DESCRIPTION OF 

THE “ENERGY TAX INCENTIVES ACT OF 2003” 

Scheduled for Markup 

By the 

SENATE COMMITTEE ON FINANCE 

on April 2, 2003 

Prepared by 

the Staff of the 

JOINT COMMITTEE ON TAXATION 

March 31, 2003 

JCX-21-03 
 

i 

CONTENTS 

Page

INTRODUCTION .......................................................................................................................... 1 

I. RENEWABLE ENERGY ........................................................................................................... 2

A. Extension and Modification of the Section 45 Electricity Production Credit .................... 2 

II. ALTERNATIVE VEHICLES AND FUEL INCENTIVES....................................................... 6 

A. Modifications and Extensions of Provisions Relating to Electric Vehicles, Clean-Fuel 

Vehicles, and Clean-Fuel Vehicle Refueling Property....................................................... 6 

B. Modifications to Small Producer Ethanol Credit.............................................................. 15 

C. Tax Credit for Biodiesel Fuel Mixtures............................................................................ 16 

III. CONSERVATION AND ENERGY EFFICIENCY PROVISIONS...................................... 18 

A. Business Credit for Construction of New Energy-Efficient Homes................................. 18 

B. Tax Credit for Energy-Efficient Appliances..................................................................... 20 

C. Credit for Residential Energy Efficient Property.............................................................. 22 

D. Business Tax Incentives for Fuel Cells............................................................................. 24 

E. Allowance of Deduction for Energy-Efficient Commercial Building Property ............... 25 

F. Three-Year Applicable Recovery Period for Depreciation of Qualified Energy 

Management Devices........................................................................................................ 27 

G. Three-Year Applicable Recovery Period for Depreciation of Qualified Water 

Submetering Devices ........................................................................................................ 28 

H. Energy Credit for Combined Heat and Power System Property....................................... 29 

I. Credit for Energy Efficiency Improvements to Existing Homes...................................... 31 

IV. CLEAN COAL INCENTIVES............................................................................................... 33 

A. Investment and Production Credits for Clean Coal Technology ...................................... 33 

V. OIL AND GAS PROVISIONS................................................................................................ 39 

A. Tax Credit for Oil and Gas Production from Marginal Wells .......................................... 39
 

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ii 

B. Natural Gas Gathering Lines Treated as Seven-Year Property ........................................ 40 

C. Expensing of Capital Costs Incurred and Credit for Production in Complying with 

Environmental Protection Agency Sulfur Regulations..................................................... 41 

D. Determination of Small Refiner Exception to Oil Depletion Deduction.......................... 42 

E. Extension of Suspension of Taxable Income Limit With Respect to Marginal 

Production......................................................................................................................... 43 

F. Amortization of Geological and Geophysical Expenditures ............................................ 46 

G. Amortization of Delay Rental Payments .......................................................................... 49 

H. Extension and Modification of Credit for Producing Fuel From a Non-Conventional 

Source ............................................................................................................................... 50 

I. Natural Gas Distribution Lines Treated as Fifteen-Year Property ................................... 53 

VI. PROVISIONS RELATING TO ELECTRIC INDUSTRY RESTRUCTURING.................. 54 

A. Modification to Special Rules for Nuclear Decommissioning Costs ............................... 54 

B. Treatment of Certain Income of Cooperatives.................................................................. 57 

C. Sales or Dispositions to Implement Federal Energy Regulatory Commission or State 

Electric Restructuring Policy ............................................................................................ 62 

VII. ADDITIONAL PROVISIONS.............................................................................................. 63 

A. Extension of Accelerated Depreciation and Wage Credit Benefits on Indian 

Reservations...................................................................................................................... 63 

B. GAO Study........................................................................................................................ 65 
1

INTRODUCTION 

The Senate Committee on Finance has scheduled a markup on April 2, 2003, on the 

“Energy Tax Incentives Act of 2003.” This document,1

 prepared by the staff of the Joint 

Committee on Taxation, provides a description of the “Energy Tax Incentives Act of 2003.

 

1

 This document may be cited as follows: Joint Committee on Taxation, Description of 

the “Energy Tax Incentives Act of 2003” (JCX-21-03), March 31, 2003. 
2

I. RENEWABLE ENERGY 

A. Extension and Modification of the Section 45 Electricity Production Credit 

Present Law

An income tax credit is allowed for the production of electricity from either qualified 

wind energy, qualified “closed-loop” biomass, or qualified poultry waste facilities (sec. 45). The 

amount of the credit is 1.5 cents per kilowatt hour (indexed for inflation) of electricity produced. 

The amount of the credit was 1.8 cents per kilowatt hour for 2002. The credit is reduced for 

grants, tax-exempt bonds, subsidized energy financing, and other credits. 

The credit applies to electricity produced by a wind energy facility placed in service after 

December 31, 1993, and before January 1, 2004, to electricity produced by a closed-loop 

biomass facility placed in service after December 31, 1992, and before January 1, 2004, and to a 

poultry waste facility placed in service after December 31, 1999, and before January 1, 2004. 

The credit is allowable for production during the 10-year period after a facility is originally 

placed in service. In order to claim the credit, a taxpayer must own the facility and sell the 

electricity produced by the facility to an unrelated party. In the case of a poultry waste facility, 

the taxpayer may claim the credit as a lessee/operator of a facility owned by a governmental unit. 

Closed-loop biomass is plant matter, where the plants are grown for the sole purpose of 

being used to generate electricity. It does not include waste materials (including, but not limited 

to, scrap wood, manure, and municipal or agricultural waste). The credit also is not available to 

taxpayers who use standing timber to produce electricity. Poultry waste means poultry manure 

and litter, including wood shavings, straw, rice hulls, and other bedding material for the 

disposition of manure. 

The credit for electricity produced from wind, closed-loop biomass, or poultry waste is a 

component of the general business credit (sec. 38(b)(8)). The credit, when combined with all 

other components of the general business credit, generally may not exceed for any taxable year 

the excess of the taxpayer’s net income tax over the greater of (1) 25 percent of net regular tax 

liability above $25,000, or (2) the tentative minimum tax. For credits arising in taxable years 

beginning after December 31, 1997, an unused general business credit generally may be carried 

back one year and carried forward 20 years (sec. 39). To coordinate the carryback with the 

period of application for this credit, the credit for electricity produced from closed-loop biomass 

facilities may not be carried back to a tax year ending before 1993 and the credit for electricity 

produced from wind energy may not be carried back to a tax year ending before 1994 (sec. 39). 

Description of Proposal

The proposal extends the placed in service date for wind facilities, closed-loop biomass 

facilities, and poultry waste facilities to facilities placed in service after December 31, 1993 

(December 31, 1992 in the case of closed-loop biomass facilities and December 31, 1999 in the 

case of poultry waste facilities) and before January 1, 2007. 
3

The proposal provides that, for facilities placed in service after the date of enactment, the 

amount of the credit will be 1.5 cents per kilowatt hour with no adjustment for inflation for 

production in years after 2003. 

The proposal also defines six new qualifying energy resources: biomass (including 

agricultural livestock waste nutrients), geothermal energy, solar energy, small irrigation power, 

municipal biosolids, and recycled sludge. 

Qualifying biomass facilities are facilities using biomass to produce electricity that are 

placed in service prior to January 1, 2005. Qualifying agricultural livestock waste nutrient 

facilities are facilities using agricultural livestock waste nutrients to produce electricity that are 

placed in service after the date of enactment and before January 1, 2007. 

For a facility placed in service after the date of enactment, the ten-year credit period 

commences when the facility is placed in service. In the case of biomass facility originally 

placed in service before the date of enactment, the ten-year credit period is reduced to a five-year 

period and commences after December 31, 2003 and the otherwise allowable 1.5 cent-perkilowatt-hour credit is reduced to a1.0 cent-per-kilowatt-hour credit. 

The proposal modifies present law to provide that qualifying closed-loop biomass 

facilities include any facility originally placed in service before December 31, 1992 and modified 

to use closed-loop biomass to co-fire with coal, to co-fire with other biomass, or to co-fire with 

coal and other biomass, before January 1, 2007. The taxpayer may claim credit for electricity 

produced at such qualifying facilities with the credit amount equal to the otherwise allowable 

credit multiplied by the ratio of the thermal content of the closed loop biomass fuel burned in the 

facility to the thermal content of all fuels burned in the facility. 

Qualifying geothermal energy facilities are facilities using geothermal deposits to 

produce electricity that are placed in service after the date of enactment and before January 1, 

2007. Qualifying solar energy facilities are facilities using solar energy to generate electricity 

that are placed in service after the date of enactment and before January 1, 2007. In the case of 

qualifying geothermal energy facilities and qualifying solar energy facilities, taxpayers may 

claim the otherwise allowable credit for the five-year period commencing when the facility is 

placed service. 

A qualified small irrigation power facility is a facility originally placed in service after 

the date of enactment and before January 1, 2007. A small irrigation power facility is a facility 

that generates electric power through an irrigation system canal or ditch without any dam or 

impoundment of water. The installed capacity of a qualified facility is less than five megawatts. 

A qualified municipal biosolids facility is a facility originally placed in service after the 

date of enactment and before January 1, 2007. A qualifying recycled sludge facilities is a facility 

originally placed in service after the date of enactment and before January 1, 2007. 

Biomass is defined as any solid, nonhazardous, cellulosic waste material which is 

segregated from other waste materials and which is derived from any of forest-related resources, 

solid wood waste materials, or agricultural sources. Eligible forest-related resources are mill and 

harvesting residues, precommercial thinnings, slash, and brush. Solid wood waste materials 
4

include waste pallets, crates, dunnage, manufacturing and construction wood wastes (other than 

pressure-treated, chemically-treated, or painted wood wastes), and landscape or right-of-way tree 

trimmings. Agricultural sources include orchard tree crops, vineyard, grain, legumes, sugar, and 

other crop by-products or residues. However, qualifying biomass for purposes of this proposal 

does not include municipal solid waste (garbage), gas derived from biodegradation of solid 

waste, or paper that is commonly recycled. Agricultural waste nutrients are defined as livestock 

manure and litter, including bedding material for the disposition of manure. Agricultural 

livestock comprise bovine, swine, poultry,2

 and sheep among others. 

Geothermal energy is energy derived from a geothermal deposit which is a geothermal 

reservoir consisting of natural heat which is stored in rocks or in an aqueous liquid or vapor 

(whether or not under pressure). 

Municipal biosolids are the residue or solids removed by a municipal wastewater 

treatment facility. 

Recycled sludge is the recycled residue byproduct created in the treatment of 

commercial, industrial, municipal, or navigational wastewater, but not including residues from 

incineration. 

The proposal provides that certain persons (public utilities, electric cooperatives, rural 

electric cooperatives, and Indian tribes) may sell, trade, or assign to any taxpayer any credits that 

would otherwise be allowable to that person, if that person were a taxpayer, for production of 

electricity from a qualified facility owned by such person. However, any credit sold, traded, or 

assigned may only be sold, traded, or assigned once. Subsequent transfers are not permitted. In 

addition, any credits that would otherwise be allowable to such person, to the extent provided by 

the Administrator of the Rural Electrification Administration, may be applied as a prepayment to 

certain loans or obligations undertaken by such person under the Rural Electrification Act of 

1936. 

In the case of qualifying open-loop biomass facilities and qualifying closed-loop biomass 

facilities modified to use closed-loop biomass to co-fire with coal, with other biomass, or with 

coal and other biomass, the provision permits a lessee or operator to claim the credit in lieu of 

the owner of the facilities. 

Lastly, the proposal repeals the present-law reduction in allowable credit for facilities 

financed with tax-exempt bonds or with certain loans received under the Rural Electrification 

Act of 1936. In the case of qualifying closed-loop biomass facilities modified to use closed-loop 

biomass to co-fire with coal, with other biomass, or with coal and other biomass, the proposal 

repeals the present-law reduction in allowable credit for facilities that receive any subsidy. 

 2

 The proposal deletes poultry litter as a separate qualifying facility for facilities placed 

in service after the effective date. 
5

Effective Date

The proposal generally is effective for electricity sold from qualifying facilities after the 

date of enactment. For electricity produced from qualifying open-loop biomass facilities 

originally placed in service prior to the date of enactment, the provision is effective January 1, 

2004. 
6

II. ALTERNATIVE VEHICLES AND FUEL INCENTIVES 

A. Modifications and Extensions of Provisions Relating to Electric Vehicles, 

Clean-Fuel Vehicles, and Clean-Fuel Vehicle Refueling Property 

Present Law

Electric vehicles

A 10-percent tax credit is provided for the cost of a qualified electric vehicle, up to a 

maximum credit of $4,000 (sec. 30). A qualified electric vehicle is a motor vehicle that is 

powered primarily by an electric motor drawing current from rechargeable batteries, fuel cells, or 

other portable sources of electrical current, the original use of which commences with the 

taxpayer, and that is acquired for the use by the taxpayer and not for resale. The full amount of 

the credit is available for purchases prior to 2002. The credit phases down in the years 2004 

through 2006, and is unavailable for purchases after December 31, 2006. 

