It has been over thirty years since the last major overhaul of the U.S. tax code, President Reagan's Tax Reform Act of 1986. That process took over two years and required cooperation between the President and both parties in Congress. Since then, there have been thousands of changes to the tax code, making it much more complicated and, as a consequence, more difficult for businesses to operate. With Republicans in control on both Capitol Hill and in the White House, there has been an increasing amount of public pressure to once again do the impossible and overhaul the code to make it simpler for businesses and individuals.
Although there have been several attempts to reform the tax code since 1986, this year presents the best opportunity to accomplish this effort. President Trump and congressional leadership have identified tax reform as a top priority before the end of the year. Although a lot of information is still forthcoming, both House Republicans and the Trump administration have produced concepts on reform. These outlines are not fully-detailed plans, but the information that has been revealed includes proposals that would have a significant impact on the energy sector. Stakeholders in the energy industry will need to keep a close eye on the details of the outlines listed below as well as any future developments regarding tax reform.
House of Representatives Blueprint
The House Republican blueprint for individual and corporate tax reform (A Better Way) introduced last year recommends substantial and wide-ranging changes in how energy companies are taxed. These changes are complex and, at this point, many significant details of the plan remain vague or unspecified. The plan moves the tax code towards a cash-flow consumption tax and creates a mixed bag of positive and negative effects for the energy industry.
For starters, it lowers the corporate tax rate from 35 percent to 20 percent, which for some sectors in the energy industry would represent the single largest reduction in tax liability under the plan. Secondly, the plan allows for the immediate expensing of all assets including tangible and intangible assets, but not the cost of land. The plan repeals the corporate Alternative Minimum Tax (AMT), which would benefit some sectors; however, the plan does not mention the transition rules for AMT credits, so it is unclear if companies can still use accumulated credits.
There are some provisions that will not be as well-received by certain sectors of the industry. While the plan does not specifically mention depletion allowances, many believe that it would in fact repeal it in its current form. The loss of the depletion allowance would have a huge impact on the oil and gas and mining sectors, as they rely on it to recover capital investment. The plan also makes significant changes to the deduction used by energy companies for interest expenses in acquiring assets used in production. In exchange for the immediate expensing of assets mentioned above, companies would only be allowed to deduct the net interest expense. This would have a significant effect on the fossil fuel industry and the power and utility sector, especially those that are highly leveraged.
One of the most controversial provisions in A Better Way is the inclusion of a Border Adjustment Tax (BAT). This could have ramifications for all energy sectors as it would call for a 20 percent tax on imported products, including equipment, while exempting exports. It would especially impact refiners who rely on crude oil imports. However, it would benefit those who export overseas, such as companies who export crude oil products.
Senate Finance Committee Chairman Orrin Hatch (R-UT) has been working on an alternative route that includes corporate integration. He has been working on his plan for several years to eliminate the double taxation of corporate income, but details are scarce. He has publicly stated that he won’t move on his reform bill unless the House bill collapses. Additionally, the BAT proposal in the House is not popular in the Senate and could further complicate reform efforts. In fact, some Senators have said it would be dead on arrival if it were included, which is why Senate finance staff have been working behind the scenes on a draft just in case.
Trump Administration Proposals
President Trump has also produced a tax reform outline that has some similarities to A Better Way, but also diverges from it in many aspects. To start, it has a lower corporate tax rate than the House plan, taking it from the current level of 35 percent to 15 percent. The plan allows for full and immediate expensing for all business expenditures, but this only applies to manufacturing activities.
The House plan allows for full expensing, which some have speculated is in exchange for the elimination of the deductibility of net interest expense. Rather than completely eliminate the net interest expense, the Trump administration’s plan gives manufacturers the option to choose between full expensing and the net interest deduction. The plan is largely silent on a border tax, although President Trump has discussed the difference between trade tariffs and a border tax in several recent speeches, leading some to believe that he prefers instituting tariffs.
Impact on Renewable Energy Unclear
Still undetermined is how any of these proposals would impact the renewable energy sector. Both the Investment Tax Credit and Production Tax Credit received multi-year extensions that include phase-outs of the credit over time. The purported justification for reducing the corporate tax rate is the elimination of individual corporate tax credits. Whether the renewable credits will be allowed to continue as currently crafted, or whether they will be “on the table” as well, will be critical to the renewable industries, particularly wind and solar.
The timeline for completing tax reform has been pushed back repeatedly since the beginning of the year. President Trump had hoped to complete tax reform by August, but members of his own cabinet and Senate Majority Leader Mitch McConnell have recently stated this is unlikely to occur. Not only do House leaders need to work out the differences in their outline with President Trump, but they also need to ensure it can pass the Senate. A potential sweetener for tax reform is the prospect that it might be paired with new infrastructure spending.
Part of the reason why tax reform has been delayed is because of the failure to enact health care legislation in March, which Congress will likely once again focus on before fully turning to taxes. Last week, President Trump stated that health care must be taken care of before tax reform. The bottom line is that the federal government is expected to pursue tax reform — and their decisions could have wide ranging impacts on the energy sector.