Yesterday, the IRS issued a notice confirming the effects of the Cash Grant sequestration with respect to the tax attributes associated with the renewable energy projects that received the Cash Grant.1 Notice 2014-39 is available here.
Sequestration became effective due to the inability of Congress and the president to effectuate the reduction in the federal deficit required by the Budget Control Act of 2011 (BCA). The BCA reflected a legislative compromise in 2011 to increase the debt ceiling while imposing automatic future budgets cuts (i.e., sequestration) if deficit reduction targets were not achieved. The targets were missed and another legislative compromise was unable to reached, so the automatic budget cuts went into effect on January 2, 2013.
From January 2, 2013 to September 30, 2013, sequestration was 8.7 percent of the Cash Grant awards. Cash Grants awarded from October 1, 2013 to September 30, 2014 are subject to a 7.2 percent sequestration. The sequester percentage will be re-set as of October 1, 2014 when the federal government’s 2015 fiscal year starts. The sequester percentage is based on the size of the deficit relative to the targets provided for in the BCA. As tax collections have been exceeding targets, the sequester percentage is likely to decline slightly for fiscal year 2015 but that could change between now and then.
Notice 2014-39 addresses how sequestration affects the tax attributes of the renewable energy projects that received Cash Grants. First, Notice 2014-39 confirms that a taxpayer that receives a Cash Grant subject to reduction as a result of sequestration may not make itself whole by claiming the investment tax credit (ITC) on the sequestered portion. Further, the taxpayer may not claim the production tax credit (PTC) with respect to energy produced by the project that received a Cash Grant.
The notice’s conclusions with respect to the tax credits respect is not surprising. Members of Congress had requested that the Treasury publish guidance enabling taxpayers to claim the ITC with respect to a portion of the Cash Grant “eligible basis” attributable to the sequester. Treasury’s letter in response to that request provided the owner of a renewable energy project by applying for and receiving a Cash Grant was precluded from claiming the ITC with respect to any portion of that same project. Treasury’s letter is available here, and the letter’s substance is in this respect comparable to the Notice.
Second, Notice 2013-39 confirms that the 50 percent basis adjustment associated with the Cash Grant only applies to the extent of the Cash Grant actually paid. For instance, if a renewable energy project has an “eligible basis” of $100, so the pre-sequester Cash Grant would be $30, but the actual Cash Grant paid is $27.84 after the 7.2% percent sequestration, then the 50 percent basis reduction is $13.92 (rather than $15). Fortunately, the IRS did not take the position that the basis was reduced by the pre-sequester gross Cash Grant award.
If a Cash Grant applicant wants to avoid the sequester haircut and has not yet received its Cash Grant, it may terminate its application and claim the ITC. Since non-refundable tax credits, like the ITC, are outside the scope of the automatic cuts in the BCA, the ITC is not reduced by sequestration. Of course, an economic benefit from the ITC requires a tax liability that can be reduced by the tax credit. If an applicant does not have sufficient tax liability, it leads to the question of what has a greater cost: (a) 7.2 percent sequestration; or (b) receiving the full ITC but having the time value drag of carrying the tax credit to a future year in which the taxpayer has sufficient tax liability. Further, in the case of individuals, the “passive activity loss” and “at risk” rules must also be factored into that calculation.
1 The cash grant is provided for in Section 1603 of division B of the American Recovery and Reinvestment Act, as amended (Cash Grant). For wind and solar projects, the Cash Grant is 30 percent of “eligible basis.” Solar projects have until the end of 2016 to be “placed in service”; however, a preliminary cash grant application must have been filed before the end of 2012. Wind projects must have been placed in service before the end of 2012.