Clean-fuel vehicles

Certain costs of qualified clean-fuel vehicle may be expensed and deducted when such 

property is placed in service (sec. 179A). Qualified clean-fuel vehicle property includes motor 

vehicles that use certain clean-burning fuels (natural gas, liquefied natural gas, liquefied 

petroleum gas, hydrogen, electricity and any other fuel at least 85 percent of which is methanol, 

ethanol, any other alcohol or ether). The maximum amount of the deduction is $50,000 for a 

truck or van with a gross vehicle weight over 26,000 pounds or a bus with seating capacities of at 

least 20 adults; $5,000 in the case of a truck or van with a gross vehicle weight between 10,000 

and 26,000 pounds; and $2,000 in the case of any other motor vehicle. Qualified electric 

vehicles do not qualify for the clean-fuel vehicle deduction. The deduction phases down in the 

years 2004 through 2006, and is unavailable for purchases after December 31, 2006. 

Clean-fuel vehicle refueling property

Clean-fuel vehicle refueling property may be expensed and deducted when such property 

is placed in service (sec. 179A). Clean-fuel vehicle refueling property comprises property for the 

storage or dispensing of a clean-burning fuel, if the storage or dispensing is the point at which 

the fuel is delivered into the fuel tank of a motor vehicle. Clean-fuel vehicle refueling property 

also includes property for the recharging of electric vehicles, but only if the property is located at 

a point where the electric vehicle is recharged. Up to $100,000 of such property at each location 

owned by the taxpayer may be expensed with respect to that location. The deduction is 

unavailable for costs incurred after December 31, 2006. 

Description of Proposal

Alternative motor vehicle credits

The proposal would provide a credit for the purchase of a new qualified fuel cell motor 

vehicle, a new qualified hybrid motor vehicle, and a new qualified alternative fuel motor vehicle. 
7

In general the proposal provides that the buyer claims the credit, unless the buyer is a tax-exempt 

entity in which case the seller or lessor of the vehicle may claim the credit. The taxpayer may 

carry forward unused credits for 20 years or carry unused credits back for three years (but not to 

any taxable year beginning before the date of enactment). Qualified vehicles are vehicles placed 

in service before 2007 (2012 in the case of fuel cell vehicles). Any deduction otherwise 

allowable under sec. 179A is reduced by the amount of credit allowable. 

Fuel cell vehicles

A qualifying fuel cell vehicle is a motor vehicle that is propelled by power derived from 

one or more cells which convert chemical energy directly into electricity by combining oxygen 

with hydrogen fuel which is stored on board the vehicle and may or may not require reformation 

prior to use. The amount of credit for the purchase of a fuel cell vehicle is determined by a base 

credit amount that depends upon the weight class of the vehicle and, in the case of automobiles 

or light trucks, an additional credit amount that depends upon the rated fuel economy of the 

vehicle compared to a base fuel economy. For these purposes the base fuel economy is the 2002 

model year city fuel economy rating for vehicles of various weight classes (see below). Table 1 

below, shows the proposed base credit amounts. 

Table 1.–Base Credit Amount for Fuel Cell Vehicles 

Vehicle Gross Weight Rating in Pounds Credit Amount 

vehicle ≤ 8,500.................................................. $3,400 

8,500 < vehicle ≤ 14,000................................... $8,500 

14,000 < vehicle ≤ 26,000................................. $17,000 

26,000 < vehicle................................................ $34,000 

Table 2, below, shows the proposed additional credits for passenger automobiles or light 

trucks. 
8

Table 2.–Credit for Qualifying Fuel Cell Vehicles

If Fuel Economy of the Fuel Cell Vehicle Is: 

Credit at least but less than 

$1,000 150% of base fuel economy 175% of base fuel economy 

$1,500 175% of base fuel economy 200% of base fuel economy 

$2,000 200% of base fuel economy 225% of base fuel economy 

$2,500 225% of base fuel economy 250% of base fuel economy 

$3,000 250% of base fuel economy 275% of base fuel economy 

$3,500 275% of base fuel economy 300% of base fuel economy 

$4,000 300% of base fuel economy 

Hybrid vehicles

A qualifying hybrid vehicle is a motor vehicle that draws propulsion energy from onboard sources of stored energy which include both an internal combustion engine or heat engine 

using combustible fuel and a rechargeable energy storage system (e.g., batteries). The amount of 

credit for the purchase of a hybrid vehicle is the sum of two components. In the case of an 

automobile or light truck, the amount of credit is the sum of a base credit amount that varies with 

the amount of power available from the rechargeable storage system and a fuel economy credit 

amount that varies with the rated fuel economy of the vehicle compared to a 2002 model year 

standard. In the case of a heavy duty hybrid motor vehicle (a vehicle weighing more than 10,000 

pounds), the amount of credit is the sum of a base credit amount that varies, by vehicle weight 

class, with the amount of power available from the rechargeable storage system and an additional 

credit for early adoption of the technology that varies with the model year of the vehicle 

purchased. 

For these purposes, a vehicle’s power available from its rechargeable energy storage 

system as a percentage of maximum available power is calculated as the maximum value 

available from the battery or other energy storage device during a standard power test, divided by 

the sum of the battery or other energy storage device and the SAE net power of the heat engine. 

Table 3, below, shows the proposed base credit amounts for automobiles and light trucks. 
9

Table 3.–Hybrid Vehicle Base Credit Amount for Automobiles and Light Trucks, 

Dependent Upon the Power Available from the Rechargeable Energy Storage 

System as a Percentage of the Vehicles Maximum Available Power 

 If Rechargeable Energy Storage System Provides: 

Base Credit 

Amount at least but less than 

$100 4% of maximum available power 10% of maximum available power 

$200 10% of maximum available power 20% of maximum available power 

$300 20% of maximum available power 30% of maximum available power 

$400 30% of maximum available power 

Table 4, below, shows the proposed additional fuel economy credit available to a hybrid 

passenger automobile or light truck whose fuel economy (on a gasoline gallon equivalent basis) 

exceeds that of a base fuel economy. For these purposes the base fuel economy is the 2002 

model year city fuel economy rating for vehicles of various weight classes (see below). 

Table 4.–Additional Fuel Economy Credit for Hybrid Vehicles 

If Fuel Economy of the Hybrid Vehicle Is: 

Credit at least but less than 

$500 125% of base fuel economy 150% of base fuel economy 

$1,000 150% of base fuel economy 175% of base fuel economy 

$1,500 175% of base fuel economy 200% of base fuel economy 

$2,000 200% of base fuel economy 225% of base fuel economy 

$2,500 225% of base fuel economy 250% of base fuel economy 

$3,000 250% of base fuel economy 

Table 5 below, shows the proposed base credit amounts for heavy duty hybrid vehicles 

weighing 14,000 pounds or less. 
10

Table 5.–Hybrid Vehicle Base Credit Amount for Heavy Duty Vehicles 

Weighing Not More Than 14,000 pounds 

 If Rechargeable Energy Storage System Provides: 

Base Credit 

Amount at least but less than 

$400 20% of maximum available power 30% of maximum available power 

$700 30% of maximum available power 40% of maximum available power 

$800 40% of maximum available power 50% of maximum available power 

$900 50% of maximum available power 60% of maximum available power 

$1,000 60% of maximum available power 

In the case of heavy duty hybrid vehicles weighing not more than 14,000 pounds, the 

additional credit amount for early adoption of the technology is $3,000 for model year 2003 

vehicles, $2,500 for model year 2004 vehicles, $2,000 for model year 2005 vehicles, and $1,500 

for model year 2006 vehicles. 

Table 6, below, shows the proposed base credit amounts for heavy duty hybrid vehicles 

weighing more than 14,000 pounds but not more than 26,000 pounds. 

Table 6.–Hybrid Vehicle Base Credit Amount for Heavy Duty Hybrid Vehicles 

Weighing More Than 14,000 Pounds, But Not More Than 26,000 Pounds 

 If Rechargeable Energy Storage System Provides: 

Base Credit Amount at least but less than 

$1,600 20% of maximum available power 30% of maximum available power 

$1,800 30% of maximum available power 40% of maximum available power 

$2,000 40% of maximum available power 50% of maximum available power 

$2,200 50% of maximum available power 60% of maximum available power 

$2,400 60% of maximum available power 

In the case of heavy duty hybrid vehicles weighing more than 14,000 pounds but not 

more than 26,000 pounds, the additional credit amount for early adoption of the technology is 

$7,750 for model year 2003 vehicles, $6,500 for model year 2004 vehicles, $5,250 for model 

year 2005 vehicles, and $4,000 for model year 2006 vehicles. 

Table 7, below, shows the proposed base credit amounts for heavy duty hybrid vehicles 

weighing more than 26,000 pounds. 
11

Table 7.–Hybrid Vehicle Base Credit Amount for Heavy Duty Hybrid 

Vehicles Weighing More Than 26,000 Pounds 

 If Rechargeable Energy Storage System Provides: 

Base Credit Amount at least but less than 

$2,400 20% of maximum available power 30% of maximum available power

$2,800 30% of maximum available power 40% of maximum available power

$3,200 40% of maximum available power 50% of maximum available power

$3,600 50% of maximum available power 60% of maximum available power

$4,000 60% of maximum available power 

In the case of heavy duty hybrid vehicles weighing more than 26,000 pounds, the 

additional credit amount for early adoption of the technology is $12,000 for model year 2003 

vehicles, $10,000 for model year 2004 vehicles, $8,000 for model year 2005 vehicles, and 

$6,000 for model year 2006 vehicles. 

Alternative fuel vehicle

The credit for the purchase of a new alternative fuel vehicle would be 40 percent of the 

incremental cost of such vehicle, plus an additional 30 percent if the vehicle meets certain 

emissions standards, but not more than between $4,000 and $35,000 depending upon the weight 

of the vehicle. Table 8, below, shows the maximum permitted incremental cost for the purpose 

of calculating the credit for alternative fuel vehicles by vehicle weight class. 

Table 8.–Maximum Allowable Incremental Cost for Calculation 

of Alternative Fuel Vehicle Credit 

Vehicle Gross Weight Rating in Pounds Maximum Allowable Incremental Cost 

vehicle ≤ 8,500.................................................. $4,000 

8,500 < vehicle ≤ 14,000................................... $8,500 

14,000 < vehicle ≤ 26,000................................. $20,000 

26,000 < vehicle................................................ $35,000 

Alternative fuels comprise compressed natural gas, liquefied natural gas, liquefied 

petroleum gas, hydrogen, and any liquid fuel that is at least 85 percent methanol. Qualifying 

alternative fuel motor vehicles are vehicles that operate only on qualifying alternative fuels and 

are incapable of operating on gasoline or diesel (except in the extent gasoline or diesel fuel is 

part of a qualified mixed fuel, described below). 
12

Certain mixed fuel vehicles, that is vehicles that use a combination of an alternative fuel 

and a petroleum-based fuel, are eligible for a reduced credit. If the vehicle operates on a mixed 

fuel that is at least 75 percent alternative fuel, the vehicle is eligible for 70 percent of the 

otherwise allowable alternative fuel vehicle credit. If the vehicle operates on a mixed fuel that is 

at least 90 percent alternative fuel, the vehicle is eligible for 90 percent of the otherwise 

allowable alternative fuel vehicle credit. 

Base fuel economy

The base fuel economy is the 2002 model year city fuel economy for vehicles by inertia 

weight class by vehicle type. The “vehicle inertia weight class” is that defined in regulations 

prescribed by the Environmental Protection Agency for purposes of Title II of the Clean Air Act. 

Table 9, below, shows the 2002 model year city fuel economy for vehicles by type and by inertia 

weight class. 

