Agribusiness Law Alert: The Wind Energy Promotion Act: Turbo Charging the Renewable Energy Production Tax Credit
U.S. Representatives Collin Peterson (MN) and Tim Walz (MN) introduced the Wind Energy Promotion Act (WEPA) last month. If WEPA becomes federal law, the Renewable Energy Production Tax Credit (PTC) promises to become an even more potent driver for wind power project development. Under current law, the PTC may only be used to shelter passive activity income from tax liability. If adopted, WEPA would allow the use of the PTC to shelter up to $40,000 of ordinary income, a modification that would boost the effectiveness of the PTC. WEPA is the subject of this alert.
If adopted, WEPA will become effective with taxable years beginning after the date of its enactment. WEPA will not be easy to adopt in either the House or Senate; in fact, it is not likely to be adopted if history is any guide. Not only is WEPA one of many, many legislative efforts (some 2,000 tax bills are submitted for consideration each year), but the passive activity loss rules that WEPA would modify were adopted in 1986, at a time when a handful of concessions were made to pass that tax legislation. The passive activity rules have not been modified since then. Congress knows it will be a Pandora's box if the rules are modified. In other words, the argument will be, if wind, then why not geothermal, wave energy, biofuels and other forms of renewable energy? And beyond renewable energy, other groups and interests would want the passive activity loss rules altered for their unique circumstances. Congress knows that if the door is opened for one issue like wind, politics will force the legislative door open for many other issues.
The PTC is the single most powerful driver of wind power project development. The PTC provides an inflation-adjusted tax credit for electricity that is produced from qualifying renewable energy projects for the first 10 years of energy production from the project. The credit was 1.5 cents per kilowatt hour at the inception of the program in 1992, but it adjusts annually with inflation and is currently at 2.1 cents per kilowatt hour. In the table that follows, notice that installation of wind turbines noticeably decreased in 2000, 2002 and 2004 after each expiration of the PTC legislation, clearly illustrating the influence of the PTC on wind power project development:
The PTC is not a permanent tax credit, but instead expires if not renewed. Parenthetically, WEPA would extend the life of the PTC far in advance of when it is set to expire to ensure the continuance of this important tax and economic driver for renewable energy.
WEPA would increase the potency of the PTC because WEPA will enlarge the class of investors who can efficiently use the PTC. As discussed above, the PTC currently shelters only passive activity income. Individual investors typically have minimal passive activity income relative to corporations and tax-paying institutional investors. Hence, individuals have not previously, either individually or collectively, invested in wind power in a significant way. By allowing the PTC to offset up to $40,000 of ordinary income, individuals would now be more likely to add an interest in a wind power project to their diversified investment portfolio. Moreover, wind power projects would not depend as strongly on the availability of a "tax investor" with passive activity gains that can be offset, a quality that is admittedly more rare these days.
WEPA would also create opportunities for generation and transmission cooperative electric associations to organize their members for making investments in wind power projects and achieving renewable energy portfolio standards. Such cooperatives cannot use the PTC efficiently because most are tax-exempt while the rest receive co-op patronage tax deductions that are roughly equal to their patronage income; they do not have (or have very little) taxable income that can be sheltered with the PTC. But these cooperatives are, in many cases, subject to the same renewable energy portfolio standards as investor-owned utilities. Hence, if adopted, WEPA would create incentives for these cooperatives to work with their members to collectively achieve portfolio standards.
It appears1 that WEPA would allow an individual to shelter $40,000 of income for the first three to four years of wind production with an investment of approximately $128,000 in wind turbines. A 2.5 megawatt wind turbine operating at 35% capacity produces 7,665,000 kilowatt hours of electricity annually. At a PTC rate of 2.01 cents per kilowatt hour (the inflation-adjusted rate for 2009), the value of the PTC generated from that single 2.5 megawatt turbine is $160,965. If the turbine costs $3 million to construct and is financed half with equity and half with debt, an 8%2 return on equity would generate $2,000 of income on a $25,000 investment, along with $2,683 of PTC. After sheltering the $2,000 of income generated by the wind turbine, $683 of PTC remains to shelter ordinary taxable income.
The WEPA tax savings would be higher than forecast in the previous paragraph because the turbine is unlikely to be profitable until after its fourth or fifth year of production. The first four to five years of wind production, therefore, should create $2,683 of annual tax shelter for ordinary income under the assumptions above. Consequently, at a 34.5% marginal tax rate, the PTC from a $25,000 investment will shelter $7,775 of ordinary income until the turbine is profitable. It follows that an investment of approximately $128,000 would shelter $40,000 of ordinary income during the first four to five years when the turbine is not profitable or perhaps is only marginally profitable.
The proposed legislation reflects the potential for new development of wind energy in the United States. The American Wind Energy Association reported that in 2008, only 1.26% of the United States' electricity was generated by wind turbines. That compares to 20% in Denmark, 9% in Spain and 7% in Portugal and Germany. Given the United States' sizable natural resource base, it has far more upside potential to develop wind power than those smaller countries.
Please note that this analysis does not address the added incentives provided by state law or the sale of carbon credits and reduction of greenhouse gases. We encourage you to contact your congressman and senator in Washington, D.C. if you support this legislation.
If you have any questions about this alert, please contact:
Joel Dahlgren at (612) 373-8806 or firstname.lastname@example.org
Greg Jenner at (612) 373-8857 or email@example.com
Kevin Johnson at (612) 373-8803 or firstname.lastname@example.org
Joe Thompson at (612) 373-8822 or email@example.com
1 Please do your own analysis for your situation prior to making judgments about the worthiness of an investment.
2 Presumably conservative, we believe.
IRS Circular 230 notice: Any tax advice contained herein was not intended or written to be used, and cannot be used, by you or any other person (i) in promoting, marketing or recommending any transaction, plan or arrangement or (ii) for the purpose of avoiding penalties that may be imposed under federal tax law.