As explained in a previous post, the sequester beginning on March 1, 2013 required Section 1603 Payments under the American Recovery and Reinvestment Tax Act of 2009 face cuts of 7.2 or 8.7 percent dependent upon the effective date of the Award Letter. While guidance the Internal Revenue Service recently released clarifies how to calculate tax treatment of Section 1603 Payments affected by the recent sequester, it fails to provide any certainty beyond September 30, 2014 for planning purposes.
Specifically, the IRS states in its June Notice 2014-39 that sequestration cuts do not affect the amount of Section 1603 Award Letters or the basis of the specified energy property taken into account when determining the Award Letter value.
In practice, this means that while an Award Letter relies upon the full basis of the energy property, the Award Payment is calculated by applying the sequester rate to the Award Letter value. The sequester rate for projects which qualified between March 1, 2013 and September 30, 2013 is 8.7 percent or for projects which qualify between October 1, 2013 and September 30, 2014, 7.2 percent.
For energy projects which are permitted after September 30, 2014, “the sequestration rate is subject to change,” according to the IRS guidance. The guidance further specifies that a taxpayer may not partition the basis of property in order to claim both a Section 45 or 48 tax credit and a Section 1603 Award based upon the same property.
To give an example, an energy property with a with a basis of $100 million granted a Section 1603 Award on May 1, 2013 would receive an Award Letter of $30 million. The sequester rate of 8.7 percent would then be applied and the taxpayer would receive a Section 1603 Award Payment of $27,390,000. The taxpayer would then reduce the basis of its property by one-half the Award Payment, or $13,695,000, and because it received a Section 1603 Award Payment, it may not partition the property basis and claim a Section 45 or 48 credit on the remainder.
Practically speaking, taxpayers whose energy projects began construction prior to December 1, 2011 may maintain a choice between claiming Section 45 or 48 credits or Section 1603 Payments in lieu of tax credit. But, in so doing, they should carefully weigh the benefits of each before making a determination due to the sequester’s effect on the latter. Moreover, if an energy investor is looking to apply for Section 1603 grant, there is no certainty from the IRS regarding sequestration rates after September 30, 2014 to aid in budgeting.