Table 9.–2002 Model Year City Fuel Economy 

Vehicle Inertia 

Weight Class 

(pounds) 

Passenger Automobile 

(miles per gallon) 

Light Truck 

(miles per gallon) 

1,500 45.2 39.4 

1,750 45.2 39.4 

2,000 39.6 35.2 

2,250 35.2 31.8 

2,500 31.7 29.0 

2,750 28.8 26.8 

3,000 26.4 24.9 

3,500 22.6 21.8 

4,000 19.8 19.4 

4,500 17.6 17.6 

5,000 15.9 16.1 

5,500 14.4 14.8 

6,000 13.2 13.7 

6,500 12.2 12.8 

7,000 11.3 12.1 

8,500 11.3 12.1 
13

Modification of credit for qualified electric vehicles

The proposal repeals the phaseout of the credit under present law. The proposal also 

modifies present law to provide for a credit equal to the lesser of $1,275 or 10 percent of the 

manufacturer’s suggested retail price of certain vehicles that conform to the Motor Vehicle 

Safety Standard 500. For all other electric vehicles, Table 10, below describes the credit. 

Table 10.–Credit for Qualifying Battery Electric Vehicles 

Vehicle Gross Weight Rating in Pounds Credit Amount 

Vehicle ≤ 8,500................................................. $2,975 

8,500 < vehicle ≤ 14,000................................... $8,500 

14,000 < vehicle ≤ 26,000................................. $17,000 

26,000 < vehicle................................................ $34,000 

If an electric vehicle weighing not more than 8,500 pounds has an estimated driving 

range of at least 100 miles on a single charge of the vehicle’s batteries or if it is capable of a 

payload capacity of at least 1,000 pounds, then the credit amount in Table 10 is $5,100. 

In the case of property purchased by tax-exempt persons, the seller may claim the credit. 

The proposal allows taxpayers to carry forward unused credits for 20 years or carry unused 

credits back for three (but not to any taxable year before the date of enactment). 

Credit for installation of alternative fueling stations

The proposal permits taxpayers to claim a 50-percent credit for the cost of installing 

clean-fuel vehicle refueling property to be used in a trade or business of the taxpayer or installed 

at the principal residence of the taxpayer. In the case of retail clean-fuel vehicle refueling 

property the allowable credit may not exceed $24,000. In the case of residential clean-fuel 

vehicle refueling property the allowable credit may not exceed $800. The taxpayer’s basis in the 

property is reduced by the amount of the credit and the taxpayer may not claim deductions under 

section 179A with respect to property for which the credit is claimed. In the case of refueling 

property installed on property owned or used by a tax-exempt person, the taxpayer that installs 

the property may claim the credit. To be eligible for the credit, the property must be placed in 

service before January 1, 2008 (January 1, 2012 in the case of hydrogen). The credit allowable 

in the taxable year cannot exceed the difference between the taxpayer’s regular tax (reduced by 

certain other credits) and the taxpayer’s tentative minimum tax. The taxpayer may carry forward 

unused credits for 20 years. 

Credit for retail sale of alternative fuels

The proposal permits taxpayers to claim a credit equal to the gasoline gallon equivalent 

of 20 cents per gallon of alternative fuel sold in 2003, 30 cents per gallon in 2004, 40 cents per 

gallon in 2005, and 40 cents per gallon in 2006. Qualifying alternative fuels are compressed 

natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, and any liquid mixture 
14

consisting of at least 85 percent methanol or ethanol. The gasoline gallon equivalency of any 

alternative fuel is determined by reference to the British thermal unit content of the alternative 

fuel compared to a gallon of gasoline. The credit may be claimed for sales prior to January 1, 

2007. Under the proposal, the credit is part of the general business credit. 

Effective Date

The proposals relating to the credit for new fuel cell motor vehicles, hybrid motor 

vehicles, and alternative fuel motor vehicles, the credit for battery electric vehicles, the credit for 

alternative fuel vehicle refueling property, and deductions for clean fuel vehicles and clean fuel 

refueling property are effective for property placed in service after the date of enactment, in 

taxable years ending after the date of enactment. The credit for retail sales of alternative fuels is 

effective for sales of fuels after the date of enactment, in taxable years ending after the date of 

enactment.
15

B. Modifications to Small Producer Ethanol Credit 

Present Law

Small producer credit

Present law provides several tax benefits for ethanol and methanol produced from 

renewable sources (e.g., biomass) that are used as a motor fuel or that are blended with other 

fuels (e.g., gasoline) for such a use. In the case of ethanol, a separate 10-cents-per-gallon credit 

for small producers, defined generally as persons whose production does not exceed 15 million 

gallons per year and whose production capacity does not exceed 30 million gallons per year. 

The alcohol fuels tax credits are includible in income. This credit, like tax credits generally, may 

not be used to offset alternative minimum tax liability. The credit is a treated as a general 

business credit, subject to the ordering rules and carryforward/carryback rules that apply to 

business credits generally. The alcohol fuels tax credit is scheduled to expire after December 31, 

2007. 

Taxation of cooperatives and their patrons

Under present law, cooperatives in essence are treated as pass-through entities in that the 

cooperative is not subject to corporate income tax to the extent the cooperative timely pays 

patronage dividends. Under present law, the only excess credits that may be flowed-through to 

cooperative patrons are the rehabilitation credit (sec. 47), the energy property credit (sec. 48(a)), 

and the reforestation credit (sec. 48(b)). 

Description of Proposal

The proposal makes several modifications to the rules governing the small producer 

ethanol credit. First, the proposal liberalizes the definition of an eligible small producer to 

include persons whose production capacity does not exceed 60 million gallons. Second, the 

proposal allows cooperatives to elect to pass-through the small ethanol producer credits to its 

patrons. The credit allowed to a particular patron is that proportion of the credit that the 

cooperative elects to pass-through for that year as the amount of patronage of that patron for that 

year bears to total patronage of all patrons for that year. 

Third, the proposal repeals the rule that includes the small producer credit in income of 

taxpayers claiming it and liberalizes the ordering and carryforward/carryback rules for the small 

producer ethanol credit. Fourth, the proposal allows the small producer credit to be claimed 

against the alternative minimum tax. Finally, the proposal provides that the small producer 

ethanol credit is not treated as derived from a passive activity under the Code rules restricting 

credits and deductions attributable to such activities. 

Effective Date

The proposal is effective for taxable years beginning after date of enactment.
16

C. Tax Credit for Biodiesel Fuel Mixtures 

Present Law

No income tax credit or excise tax rate reduction is provided for biodiesel fuels under 

present law. 

However, a 52-cents-per-gallon income tax credit (the “alcohol fuels credit”) is allowed 

for ethanol and methanol (derived from renewable sources) when the alcohol is used as a 

highway motor fuel. The benefit of this income tax credit may be claimed through reductions in 

excise taxes paid on alcohol fuels. In the case of alcohol blended with other fuels (e.g., 

gasoline), the excise tax rate reductions are allowable only for blends of 90 percent gasoline/10 

percent alcohol, 92.3 percent gasoline/7.7 percent alcohol, or 94.3 percent gasoline/5.7 percent 

alcohol. These present law provisions are scheduled to expire in 2007. 

Description of Proposal

The proposal provides a new income tax credit for qualified biodiesel fuel mixtures. The 

structure of the new credit would be similar to structure of the present-law alcohol fuels credit. 

Agri-biodiesel is derived from virgin vegetable oils from corn, soybeans, sunflower seeds, 

cottonseeds, canola, crambe, rapeseeds, safflowers, flaxseeds, rice bran, mustard seeds, or animal 

fats, for use in diesel engines. Recycled biodiesel is derived from nonvirgin vegetable oils or 

animal fats for use in diesel engines. Virgin vegetable oils or animal fats mixed with recycled 

biodiesel will be treated as recycled biodiesel. 

The per gallon biodiesel mixture credit rate for agri-biodiesel equals one cent for each 

percentage point of biodiesel in the fuels mixture, subject to a maximum credit of 20 cents per 

blended gallon of fuel. The per gallon biodiesel mixture credit rate for recycled biodiesel equals 

.5 cent for each percentage point of biodiesel in the fuels mixture, subject to a maximum credit 

of 10 cents per blended gallon of fuel. The amount of the biodiesel fuel mixture credit is 

includible in income. The credit may not be carried back to a taxable year beginning before date 

of enactment. 

Agri-biodiesel used in the production of a qualified biodiesel mixture is taken into 

account only if a certification from the producer of the agri-biodiesel which identifies the product 

produced is obtained. Both agri-biodiesel and recycled biodiesel are required to meet the 

requirements of the Environmental Protection Agency under section 211 of the Clean Air Act 

(42 U.S.C. sec. 7545) and the American Society of Testing and Materials D6751. 

Under the proposal, in lieu of an income tax credit for agri-biodiesel blends, a refiner 

blending agri-biodiesel may elect to accrue an excise tax credit equal to the amount of the 

biodiesel mixture credit for agri-biodiesel. An excise tax credit is not available for recycled 

biodiesel. 
17

Effective Date

The biodiesel fuel mixture credit (and excise tax credit) is effective for biodiesel fuel 

blended after (or fuel sold after) date of enactment, and before January 1, 2006. 
18

III. CONSERVATION AND ENERGY EFFICIENCY PROVISIONS 

A. Business Credit for Construction of New Energy-Efficient Homes 

Present Law

A nonrefundable, 10-percent business energy credit is allowed for the cost of new 

property that is equipment (1) that uses solar energy to generate electricity, to heat or cool a 

structure, or to provide solar process heat, or (2) used to produce, distribute, or use energy 

derived from a geothermal deposit, but only, in the case of electricity generated by geothermal 

power, up to the electric transmission stage. 

The business energy tax credits are components of the general business credit (sec. 

38(b)(1)). The business energy tax credits, when combined with all other components of the 

general business credit, generally may not exceed for any taxable year the excess of the 

taxpayer’s net income tax over the greater of (1) 25 percent of net regular tax liability above 

$25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after 

December 31, 1997, an unused general business credit generally may be carried back one year 

and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy provided by a public 

utility for the purchase or installation of an energy conservation measure. An energy 

conservation measure means any installation or modification primarily designed to reduce 

consumption of electricity or natural gas or to improve the management of energy demand with 

respect to a dwelling unit (sec. 136). 

There is no present-law credit for the construction of new energy-efficient homes. 

Description of Proposal 

The proposal provides a credit to an eligible contractor of an amount equal to the 

aggregate adjusted bases of all energy-efficient property installed in a qualified new energyefficient home during construction. The credit cannot exceed $1,000 ($2,000) in the case of a 

new home that has a projected level of annual heating and cooling costs that is 30 percent (50 

percent) less than a comparable dwelling constructed in accordance with Chapter 4 of the 2000 

International Energy Conservation Code. 

The eligible contractor is the person who constructed the home, or in the case of a 

manufactured home, the producer of such home. Energy efficiency property is any energyefficient building envelope component (insulation materials or system designed to reduce heat 

loss or gain, and exterior windows, including skylights, and doors) and any energy-efficient 

heating or cooling appliance that can, individually or in combination with other components, 

meet the standards for the home. 

To qualify as an energy-efficient new home, the home must be: (1) a dwelling located in 

the United States; (2) the principal residence of the person who acquires the dwelling from the 

eligible contractor, and (3) certified to have a projected level of annual heating and cooling 
19

energy consumption that meets the standards for either the 30-percent or 50-percent reduction in 

energy usage. The home may be certified according to a component-based method or an energy 

performance based method. Additionally, manufactured homes certified by the Energy Star 

Labeled New Homes program are eligible for the $1,000 credit provided criteria (1) and (2) are 

met. 

The component-based method of certification shall be based on applicable energyefficiency specifications or ratings, including current product labeling requirements. The 

Secretary shall develop component-based packages that are equivalent in energy performance to 

properties that qualify for the credit. The certification shall be provided by a third party, such as 

a local building regulatory authority, a utility, a manufactured home production inspection 

agency, or a home energy rating organization. 

The performance-based method of certification shall be based on an evaluation of the 

home in reference to a home which uses the same energy source and system heating type, and is 

constructed in accordance with the Chapter 4 of the 2000 International Energy Conservation 

Code. The certification shall be provided by an individual recognized by the Secretary for such 

purposes. 

The certification process requires that energy savings to the consumer be measured in 

terms of energy costs. To ensure consistent and reasonable energy cost analyses, the Department 

of Energy shall include in its rulemaking related to this bill specific reference data to be used for 

qualification for the credit. 

The credit will be part of the general business credit. No credits attributable to energy 

efficient homes may be carried back to any taxable year ending on or before the effective date of 

the credit. 

Effective Date

The credit applies to homes whose construction is substantially completed after the date 

of enactment and which are purchased during the period beginning on the date of enactment and 

ending on December 31, 2007 (December 31, 2005 in the case of the $1,000 credit).
20

B. Tax Credit for Energy-Efficient Appliances 

Present Law

A nonrefundable, 10-percent business energy credit is allowed for the cost of new 

property that is equipment: (1) that uses solar energy to generate electricity, to heat or cool a 

structure, or to provide solar process heat; or (2) used to produce, distribute, or use energy 

derived from a geothermal deposit, but only, in the case of electricity generated by geothermal 

power, up to the electric transmission stage. 

