). In 2005, the Senate Finance Committee issued a report on a charity's emissions credit program (see hearing of June 8, 2005).
International considerations: Guidance on a variety of international transactions involving allowances and offsets, such as transfer pricing, is needed. In PLR 200825009, the IRS held that the gain from sale of EU emission allowances was not foreign personal holding company income under IRC §954.
State issues: Little guidance has been provided by the states. Illinois Ruling ST 00-0084-GIL (PDF) concluded that the transfer of SO2 allowances were not subject to the Retailers' Occupation Tax because they were intangible. State issues include sourcing of sales of allowances and offsets and application of sales tax.
Role for CPAs
While the Senate still needs to act, a cap-and-trade system seems inevitable. This type of system provides opportunities and obligations for CPAs to assist clients in tracking and verifying emissions, allowances and offsets, as well as performing cost-benefit analyses and resolving tax issues. The ACES presents a complex, multifaceted system that will require CPAs to learn new terminology and rules, as well as understand the many ways businesses can reduce GHG emissions (including via use of federal and state tax incentives).
For additional information on ACES, see:
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Annette Nellen, CPA/Esq., is a tax professor and Director of the MST Program at San José State University. She is also a fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA and ABA. She has several reports on federal and state tax reform and a blog.