Impact of the Tax Reform Act on the energy sector

This article comes from international law firm Baker Botts LLP and is authored by Richard A. Husseini , Michael P. Bresson , Derek S. Green , Matt Hunsaker, Jon Lobb , Don J. Lonczak, Josh Mandell, Stephen D. Marcus , Jeff Munk, Renn G. Neilson,  Robert Phillpott,  Ron Scharnberg, and Jon Nelsen

On December 20, 2017, the U.S. House of Representatives and the U.S. Senate passed a tax reform act (formerly known as the Tax Cuts and Jobs Act or the “Act”). President Trump is expected to sign the Act into law. The Act includes several major changes to many areas of the Internal Revenue Code (the Code) impacting taxpayers who are engaged in the energy sector. Because most of the changes are effective January 1, 2018, prompt review of your structure and operations is warranted to understand how the new legislation will impact you and whether restructuring in early 2018 might improve your tax situation.

Executive Summary

This update summaries the general changes of the tax law of particular interest to energy companies, as well as specific provisions targeted to particular taxpayers in the energy industry. Topics summarized below include

• General Income Tax Changes

– Reduction of Corporate Income Tax Rate

– Changes to Pass-Through Taxation

– Limitation of Interest Deductibility

– Repeal of Corporate AMT

– New Restrictions on NOL Utilization

– Repeal of Technical Termination of Partnerships

– Changes to Depreciation Rules

– Repeal of Section 199 Deduction

• Changes to International Tax Provisions

– Territorial Corporate Tax System

– Repeal of Active Trade or Business Exception under Section 367(a)

– Loss Recapture on Transfer of a Foreign Branch to a Foreign Corporation

– Deemed Repatriation of Deferred Foreign Earnings of 10%-Owned Foreign Corporations

– Current-Year Taxation for Global Intangible Low-Taxed Income for U.S. Shareholders of CFCs

– Effective 13.125% Tax Rate on Foreign-Derived Intangible Income of a Domestic Corporation

– Other Changes to Subpart F Rules

– Anti-Base Erosion Rules

– Changes to Foreign Tax Credit System – The Base-Erosion Anti-Abuse Tax (BEAT)

– Shareholders Not Eligible for Preferential Tax Rate on Dividends from Inverted Companies

– Sale of a Partnership Interest by a Foreign Person

– Repeal of Fair Market Value Method of Interest Expense Apportionment

Impact to MLPs

Impact to Renewable Energy

Impact on Power Projects

Impact on Normalization Rules for Regulated Utilities

Proposed Energy Tax Changes That Were Not Enacted

Corporate Tax Rate Lowered

One such change is the reduction of the corporate income tax rate. The Act permanently reduces the corporate tax rate to a flat 21% beginning in 2018. When combined with the maximum 20% tax rate on qualified dividends paid by a C corporation to an individual shareholder, the effective tax rate on income of a C corporation distributed to its shareholders will be 36.8% (or 39.8% after the 3.8% Medicare tax on dividends).

Up to 20% Deduction for Qualified Business Income of Pass-Through Entities

Pass-through entities are also commonly used in the energy sector. Beginning in 2018, the Act provides for up to a 20% deduction for individuals for qualified business income earned through pass-through entities, such as partnerships and limited liability companies taxed as partnerships, S corporations, disregarded entities and trusts. This deduction (when combined with the reduction in individual income tax rates) theoretically would result in an effective maximum marginal tax rate of 29.6% (plus unearned income Medicare tax, where applicable), for taxpayers entitled to the full 20% deduction. However, the deduction is subject to several limitations that are likely to materially limit the deduction for many taxpayers.

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