The business energy tax credits are components of the general business credit (sec. 

38(b)(1)). The business energy tax credits, when combined with all other components of the 

general business credit, generally may not exceed for any taxable year the excess of the 

taxpayer’s net income tax over the greater of: (1) 25 percent of net regular tax liability above 

$25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after 

December 31, 1997, an unused general business credit generally may be carried back one year 

and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy provided by a public 

utility for the purchase or installation of an energy conservation measure. An energy 

conservation measure means any installation or modification primarily designed to reduce 

consumption of electricity or natural gas or to improve the management of energy demand with 

respect to a dwelling unit (sec. 136). 

There is no present-law credit for the manufacture of energy-efficient appliances. 

Description of Proposal 

The proposal provides a credit for the production of certain energy-efficient clothes 

washers and refrigerators. The credit would equal $50 per appliance for energy-efficient clothes 

washers produced with a modified energy factor (“MEF”) of 1.42 MEF or greater for washers 

produced before 2007 and for refrigerators produced before 2005 that consume 10 percent less 

kilowatt-hours per year than the energy conservation standards promulgated by the Department 

of Energy that took effect on July 1, 2001. The credit equals $100 for energy-efficient clothes 

washers produced with a MEF of 1.5 or greater and for refrigerators produced that consume at 

least 15 percent less kilowatt-hours per year (at least 20 percent less for production in 2007) than 

the energy conservation standards promulgated by the Department of Energy that took effect on 

July 1, 2001. The credit is $150 in the case of a refrigerator that consumes at least 20 percent 

less kilowatt-hours per year than such standards and is produced before 2007. A refrigerator 

must be an automatic defrost refrigerator-freezer with an internal volume of at least 16.5 cubic 

feet to qualify for the credit. A clothes washer is any residential clothes washer, including a 

residential style coin operated washer, that satisfies the relevant efficiency standard. 

For each category of appliances (e.g., washers that meet the lower MEF standard, 

washers that meet the higher MEF standard, refrigerators that meet the 10 percent standard, 

refrigerators that meet the 15 percent standard and refrigerators that meet the 20-percent 

standard), only production in excess of average production for each such category during 
21

calendar years 2000-2002 would be eligible for the credit. For 2003, only production after the 

date of enactment is eligible for the credit, and special rules apply to determine if production 

exceeds the average of the base period. The taxpayer may not claim credits in excess of $60 

million for all taxable years, and may not claim credits in excess of $30 million with respect to 

appliances that only qualify for the $50 credit. Additionally, the credit allowed for all appliances 

may not exceed two percent of the average annual gross receipts of the taxpayer for the three 

taxable years preceding the taxable year in which the credit is determined. 

The credit will be part of the general business credit. No credits attributable to energyefficient appliances may be carried back to taxable years ending before January 1, 2003. 

Effective Date

The credit applies to appliances produced after the date of enactment and prior to 

January 1, 2008. 
22

C. Credit for Residential Energy Efficient Property 

Present Law

A taxpayer may exclude from income the value of any subsidy provided by a public 

utility for the purchase or installation of an energy conservation measure. An energy 

conservation measure means any installation or modification primarily designed to reduce 

consumption of electricity or natural gas or to improve the management of energy demand with 

respect to a dwelling unit (sec. 136). 

There is no present-law personal tax credit for energy efficient residential property. 

Description of Proposal 

The proposal provides a personal tax credit for the purchase of qualified wind energy 

property, qualified photovoltaic property, and qualified solar water heating property that is used 

exclusively for purposes other than heating swimming pools and hot tubs. The credit is equal to 

15 percent for solar water heating property and photovoltaic property, and 30 percent for wind 

energy property. The maximum credit for each of these systems of property is $2,000. The 

proposal also provides a 30 percent credit for the purchase of qualified fuel cell power plants. 

The credit for any fuel cell may not exceed $1,000 for each kilowatt of capacity. 

Qualifying solar water heating property means an expenditure for property to heat water 

for use in a dwelling unit located in the United States and used as a residence if at least half of 

the energy used by such property for such purpose is derived from the sun. Qualified 

photovoltaic property is property that uses solar energy to generate electricity for use in a 

dwelling unit. Solar panels are treated as qualified photovoltaic property. Qualified wind energy 

property is property that uses wind energy to generate electricity for use in a dwelling unit. A 

qualified fuel cell power plant is an integrated system comprised of a fuel cell stack assembly 

and associated balance of plant components that converts a fuel into electricity using 

electrochemical means, and which has an electricity-only generation efficiency of greater than 30 

percent and that generates at least 0.5 kilowatts of electricity. The qualified fuel cell power plant 

must be installed on or in connection with a dwelling unit located in the United States and used 

by the taxpayer as a principal residence. 

The proposal also provides a credit for the purchase of other qualified energy efficient 

property, as described below: 

Electric heat pump hot water heaters with an Energy Factor of at least 1.7. The 

maximum credit is $75 per unit. 

Electric heat pumps with a heating efficiency of at least 9 HSPF (Heating Seasonal 

Performance Factor) and a cooling efficiency of at least 15 SEER (Seasonal Energy Efficiency 

Rating) and an energy efficiency ratio (EER) of 12.5 or greater. The maximum credit is $250 per 

unit. 
23

Natural gas furnace which achieves 95 percent annual fuel utilization efficiency. The 

maximum credit is $250 per unit. 

Central air conditioners with an efficiency of at least 15 SEER and an EER of 12.5 or 

greater. The maximum credit is $250 per unit. 

Natural gas water heaters with an Energy Factor of at least 0.8. The maximum credit is 

$75 per unit. 

Geothermal heat pumps which have an EER of at least 21. The maximum credit is $250 

per unit. 

The credit is nonrefundable, and the depreciable basis of the property is reduced by the 

amount of the credit. Expenditures for labor costs allocable to onsite preparation, assembly, or 

original installation of property eligible for the credit are eligible expenditures. The credit is 

allowed against the regular and alternative minimum tax. 

Certain equipment safety requirements need to be met to qualify for the credit. Special 

proration rules apply in the case of jointly owned property, condominiums, and tenantstockholders in cooperative housing corporations. With the exception of wind energy property, 

if less than 80 percent of the property is used for nonbusiness purposes, only that portion of 

expenditures that is used for nonbusiness purposes is taken into account. 

Effective Date

The credit applies to purchases after the date of enactment and before January 1, 2008.
24

D. Business Tax Incentives for Fuel Cells 

Present Law

A nonrefundable, 10-percent business energy credit is allowed for the cost of new 

property that is equipment (1) that uses solar energy to generate electricity, to heat or cool a 

structure, or to provide solar process heat, or (2) used to produce, distribute, or use energy 

derived from a geothermal deposit, but only, in the case of electricity generated by geothermal 

power, up to the electric transmission stage. 

The business energy tax credits are components of the general business credit (sec. 

38(b)(1)). The business energy tax credits, when combined with all other components of the 

general business credit, generally may not exceed for any taxable year the excess of the 

taxpayer’s net income tax over the greater of (1) 25 percent of net regular tax liability above 

$25,000 or (2) the tentative minimum tax. An unused general business credit generally may be 

carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy provided by a public 

utility for the purchase or installation of an energy conservation measure. An energy 

conservation measure means any installation or modification primarily designed to reduce 

consumption of electricity or natural gas or to improve the management of energy demand with 

respect to a dwelling unit (sec. 136). 

There is no present-law credit for fuel cell power plant property. 

Description of Proposal 

The proposal provides a 30 percent business energy credit for the purchase of qualified 

fuel cell power plants for businesses. A qualified fuel cell power plant is an integrated system 

comprised of a fuel cell stack assembly and associated balance of plant components that converts 

a fuel into electricity using electrochemical means, and which has an electricity-only generation 

efficiency of greater than 30 percent and generates at least 0.5 kilowatts of electricity using an 

electrochemical process. The credit for any fuel cell may not exceed $500 for each 0.5 kilowatts 

of capacity. The credit is nonrefundable. The taxpayer’s basis in the property is reduced by the 

amount of the credit claimed. 

Effective Date

The credit for businesses applies to property placed in service after the date of enactment 

and before January 1, 2008, under rules similar to rules of section 48(m) of the Internal Revenue 

Code of 1986 (as in effect on the day before the date of enactment of the Revenue Reconciliation 

Act of 1990).
25

E. Allowance of Deduction for Energy-Efficient Commercial Building Property 

Present Law

No special deduction is currently provided for expenses incurred for energy-efficient 

commercial building property. 

Description of Proposal

The proposal provides a deduction equal to energy-efficient commercial building 

property expenditures made by the taxpayer. Energy-efficient commercial building property 

expenditures are defined as amounts paid or incurred for energy-efficient commercial building 

property installed in connection with the new construction or reconstruction of property: 

(1) which is otherwise depreciable property; (2) which is located in the United States, and (3) the 

construction or erection of which is completed by the taxpayer. The deduction is limited to an 

amount equal to the product of $2.25 and the square footage of the property for which such 

expenditures were made. No deduction is permitted unless the entire building satisfies the 

energy efficiency standard. The deduction is allowed in the year in which the property is placed 

in service. 

Energy-efficient commercial building property generally means any property that reduces 

total annual energy and power costs with respect to the lighting, heating, cooling, ventilation, and 

hot water supply systems of the building by 50 percent or more in comparison to a reference 

building which meets the requirements of a Standard 90.1-2001 of the American Society of 

Heating, Refrigerating, and Air Conditioning Engineers (“ASHRAE”) and the Illuminating 

Engineering Society of North America. 

Certain certification requirements must be met in order to qualify for the deduction. The 

Secretary, in consultation with the Secretary of Energy, will promulgate regulations that describe 

methods of calculating and verifying energy power consumption and cost, taking into 

consideration provisions of the 2001 California Nonresidential Alternative Calculation Method 

Approval Manual or the 2001 California Residential Alternative Calculation Method Approval 

Manual. Additionally, the calculation methods must take into account appropriate energy 

savings from design methodologies and technologies not otherwise credited in either such 

ASHRAE Standard 90.1-2001 or in the 2001 California Nonresidential Alternative Calculation 

Method Approval Manual, including the following: (1) natural ventilation; (2) evaporative 

cooling; (3) automatic lighting controls such as occupancy sensors, photocells, and timeclocks; 

(4) daylighting; (5) designs utilizing semi-conditioned spaces which maintain adequate comfort 

conditions without air conditioning or without heating; (6) improved fan system efficiency, 

including reductions in static pressure; and (7) advanced unloading mechanisms for mechanical 

cooling, such as multiple or variable speed compressors. Additionally, the calculational methods 

may take into account the extent of commissioning in the building, and allow the taxpayer to 

take into account measured performance which exceeds typical performance. 

The Secretary shall promulgate procedures for the inspection and testing for compliance 

of buildings that are comparable, given the difference between commercial and residential 

buildings, to the requirements in the Mortgage Industry National Accreditation Procedures for 
26

Home Energy Rating Systems. Individuals qualified to determine compliance shall only be those 

recognized by one or more organizations certified by the Secretary for such purposes. 

For public property, such as schools, the Secretary will issue regulations to allow the 

deduction to be allocated to the person primarily responsible for designing the property in lieu of 

the public entity owner. Other rules apply. 

Effective Date

The provision is effective for taxable years beginning after the date of enactment for 

plans certified prior to December 31, 2007, whose construction is completed on or before 

December 31, 2009.
27

F. Three-Year Applicable Recovery Period for Depreciation 

of Qualified Energy Management Devices 

Present Law

No special recovery period is currently provided for depreciation of qualified energy 

management devices. 

Description of Proposal

The proposal provides a three-year recovery period for qualified new energy management 

devices placed in service by any taxpayer who is a supplier of electric energy or is a provider of 

electric energy services. A qualified energy management device is any tangible property eligible 

for accelerated depreciation under code section 168 and which 

(1) is acquired and used by the taxpayer to measure and record electricity usage data on a 

time-differentiated basis in at least four separate time segments per day, and 

(2) provides such time-differentiated electricity price and usage data on at least a monthly 

basis to both consumers and the supplier or provider. 

Effective Date

The proposal is effective for any qualified energy management device placed in service 

after the date of enactment of the Act and before January 1, 2008. 
28

G. Three-Year Applicable Recovery Period for Depreciation 

of Qualified Water Submetering Devices 

Present Law

No special recovery period is currently provided for depreciation of qualified water 

submetering devices. 

Description of Proposal

The proposal provides a three-year recovery period for qualified new water submetering 

devices placed in service by any taxpayer who is an eligible resupplier. An eligible resupplier is 

any taxpayer who purchases and installs qualified water submetering devices in every unit in any 

multi-unit property. A qualified water submetering device is any tangible property eligible for 

accelerated depreciation under code section 168 and which 

(1) is acquired and used by the taxpayer to measure and record water usage data, and 

(2) provides such water usage data on at least a monthly basis to both consumers and the 

supplier or provider. 

Effective Date

The proposal is effective for any qualified water submetering device placed in service 

after the date of enactment of the Act and before January 1, 2008. 
29

H. Energy Credit for Combined Heat and Power System Property 

Present Law

A nonrefundable, 10-percent business energy credit is allowed for the cost of new 

property that is equipment (1) that uses solar energy to generate electricity, to heat or cool a 

structure, or to provide solar process heat, or (2) used to produce, distribute, or use energy 

derived from a geothermal deposit, but only, in the case of electricity generated by geothermal 

power, up to the electric transmission stage. 

The business energy tax credits are components of the general business credit (sec. 

38(b)(1)). The business energy tax credits, when combined with all other components of the 

general business credit, generally may not exceed for any taxable year the excess of the 

taxpayer’s net income tax over the greater of (1) 25 percent of net regular tax liability above 

$25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after 

December 31, 1997, an unused general business credit generally may be carried back one year 

and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy provided by a public 

utility for the purchase or installation of an energy conservation measure. An energy 

conservation measure means any installation or modification primarily designed to reduce 

consumption of electricity or natural gas or to improve the management of energy demand with 

respect to a dwelling unit (sec. 136). 

There is no present-law credit for combined heat and power (“CHP”) property. 

Description of Proposal 

The proposal provides a 10-percent credit for the purchase of combined heat and power 

property. CHP property is defined as property: (1) which uses the same energy source for the 

simultaneous or sequential generation of electrical power, mechanical shaft power, or both, in 

combination with the generation of steam or other forms of useful thermal energy (including 

heating and cooling applications); (2) which has an electrical capacity of more than 50 kilowatts 

or a mechanical energy capacity of more than 67 horsepower or an equivalent combination of 

electrical and mechanical energy capacities; (3) which produces at least 20 percent of its total 

useful energy in the form of thermal energy and at least 20 percent in the form of electrical or 

mechanical power (or a combination thereof); and (4) the energy efficiency percentage of which 

exceeds 60 percent (70 percent in the case of a system with an electrical capacity in excess of 50 

megawatts or a mechanical energy capacity in excess of 67,000 horsepower, or an equivalent 

combination of electrical and mechanical capacities.) Also, for purposes of determining whether 

CHP property includes technologies which generate electricity or mechanical power using backpressure steam turbines in place of existing pressure-reducing valves, or which make use of 

waste heat from industrial processes such as by using organic rankine, stirling, or kalina heat 

engine systems, the energy output requirements related to heat versus power described under (3), 

above, and the energy efficiency requirements of (4), above, may be disregarded. 
30

CHP property does include property used to transport the energy source to the generating 

facility or to distribute energy produced by the facility. 

If a taxpayer is allowed a credit for CHP property, and the property would ordinarily have 

a depreciation class life of 15 years or less, the depreciation period for the property is treated as 

having a 22-year class life. The present-law carry back rules of the general business credit 

generally would apply except that no credits attributable to combined heat and power property 

may be carried back before the effective date of this provision. 

Effective Date

The credit applies to property placed in service after the date of enactment and before 

January 1, 2007. 
31

I. Credit for Energy Efficiency Improvements to Existing Homes 

Present Law

A taxpayer may exclude from income the value of any subsidy provided by a public 

utility for the purchase or installation of an energy conservation measure. An energy 

conservation measure means any installation or modification primarily designed to reduce 

consumption of electricity or natural gas or to improve the management of energy demand with 

respect to a dwelling unit (sec. 136). 

There is no present law credit for energy efficiency improvements to existing homes. 

Description of Proposal 

The proposal would provide a 10-percent nonrefundable credit for the purchase of 

qualified energy efficiency improvements. The maximum credit for a taxpayer with respect to 

the same dwelling for all taxable years is $300. A qualified energy efficiency improvement 

would be any energy efficiency building envelope component that is certified to meet or exceed 

the prescriptive criteria for such a component established by the 2000 International Energy 

Conservation Code, or any combination of energy efficiency measures that is certified to achieve 

at least a 30 percent reduction in heating and cooling energy usage for the dwelling and (1) that 

is installed in or on a dwelling located in the United States; (2) owned and used by the taxpayer 

as the taxpayer’s principal residence; (3) the original use of which commences with the taxpayer; 

and (4) such component can reasonably be expected to remain in use for at least five years. 

Building envelope components would be: (1) insulation materials or systems which are 

specifically and primarily designed to reduce the heat loss or gain for a dwelling, and (2) exterior 

windows (including skylights) and doors. 

Homes shall be certified according to a component-based method or a performance-based 

method. The component-based method shall be based on applicable energy-efficiency ratings, 

including current product labeling requirements. Certification by the component method shall be 

provided by a third party, such as a local building regulatory authority, a utility, a manufactured 

home production inspection primary inspection agency, or a home energy rating organization. 

The performance-based method shall be based on a comparison of the projected energy 

consumption of the dwelling in its original condition and after the completion of energy 

efficiency measures. The performance-based method of certification shall be conducted by an 

individual or organization recognized by the Secretary of the Treasury for such purposes. 

The certification process requires that energy savings to the consumer be measured in 

terms of energy costs. To ensure consistent and reasonable energy cost analyses, the Department 

of Energy shall include in its rulemaking related to this bill specific reference data to be used for 

qualification for the credit. 

The taxpayer’s basis in the property would be reduced by the amount of the credit. 

Special rules would apply in the case of condominiums and tenant-stockholders in cooperative 

housing corporations. 
32

The credit is allowed against the regular and alternative minimum tax. 

Effective Date

The credit is effective for qualified energy efficiency improvements installed on or after 

the date of enactment and before January 1, 2007.
33

IV. CLEAN COAL INCENTIVES 

A. Investment and Production Credits for Clean Coal Technology 

Present Law

Present law does not provide an investment credit for electricity generating units that use 

coal as a fuel. Nor does present law provide a production credit for electricity generated at units 

that use coal as a fuel. However, a nonrefundable, 10-percent investment tax credit (“business 

energy credit”) is allowed for the cost of new property that is equipment (1) that uses solar 

energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or 

(2) that is used to produce, distribute, or use energy derived from a geothermal deposit, but only, 

in the case of electricity generated by geothermal power, up to the electric transmission stage 

(sec. 48). Also, an income tax credit is allowed for the production of electricity from either 

qualified wind energy, qualified “closed-loop” biomass, or qualified poultry waste units placed 

in service prior to January 1, 2004 (sec. 45). The credit allowed equals 1.5 cents per kilowatthour of electricity sold. The 1.5 cent figure is indexed for inflation and equaled 1.8 cents for 

2002. The credit is allowable for production during the 10-year period after a unit is originally 

placed in service. The business energy tax credits and the production tax credit are components 

of the general business credit (sec. 38(b)(1)). 

Description of Proposal

In general

The proposal creates three new credits: a production credit for electricity produced from 

qualifying clean coal technology units; a production credit for electricity produced from 

qualifying advanced clean coal technology units; and a credit for investments in qualifying 

advanced clean coal technology units. Certain persons (public utilities, electric cooperatives, 

Indian tribes, and the Tennessee Valley Authority) will be eligible to obtain certifications from 

the Secretary of the Treasury (as described below) for each of these credits and sell, trade, or 

assign the credit to any taxpayer. However, any credit sold, traded, or assigned may only be 

sold, traded, or assigned once. Subsequent transfers are not permitted. 

Credit for investments in qualifying advanced clean coal technology units

The proposal provides a 10-percent investment tax credit for qualified investments in 

advanced clean coal technology units. A qualified investment is that amount that would 

otherwise be a qualified investment multiplied by a fraction equal to the amount of national 

megawatt capacity allocated to the taxpayer (as described below) divided by the megawatt 

capacity of the qualifying unit. Qualifying advanced clean coal technology units must utilize 

advanced pulverized coal or atmospheric fluidized bed combustion technology, integrated 

gasification combined cycle technology, or some other technology certified by the Secretary of 

Energy. Any qualifying advanced clean coal technology unit must meet certain capacity 

standards, thermal efficiency standards, and emissions standards for SO2, nitrous oxides, 

particulate emissions, and source emissions standards as provided in the Clean Air Act. In 
34

addition, a qualifying advanced clean coal technology unit must meet certain carbon emissions 

requirements. 

The proposal defines three types of qualifying advanced clean coal technology units: 

(1) advanced pulverized coal or atmospheric fluidized bed combustion technology units 

(2) integrated gasification combined cycle technology units; and (3) other technology units. 

(1) A qualifying advanced pulverized coal or atmospheric fluidized bed combustion 

technology unit is a unit placed in service after the date of enactment and before 

2013 and having a design net heat rate of not more than 8,500 Btu (8,900 Btu if 

the unit is placed in service before 2009). 

(2) A qualifying integrated gasification combined cycle technology unit is a unit 

placed in service after the date of enactment and before 2017 and having a design 

net heat rate of not more than 7,720 Btu (8,900 Btu if the unit is placed in service 

before 2009 and 8,350 Btu if the unit is placed in service after 2008 and before 

2013). 

(3) A qualifying other technology unit use any other technology and is placed in 

service after the date of enactment and before 2017. 

The proposal provides that qualifying advanced clean coal units must satisfy carbon 

emissions standards. For units using design coal with a heat content of not more than 9,000 Btu 

per pound, the carbon emission rate must be less than 0.60 pound of carbon per kilowatt hour 

(0.51 if the unit qualifies as an other technology unit). For units using design coal with a heat 

content in excess of 9,000 Btu per pound, the carbon emission rate must be less than 0.54 pound 

of carbon per kilowatt hour (0.459 if the unit qualifies as an other technology unit). 

To be a qualified investment in advanced clean coal technology, the taxpayer must 

receive a certificate from the Secretary of the Treasury. The Secretary may grant certificates to 

investments only to the point that 3,500 megawatts of electricity production capacity qualifies for 

the credit. From the potential pool of 3,500 megawatts of capacity, not more than 1,000 

megawatts in total and not more than 500 megawatts in years prior to 2009 shall be allocated to 

units using advanced pulverized coal or atmospheric fluidized bed combustion technology. 

From the potential pool of 3,500 megawatts of capacity, not more than 2,000 megawatts in total 

and not more than 750 megawatts in years prior to 2009 shall be allocated to units using 

integrated gasification combined cycle technology, with or without fuel or chemical coproduction. From the potential pool of 3,500 megawatts of capacity, not more than 500 in total 

and not more than 250 megawatts in years prior to 2009 shall be allocated to any other 

technology certified by the Secretary of Energy. 

Production credit for electricity produced from qualifying clean coal technology units

The proposal provides a production credit for electricity produced from certain units that 

have been retrofitted, repowered, or replaced with a clean coal technology within ten years of the 

date of enactment. The value of the credit is 0.34 cents per kilowatt-hour of electricity and the 
35

heat value of other fuels or chemicals produced at the unit3 multiplied by the fraction equal to the 

amount of national megawatt capacity limitation (see below) allocated to the qualifying unit 

divided by the total megawatt capacity of the unit. The value of the credit is indexed for 

inflation occurring after 2003 with the first potential adjustment in 2005. The taxpayer may 

claim the credit throughout the ten-year period commencing from the date on which the 

qualifying unit is placed in service. 

A qualifying clean coal technology unit is a clean coal technology unit that meets certain 

capacity standards, thermal efficiency standards, and emissions standards for SO2, nitrous 

oxides, particulate emissions, and source emissions standards as provided in the Clean Air Act. 

In addition, a qualifying clean coal technology unit cannot be a unit that is receiving or is 

scheduled to receive funding under the Clean Coal Technology Program, the Power Plant 

Improvement Initiative, or the Clean Coal Power Initiative administered by the Secretary of the 

Department of Energy. Lastly, to be a qualified clean coal technology unit, the taxpayer must 

receive a certificate from the Secretary of the Treasury. The Secretary may grant certificates to 

units only to the point that 4,000 megawatts of electricity production capacity qualifies for the 

credit. However, no qualifying unit would be eligible if the unit’s capacity exceeded 300 

megawatts prior to having been retrofitted, repowered, or replaced. The maximum eligible 

allocation to any qualifying unit may not exceed 300 megawatts. 

Production credit for electricity produced from qualifying advanced clean coal technology

The proposal also provides a production credit for electricity produced from any qualified 

advanced clean coal technology electricity generation unit that qualifies for the investment credit 

for qualifying clean coal technology units, as described above.4 The taxpayer may claim a 

production credit on the sum of each kilowatt-hour of electricity produced and the heat value of 

other fuels or chemicals produced by the taxpayer at the unit.5 The taxpayer may claim the 

production credit for the 10-year period commencing with the date the qualifying unit is placed 

in service (or the date on which a conventional unit was retrofitted or repowered). The value of 

the credit varies depending upon the year the unit is placed in service, whether the unit produces 

solely electricity or electricity and fuels or chemicals, and the rated thermal efficiency of the 

unit. In addition, the value of the credit is reduced for the second five years of eligible 

production. If a unit meets the more stringent qualification standards of post-2008 in years 

before 2009, the taxpayer may claim the higher post-2008 credit amounts. The value of the 

 3

 Each 3,413 Btu of heat content of the fuel or chemical is treated as equivalent to one 

kilowatt-hour of electricity. 

4

 In the case of a taxpayer who received a megawatt allocation for a qualifying advanced 

clean coal technology unit that is less than the rated capacity of such unit, the taxpayer may 

claim credit on a percentage of the electricity produced from the unit. The percentage is the 

percentage that the taxpayer’s megawatt allocation represents as a percentage of the rated 

capacity of the unit. 

5

 Each 3,413 Btu of heat content of the fuel or chemical is treated as equivalent to one 

kilowatt-hour of electricity. 
36

credit is indexed for inflation occurring after 2003 with the first potential adjustment in 2005. 

The tables below specify the value of the credit (before indexing is applied). 

Advanced clean coal technology units producing solely electricity

Table 11.–Units Placed in Service Before 2009 

Credit amount per kilowatt-hour The unit net heat rate, Btu/kWh adjusted for 

the heat content for the design coal is equal 

to: For the first five years For the second five 

years 

Not more than 8,500 $.0060 $.0038 

More than 8,500 but not more than 8,750 $.0025 $.0010 

More than 8,750 but less than 9,000 $.0010 $.0010 

Table 12.–Units Placed in Service After 2008 and Before 2013 

Credit amount per kilowatt-hour The unit net heat rate, Btu/kWh adjusted for 

the heat content for the design coal is equal 

to: For the first five years For the second five 

years 

Not more than 7,770 $.0105 $.0090 

More than 7,770 but not more than 8,125 $.0085 $.0068 

More than 8,125 but less than 8,350 $.0075 $.0055 

Table 13.–Units Placed in Service After 2012 and Before 2017 

Credit amount per kilowatt-hour The unit net heat rate, Btu/kWh adjusted for 

the heat content for the design coal is equal 

to: For the first five years For the second five 

years 

Not more than 7,380 $.0140 $.0115 

More than 7,380 but not more than 7,720 $.0120 $.0090 
37

Advanced clean coal technology units producing electricity and a fuel or chemical

Table 14.–Units Placed in Service Before 2009 

Credit amount per kilowatt-hour 

The unit design net thermal efficiency is 

equal to: For the first five years For the second five 

years 

Not less than 40.6% $.0060 $.0038 

Less than 40.6% but not less than 40% $.0025 $.0010 

Less than 40% but not less than 38.4% $.0010 $.0010 

Table 15.–Units Placed in Service After 2008 and Before 2013 

Credit amount per kilowatt-hour 

The unit design net thermal efficiency is 

equal to: For the first five years For the second five 

years 

Not less than 43.6% $.0105 $.0090 

Less than 43.6% but not less than 42% $.0085 $.0068 

Less than 42% but not less than 40.2% $.0075 $.0055 

Table 16.–Units Placed in Service After 2012 and Before 2017 

Credit amount per kilowatt-hour 

The unit design net thermal efficiency is 

equal to: For the first five years For the second five 

years 

Not less than 44.2% $.0140 $.0115 

Less than 44.2% but not less than 43.9% $.0120 $.0090 

The credits are part of the general business credit. No credit may be carried back to 

taxable years ending on or before the date of enactment. 
38

Effective Date

The proposal relating to investment credits for advanced clean coal technology units is 

effective after the date of enactment. The proposal relating to production credits are effective 

after the date of enactment. 
39

V. OIL AND GAS PROVISIONS 

A. Tax Credit for Oil and Gas Production from Marginal Wells 

Present Law

There is no credit for the production of oil and gas from marginal wells. The costs of 

such production may be recovered under the Code’s depreciation and depletion rules and in other 

cases as a deduction for ordinary and necessary business expenses. 

Description of Proposal

The provision would create a new, $3 per barrel credit for the production of crude oil and 

a $0.50 credit per 1,000 cubic feet of qualified natural gas production. The maximum amount of 

production on which credit could be claimed is 1,095 barrels or barrel equivalents. In both cases, 

the credit is available only for production from a “qualified marginal well.” The credit is not 

available to production occurring if the reference price of oil exceeded $18 ($2.00 for natural 

gas). The credit is reduced proportionately as for reference prices between $15 and $18 ($1.67 

and $2.00 for natural gas). Reference prices are determined on a one-year look-back basis. 

A qualified marginal well is defined as (1) a well production from which was marginal 

production for purposes of the Code percentage depletion rules or (2) a well that during the 

taxable year had (a) average daily production of not more than 25 barrel equivalents and 

(b) produced water at a rate of not less than 95 percent of total well effluent. 

The credit is treated as part of the general business credit. The credit cannot be carried 

back to a taxable year ending on or before the date of enactment of the proposal. 

Effective Date

The proposal is effective for production in taxable years beginning after the date of 

enactment.
40

B. Natural Gas Gathering Lines Treated as Seven-Year Property 

Present Law

The applicable recovery period for assets placed in service under the Modified 

Accelerated Cost Recovery System is based on the “class life of the property.” The class lives of 

assets placed in service after 1986 are generally set forth in Revenue Procedure 87-56.6 Revenue 

Procedure 87-56 includes two asset classes that could describe natural gas gathering lines owned 

by nonproducers of natural gas. Asset class 46.0, describing pipeline transportation, provides a 

class life of 22 years and a recovery period of 15 years. Asset class 13.2, describing assets used 

in the exploration for and production of petroleum and natural gas deposits, provides a class life 

of 14 years and a depreciation recovery period of seven years. The uncertainty regarding the 

appropriate recovery period of natural gas gathering lines has resulted in litigation between 

taxpayers and the IRS. The 10th Circuit Court of Appeals held that natural gas gathering lines 

owned by nonproducers falls within the scope of Asset class 13.2 (i.e., seven-year recovery 

period).7

 More recently, the Tax Court and the U.S. District Court for the Eastern District of 

Michigan, Southern Division, held that natural gas gathering lines owned by nonproducers falls 

within the scope of Asset class 46.0 (i.e., 15-year recovery period).8

Description of Proposal

The proposal establishes a statutory seven-year recovery period and a class life of 10 

years for natural gas gathering lines. A natural gas gathering line is defined to include any pipe, 

equipment, and appurtenance that is (1) determined to be a gathering line by the Federal Energy 

Regulatory Commission, or (2) used to deliver natural gas from the wellhead or a common point 

to the point at which such gas first reaches (a) a gas processing plant, (b) an interconnection with 

an interstate transmission line, (c) an interconnection with an intrastate transmission line, or (d) a 

direct interconnection with a local distribution company, a gas storage facility, or an industrial 

consumer. 

Effective Date

The proposal is effective for property placed in service after the date of enactment. No 

inference is intended as to the proper treatment of natural gas gathering lines placed in service 

before the date of enactment.

 6

 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785). 

7

 Duke Energy v. Commissioner, 172 F.3d 1255 (10th Cir. 1999), rev’g 109 T.C. 416 

(1997). See also True v. United States, 97-2 U.S. Tax Cas. (CCH) par. 50,946 (D. Wyo. 1997). 

8

 Clajon Gas Co., L.P. v. Commissioner, 119 T.C. 197 (2002) and Saginaw Bay Pipeline 

Co. v. United States, 124 F. Supp. 2d 465 (E.D. Mich. 2001). 
41

C. Expensing of Capital Costs Incurred and Credit for Production in Complying 

with Environmental Protection Agency Sulfur Regulations 

Present Law

Taxpayers generally may recover the costs of investments in refinery property through 

annual depreciation deductions. Present law does not provide a credit for the production of lowsulfur diesel fuel. 

Description of Proposal

The proposal generally permits small business refiners to claim an immediate deduction 

(i.e., expensing) for up to 75 percent of the qualified capital costs paid or incurred for the 

purpose of complying with the Highway Diesel Fuel Sulfur Control Requirements of the 

Environmental Protection Agency. Qualified capital costs are those costs paid or incurred and 

otherwise chargeable to the taxpayer’s capital account that are necessary for the refinery to come 

into compliance with the EPA diesel fuel requirements. 

In addition, the proposal provides that a small business refiner may claim a credit equal to 

five cents per gallon for each gallon of low sulfur diesel fuel produced at a facility of a small 

business refiner. The total production credit claimed by the taxpayer generally is limited to 25 

percent of the qualified capital costs incurred with respect to expenditures at the refinery during 

the period beginning after the date of enactment and ending with the date that is one year after 

the date on which the taxpayer must comply with applicable EPA regulations. No deduction is 

allowed to the taxpayer for expenses otherwise allowable as a deduction in an amount equal to 

the amount of production credit claimed during the taxable year. 

For these purposes a small business refiner is a taxpayer who within the business of 

refining petroleum products employs not more than 1,500 employees directly in refining on 

business days during a taxable year in which the deduction or production credit is claimed and 

had an average daily refinery run (or retained production) not exceeding 205,000 barrels per day 

for the year prior to enactment. 

For taxpayers with an average daily refinery run in the year prior to enactment in excess 

of 155,000 and not greater than 205,000 barrels per day, the provision limits otherwise 

qualifying small business refiners to an immediate deduction for a percentage of qualifying 

capital costs equal to 75 percent less the percentage points determined by the excess of the 

average daily refinery runs over 155,000 barrels per day divided by 50,000 barrels per day. In 

addition, for these taxpayers, the limitation on the total production credit that may be claimed 

also is reduced proportionately. 

In the case of a qualifying small business refiner that is owned by a cooperative, the 

cooperative is allowed to elect to pass any production credits to patrons of the organization. 

Effective Date

The proposal is effective for expenses paid or incurred after December 31, 2002.
42

D. Determination of Small Refiner Exception to Oil Depletion Deduction 

Present Law

Present law classifies oil and gas producers as independent producers or integrated 

companies. The Code provides numerous special tax rules for operations by independent 

producers. One such rule allows independent producers to claim percentage depletion 

deductions rather than deducting the costs of their asset, a producing well, based on actual 

production from the well (i.e., cost depletion). 

A producer is an independent producer only if its refining and retail operations are 

relatively small. For example, an independent producer may not have refining operations the 

runs from which exceed 50,000 barrels on any day in the taxable year during which independent 

producer status is claimed. 

Description of Proposal 

The proposal increases the current 50,000-barrel-per-day limitation to 60,000. In 

addition, the proposal changes the refinery limitation on claiming independent producer status 

from a limit based on actual daily production to a limit based on average daily production for the 

taxable year. Accordingly, the average daily refinery run for the taxable year cannot exceed 

60,000 barrels. For this purpose, the taxpayer calculates average daily refinery run by dividing 

total production for the taxable year by the total number of days in the taxable year. 

Effective Date

The proposal is effective for taxable years ending after the date of enactment.
43

E. Extension of Suspension of Taxable Income Limit 

With Respect to Marginal Production 

Present Law

In general

Depletion, like depreciation, is a form of capital cost recovery. In both cases, the 

taxpayer is allowed a deduction in recognition of the fact that an asset--in the case of depletion 

for oil or gas interests, the mineral reserve itself--is being expended in order to produce income. 

Certain costs incurred prior to drilling an oil or gas property are recovered through the depletion 

deduction. These include costs of acquiring the lease or other interest in the property and 

geological and geophysical costs (in advance of actual drilling). 

Depletion is available to any person having an economic interest in a producing property. 

An economic interest is possessed in every case in which the taxpayer has acquired by 

investment any interest in minerals in place, and secures, by any form of legal relationship, 

income derived from the extraction of the mineral, to which it must look for a return of its 

capital.9 Thus, for example, both working interests and royalty interests in an oil- or gasproducing property constitute economic interests, thereby qualifying the interest holders for 

depletion deductions with respect to the property. A taxpayer who has no capital investment in 

the mineral deposit does not possess an economic interest merely because it possesses an 

economic or pecuniary advantage derived from production through a contractual relation. 

Cost depletion

Two methods of depletion are currently allowable under the Internal Revenue Code (the 

“Code”): (1) the cost depletion method, and (2) the percentage depletion method (secs. 611-613). 

Under the cost depletion method, the taxpayer deducts that portion of the adjusted basis of the 

depletable property which is equal to the ratio of units sold from that property during the taxable 

year to the number of units remaining as of the end of taxable year plus the number of units sold 

during the taxable year. Thus, the amount recovered under cost depletion may never exceed the 

taxpayer’s basis in the property. 

Percentage depletion and related income limitations

The Code generally limits the percentage depletion method for oil and gas properties to 

independent producers and royalty owners.10 Generally, under the percentage depletion method 

15 percent of the taxpayer’s gross income from an oil- or gas-producing property is allowed as a 

deduction in each taxable year (sec. 613A(c)). The amount deducted generally may not exceed 

100 percent of the net income from that property in any year (the “net-income limitation”) (sec. 

613(a)). By contrast, for any other mineral qualifying for the percentage depletion deduction, 

 9

 Treas. Reg. sec. 1.611-1(b)(1). 

10 Sec. 613A. 
44

such deduction may not exceed 50 percent of the taxpayer’s taxable income from the depletable 

property. A similar 50-percent net-income limitation applied to oil and gas properties for taxable 

years beginning before 1991. Section 11522(a) of the Omnibus Budget Reconciliation Act of 

1990 prospectively changed the net-income limitation threshold to 100 percent only for oil and 

gas properties, effective for taxable years beginning after 1990. The 100-percent net-income 

limitation for marginal wells has been suspended for taxable years beginning after December 31, 

1997, and before January 1, 2004. 

Additionally, the percentage depletion deduction for all oil and gas properties may not 

exceed 65 percent of the taxpayer’s overall taxable income (determined before such deduction 

and adjusted for certain loss carrybacks and trust distributions) (sec. 613A(d)(1)).11 Because 

percentage depletion, unlike cost depletion, is computed without regard to the taxpayer’s basis in 

the depletable property, cumulative depletion deductions may be greater than the amount 

expended by the taxpayer to acquire or develop the property. 

A taxpayer is required to determine the depletion deduction for each oil or gas property 

under both the percentage depletion method (if the taxpayer is entitled to use this method) and 

the cost depletion method. If the cost depletion deduction is larger, the taxpayer must utilize that 

method for the taxable year in question (sec. 613(a)). 

Limitation of oil and gas percentage depletion to independent producers and royalty 

owners

Generally, only independent producers and royalty owners (as contrasted to integrated oil 

companies) are allowed to claim percentage depletion. Percentage depletion for eligible 

taxpayers is allowed only with respect to up to 1,000 barrels of average daily production of 

domestic crude oil or an equivalent amount of domestic natural gas (sec. 613A(c)). For 

producers of both oil and natural gas, this limitation applies on a combined basis. 

In addition to the independent producer and royalty owner exception, certain sales of 

natural gas under a fixed contract in effect on February 1, 1975, and certain natural gas from 

geopressured brine,12 are eligible for percentage depletion, at rates of 22 percent and 10 percent, 

respectively. These exceptions apply without regard to the 1,000-barrel-per-day limitation and 

regardless of whether the producer is an independent producer or an integrated oil company. 

Description of Proposal 

The suspension of the 100-percent net-income limitation for marginal wells is extended 

through taxable years beginning before January 1, 2007. 

 11 Amounts disallowed as a result of this rule may be carried forward and deducted in 

subsequent taxable years, subject to the 65-percent taxable income limitation for those years. 

12 This exception is limited to wells, the drilling of which began between September 30, 

1978, and January 1, 1984. 
45

Effective Date

The proposal is effective on date of enactment.
46

F. Amortization of Geological and Geophysical Expenditures 

Present Law

In general

Geological and geophysical expenditures are costs incurred by a taxpayer for the purpose 

of obtaining and accumulating data that will serve as the basis for the acquisition and retention of 

mineral properties by taxpayers exploring for minerals. A key issue with respect to the tax 

treatment of such expenditures is whether or not they are capital in nature. Capital expenditures 

are not currently deductible as ordinary and necessary business expenses, but are allocated to the 

cost of the property.13

Courts have held that geological and geophysical costs are capital, and therefore are 

allocable to the cost of the property14 acquired or retained.15 The costs attributable to such 

exploration are allocable to the cost of the property acquired or retained. As described further 

below, IRS administrative rulings have provided further guidance regarding the definition and 

proper tax treatment of geological and geophysical costs. 

Revenue Ruling 77-188

In Revenue Ruling 77-18816 (hereinafter referred to as the “1977 ruling”), the IRS 

provided guidance regarding the proper tax treatment of geological and geophysical costs. The 

ruling describes a typical geological and geophysical exploration program as containing the 

following elements: 

• It is customary in the search for mineral producing properties for a taxpayer to 

conduct an exploration program in one or more identifiable project areas. Each 

 13 Under section 263, capital expenditures are defined generally as any amount paid for 

new buildings or for permanent improvements or betterments made to increase the value of any 

property or estate. Treasury regulations define capital expenditures to include amounts paid or 

incurred (1) to add to the value, or substantially prolong the useful life, of property owned by the 

taxpayer or (2) to adapt property to a new or different use. Treas. Reg. sec. 1.263(a)-1(b). 

14 “Property” means an interest in a property as defined in section 614 of the Code, and 

includes an economic interest in a tract or parcel of land notwithstanding that a mineral deposit 

has not been established or proved at the time the costs are incurred. 

15 See, e.g., Schermerhorn Oil Corporation v. Commissioner, 46 B.T.A. 151 (1942). By 

contrast, section 617 of the Code permits a taxpayer to elect to deduct certain expenditures 

incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit 

of ore or other mineral (but not oil and gas). These deductions are subject to recapture if the 

mine with respect to which the expenditures were incurred reaches the producing stage. 

16 1977-1 C.B. 76. 
47

project area encompasses a territory that the taxpayer determines can be explored 

advantageously in a single integrated operation. This determination is made after 

analyzing certain variables such as (1) the size and topography of the project area to 

be explored, (2) the existing information available with respect to the project area and 

nearby areas, and (3) the quantity of equipment, the number of personnel, and the 

amount of money available to conduct a reasonable exploration program over the 

project area. 

• The taxpayer selects a specific project area from which geological and geophysical 

data are desired and conducts a reconnaissance-type survey utilizing various 

geological and geophysical exploration techniques. These techniques are designed to 

yield data that will afford a basis for identifying specific geological features with 

sufficient mineral potential to merit further exploration. 

• Each separable, noncontiguous portion of the original project area in which such a 

specific geological feature is identified is a separate “area of interest.” The original 

project area is subdivided into as many small projects as there are areas of interest 

located and identified within the original project area. If the circumstances permit a 

detailed exploratory survey to be conducted without an initial reconnaissance-type 

survey, the project area and the area of interest will be coextensive. 

• The taxpayer seeks to further define the geological features identified by the prior 

reconnaissance-type surveys by additional, more detailed, exploratory surveys 

conducted with respect to each area of interest. For this purpose, the taxpayer 

engages in more intensive geological and geophysical exploration employing 

methods that are designed to yield sufficiently accurate sub-surface data to afford a 

basis for a decision to acquire or retain properties within or adjacent to a particular 

area of interest or to abandon the entire area of interest as unworthy of development 

by mine or well. 

The 1977 ruling provides that if, on the basis of data obtained from the preliminary 

geological and geophysical exploration operations, only one area of interest is located and 

identified within the original project area, then the entire expenditure for those exploratory 

operations is to be allocated to that one area of interest and thus capitalized into the depletable 

basis of that area of interest. On the other hand, if two or more areas of interest are located and 

identified within the original project area, the entire expenditure for the exploratory operations is 

to be allocated equally among the various areas of interest. 

If no areas of interest are located and identified by the taxpayer within the original project 

area, then the 1977 ruling states that the entire amount of the geological and geophysical costs 

related to the exploration is deductible as a loss under section 165. The loss is claimed in the 

taxable year in which that particular project area is abandoned as a potential source of mineral 

production. 

A taxpayer may acquire or retain a property within or adjacent to an area of interest, 

based on data obtained from a detailed survey that does not relate exclusively to any discrete 

property within a particular area of interest. Generally, under the 1977 ruling, the taxpayer 
48

allocates the entire amount of geological and geophysical costs to the acquired or retained 

property as a capital cost under section 263(a). If more than one property is acquired, it is proper 

to determine the amount of the geological and geophysical costs allocable to each such property 

by allocating the entire amount of the costs among the properties on the basis of comparative 

acreage. 

If, however, no property is acquired or retained within or adjacent to that area of interest, 

the entire amount of the geological and geophysical costs allocable to the area of interest is 

deductible as a loss under section 165 for the taxable year in which such area of interest is 

abandoned as a potential source of mineral production. 

In 1983, the IRS issued Revenue Ruling 83-105,17 which elaborates on the positions set 

forth in the 1977 ruling by setting forth seven factual situations and applying the principles of the 

1977 ruling to those situations. In addition, Revenue Ruling 83-105 explains what constitutes 

“abandonment as a potential source of mineral production.” 

Description of Proposal

The proposal allows geological and geophysical costs incurred in connection with oil and 

gas exploration in the United States to be amortized over four years. In the case of abandoned 

property, remaining basis may no longer be recovered in the year of abandonment of a property 

as all basis is recovered over the four-year amortization period. 

Effective Date

The proposal is effective for geological and geophysical costs paid or incurred in taxable 

years beginning after the date of enactment. No inference is intended from the prospective 

effective date of this proposal as to the proper treatment of pre-effective date geological and 

geophysical costs.

 17 1983-2 C.B. 51. 
49

G. Amortization of Delay Rental Payments 

Present Law

Present law generally requires costs associated with inventory and property held for 

resale to be capitalized rather than currently deducted as they are incurred. (sec. 263). Oil and 

gas producers typically contract for mineral production in exchange for royalty payments. If 

mineral production is delayed, these contracts provide for “delay rental payments” as a condition 

of their extension. In proposed regulations issued in 2000, the Treasury Department took the 

position that the uniform capitalization rules of section 263A require delay rental payments to be 

capitalized.18

Description of Proposal 

The proposal allows delay rental payments incurred in connection with the development 

of oil or gas within the United States to be amortized over two years. In the case of abandoned 

property, remaining basis may no longer be recovered in the year of abandonment of a property 

as all basis is recovered over the two-year amortization period. 

Effective Date

The proposal applies to delay rental payments paid or incurred in taxable years beginning 

after the date of enactment. No inference is intended from the prospective effective date of this 

proposal as to the proper treatment of pre-effective date delay rental payments.

 18 65 Fed. Reg. 6090 (2000). 
50

H. Extension and Modification of Credit for Producing Fuel 

From a Non-Conventional Source 

Present Law

Certain fuels produced from “non-conventional sources” and sold to unrelated parties are 

eligible for an income tax credit equal to $3 (generally adjusted for inflation)19 per barrel or Btu 

oil barrel equivalent (sec. 29). Qualified fuels must be produced within the United States. 

Qualified fuels include: 

(1) oil produced from shale and tar sands; 

(2) gas produced from geopressured brine, Devonian shale, coal seams, tight 

formations (“tight sands”), or biomass; and 

(3) liquid, gaseous, or solid synthetic fuels produced from coal (including lignite). 

In general, the credit is available only with respect to fuels produced from wells drilled or 

facilities placed in service after December 31, 1979, and before January 1, 1993. An exception 

extends the January 1, 1993 expiration date for facilities producing gas from biomass and 

synthetic fuel from coal if the facility producing the fuel is placed in service before July 1, 1998, 

pursuant to a binding contract entered into before January 1, 1997. 

The credit may be claimed for qualified fuels produced and sold before January 1, 2003 

(in the case of non-conventional sources subject to the January 1, 1993 expiration date) or 

January 1, 2008 (in the case of biomass gas and synthetic fuel facilities eligible for the extension 

period). 

Description of Proposal

In general

The proposal extends the placed in service date for certain facilities that would otherwise 

qualify for the section 29 credit under present law and modifies the amount of the credit. The 

proposal also expands the class of facilities that are eligible for the credit. In addition, under the 

proposal, the taxpayer would not be able to claim any credit for production in excess of a daily 

average of 200,000 cubic feet of gas (or barrel of oil equivalent) from a qualifying well or 

facility.20

 19 The value of the section 29 credit for production in 2001 was $6.28 per barrel of oil 

equivalent. 

20 The daily average would be computed as total production divided by the total number 

of days the well or facility was in production during the year. 
51

Extension for certain non-conventional fuels

The proposal permits taxpayers to claim the section 29 credit for production of certain 

non-conventional fuels produced at wells placed in service after the date of enactment and before 

January 1, 2007. 21 Under the proposal, qualifying fuels are oil from shale or tar sands, and gas 

from geopressured brine, Devonian shale, coal seams, a tight formation, or biomass. The value 

of the credit is re-based to $2.00 and the amount is not indexed for inflation. Taxpayers may 

claim the credit for production from the well for each of the first three years of production from 

the qualifying well. 

Expansion for fuels from agricultural and animal waste

The proposal adds facilities producing liquid, gaseous, or solid fuels, from agricultural 

and animal waste placed in service after the date of enactment and before January 1, 2007, to the 

list of qualified facilities for purposes of the non-conventional fuel credit. The amount of the 

credit is equal to $3 (unindexed) per barrel or Btu oil barrel equivalent, for three years of 

production commencing on the date the facility is placed in service. Agricultural and animal 

waste includes by-products, packaging, and any materials associated with processing, feeding, 

selling, transporting, or disposal of agricultural or animal products or wastes, including wood 

shavings, straw, rice hulls, and other bedding for the disposition of manure. 

Expansion for “viscous oil”

The proposal expands section 29 to permit taxpayers to claim the section 29 credit for 

production of certain viscous oil produced at wells placed in service after the date of enactment 

and before January 1, 2007. The proposal defines “viscous oil” as domestic crude oil produced 

from any property if the crude oil has a weighted average gravity of 22 degrees API or less 

(corrected to 60 degrees Fahrenheit). The value of the credit for viscous oil also is $3.00 per 

barrel. Taxpayers may claim the credit for production from the well for each of the first three 

years of production from the time the well is placed in service. The proposal provides that 

qualifying sales to related parties for consumption not in the immediate vicinity of the wellhead 

qualify for the credit. 

Expansion for “refined coal”

The proposal also expands section 29 to include certain “refined coal” as a qualified nonconventional fuel. “Refined coal” is a qualifying liquid, gaseous, or solid synthetic fuel 

produced from coal (including lignite) from facilities placed in service after date of enactment 

and before January 1, 2007. Refined coal also would include a qualifying fuel derived from 

high-carbon fly ash produced from facilities placed in service after the date of enactment and 

before January 1, 2007. A qualifying fuel is a fuel that when burned emits 20 percent less 

nitrogen oxide and either sulfur dioxide or mercury than the burning of feedstock coal or 

comparable coal predominantly available in the marketplace as of January 1, 2003, and if the 

 21 The proposal does not apply to liquid, gaseous, or solid synthetic fuels produced from 

coal as described under present law section 29(c)(1)(C), but does provide credit for a new 

category, refined coal, described below. 
52

fuel sells at prices at least 50 percent greater than the prices of the feedstock coal or comparable 

coal. However, no fuel produced at a qualifying advanced clean coal facility (as defined 

elsewhere in the committee bill) would be a qualifying fuel. The amount of credit for refined 

coal also is $3.00 per barrel equivalent. Taxpayers may claim the credit for fuel produced during 

the five-year period beginning on the date the facility is placed in service. 

Expansion for coalmine gas

In addition, the proposal permits taxpayers to claim credit for coalmine gas captured by 

the taxpayer and utilized as a fuel source or sold by or on behalf of the taxpayer to an unrelated 

person. The term “coalmine gas” means any methane gas which is being liberated during 

qualified coal mining operations or as a result of past qualified coal mining operations, or which 

is captured in advance of qualified coal mining operations as part of specific plan to mine a coal 

deposit. In the case of coalmine gas that is captured in advance of qualified coal mining 

operations, the credit is allowed only after the date the coal extraction occurs in the immediate 

area where the coalmine gas was removed. The value of the credit for coalmine methane also is 

$3.00 per Btu oil barrel equivalent (51.7 cents per million Btu of heat value in the gas) for gas 

captured and utilized or sold. Taxpayers may claim the credit for gas captured and utilized or 

sold after the date of enactment and before January 1, 2007. 

Extension of credit for certain existing facilities

The proposal extends the present-law credit through December 31, 2005 for production 

from existing facilities producing coke, coke gas, or natural gas and by-products produced by 

coal gasification from lignite. The proposal provides that the credit amount will be $3.00 per Btu 

oil barrel equivalent for production from such facilities after December 31, 2002. 

Study of coal bed methane gas

Lastly, the proposal directs the Secretary of the Treasury to undertake a study of effect 

section 29 has had on the production of coal bed methane. The Secretary’s study is to be made 

in conjunction with the study to be undertaken by the Secretary of the Interior on the effects of 

coal bed methane production on surface and water resources, as provided in section 608 of the 

Energy Policy Act of 2002 (should that study be required by law). The study should estimate the 

total amount of credit claimed annually and in aggregate related to the production of coal bed 

methane since the enactment of section 29. The study should report the annual value of the 

credit allowable for coal bed methane compared to the average annual wellhead price of natural 

gas (per thousand cubic feet of natural gas). The study should estimate the incremental increase 

in production of coal bed methane that has resulted from the enactment of section 29. The study 

should estimate the cost to the Federal government, in terms of the net tax benefits claimed, per 

thousand cubic feet of incremental coal bed methane produced annually and in aggregate since 

the enactment of section 29. 

Effective Date

The proposals apply to fuels sold from qualifying wells and facilities after the date of 

enactment. 
53

I. Natural Gas Distribution Lines Treated as Fifteen-Year Property 

Present Law

The applicable recovery period for assets placed in service under the Modified 

Accelerated Cost Recovery System is based on the “class life of the property.” The class lives of 

assets placed in service after 1986 are generally set forth in Revenue Procedure 87-56.22 Natural 

gas distribution pipelines are assigned a 20-year recovery period and a class life of 35 years. 

Description of Proposal

The proposal establishes a statutory 15-year recovery period and a class life of 20 years 

for natural gas distribution lines. 

Effective Date

The proposal is effective for property placed in service after the date of enactment. 

 22 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785). 
54

VI. PROVISIONS RELATING TO ELECTRIC INDUSTRY RESTRUCTURING 

A. Modification to Special Rules for Nuclear Decommissioning Costs 

Present Law

Overview

Special rules dealing with nuclear decommissioning reserve funds were adopted by 

Congress in the Deficit Reduction Act of 1984 (“1984 Act”), when tax issues regarding the time 

value of money were addressed generally. Under general tax accounting rules, a deduction for 

accrual basis taxpayers is deferred until there is economic performance for the item for which the 

deduction is claimed. However, the 1984 Act contains an exception under which a taxpayer 

responsible for nuclear powerplant decommissioning may elect to deduct contributions made to a 

qualified nuclear decommissioning fund for future decommissioning costs. Taxpayers who do 

not elect this provision are subject to general tax accounting rules. 

Qualified nuclear decommissioning fund

A qualified nuclear decommissioning fund (a “qualified fund”) is a segregated fund 

established by a taxpayer that is used exclusively for the payment of decommissioning costs, 

taxes on fund income, management costs of the fund, and for making investments. The income 

of the fund is taxed at a reduced rate of 20 percent for taxable years beginning after 

December 31, 1995.23 

Contributions to a qualified fund are deductible in the year made to the extent that these 

amounts were collected as part of the cost of service to ratepayers (the “cost of service 

requirement”).24 Funds withdrawn by the taxpayer to pay for decommissioning costs are 

included in the taxpayer’s income, but the taxpayer also is entitled to a deduction for 

decommissioning costs as economic performance for such costs occurs. 

Accumulations in a qualified fund are limited to the amount required to fund 

decommissioning costs of a nuclear powerplant for the period during which the qualified fund is 

in existence (generally post-1984 decommissioning costs of a nuclear powerplant). For this 

purpose, decommissioning costs are considered to accrue ratably over a nuclear powerplant’s 

estimated useful life. In order to prevent accumulations of funds over the remaining life of a 

nuclear powerplant in excess of those required to pay future decommissioning costs of such 

 23 As originally enacted in 1984, a qualified fund paid tax on its earnings at the top 

corporate rate and, as a result, there was no present-value tax benefit of making deductible 

contributions to a qualified fund. Also, as originally enacted, the funds in the trust could be 

invested only in certain low risk investments. Subsequent amendments to the provision have 

reduced the rate of tax on a qualified fund to 20 percent and removed the restrictions on the types 

of permitted investments that a qualified fund can make.

24 Taxpayers are required to include in gross income customer charges for 

decommissioning costs (sec. 88). 
55

nuclear powerplant and to ensure that contributions to a qualified fund are not deducted more 

rapidly than level funding (taking into account an appropriate discount rate), taxpayers must 

obtain a ruling from the IRS to establish the maximum annual contribution that may be made to a 

qualified fund (the “ruling amount”). In certain instances (e.g., change in estimates), a taxpayer 

is required to obtain a new ruling amount to reflect updated information. 

A qualified fund may be transferred in connection with the sale, exchange or other 

transfer of the nuclear powerplant to which it relates. If the transferee is a regulated public utility 

and meets certain other requirements, the transfer will be treated as a nontaxable transaction. No 

gain or loss will be recognized on the transfer of the qualified fund and the transferee will take 

the transferor’s basis in the fund.25 The transferee is required to obtain a new ruling amount from 

the IRS or accept a discretionary determination by the IRS.26 

Nonqualified nuclear decommissioning funds

Federal and State regulators may require utilities to set aside funds for nuclear 

decommissioning costs in excess of the amount allowed as a deductible contribution to a 

qualified fund. In addition, taxpayers may have set aside funds prior to the effective date of the 

qualified fund rules.27 The treatment of amounts set aside for decommissioning costs prior to 

1984 varies. Some taxpayers may have received no tax benefit while others may have deducted 

such amounts or excluded such amounts from income. Since 1984, taxpayers have been required 

to include in gross income customer charges for decommissioning costs (sec. 88), and a 

deduction has not been allowed for amounts set aside to pay for decommissioning costs except 

through the use of a qualified fund. Income earned in a nonqualified fund is taxable to the fund’s 

owner as it is earned. 

Description of Proposal

Repeal of cost of service requirement 

The proposal repeals the cost of service requirement for deductible contributions to a 

nuclear decommissioning fund. Thus, all taxpayers, including unregulated taxpayers, would be 

allowed a deduction for amounts contributed to a qualified fund. 

Clarify treatment of transfers of qualified funds

The proposal clarifies the Federal income tax treatment of the transfer of a qualified fund. 

No gain or loss would be recognized to the transferor or the transferee (or the qualified fund) as a 

result of the transfer of a qualified fund in connection with the transfer of the power plant with 

respect to which such fund was established. 

 25 Treas. reg. sec. 1.468A-6.

26 Treas. reg. sec. 1.468A-6(f). 

27 These funds are generally referred to as “nonqualified funds.” 
56

Exception to ruling amount for certain decommissioning costs 

The proposal permits a taxpayer to make contributions to a qualified fund in excess of the 

ruling amount in one circumstance. Specifically, a taxpayer is permitted to contribute up to the 

present value of the amount required to fund a nuclear powerplant’s decommissioning costs 

which, under present law, is not permitted to be accumulated in a qualified fund (generally pre1984 decommissioning costs).28 It is anticipated that an amount that is permitted to be 

contributed under this special rule shall be determined using the estimate of total 

decommissioning costs used for purposes of determining the taxpayer’s most recent ruling 

amount. Any amount transferred to the qualified fund under this special rule that has not 

previously been deducted, or excluded from gross income is allowed as a deduction over the 

remaining useful life of the nuclear powerplant.29 If a qualified fund that has received amounts 

under this rule is transferred to another person, that person will be entitled to the deduction at the 

same time and in the same manner as the transferor. Thus, if the transferor was not subject to tax 

at the time and thus would have been unable to use the deduction, the transferee will similarly 

not be able to utilize the deduction. 

Effective Date

The proposal is effective for taxable years beginning after date of enactment. 

 28 The ability to transfer property into a qualified fund under this special rule is available 

only to the extent the taxpayer has not obtained a new ruling amount incorporating the repeal of 

the limitation that a qualified fund only accumulate an amount sufficient to pay for 

decommissioning costs of a nuclear powerplant incurred during the period that the fund is in 

existence (generally post 1984 decommissioning costs). 

29 A taxpayer recognizes no gain or loss on the contribution of property to a qualified 

fund under this special rule. The qualified fund will take a transferred (carryover) basis in such 

property. Correspondingly, a taxpayer’s deduction (over the estimated life of the nuclear 

powerplant) is to be based on the adjusted tax basis of the property contributed rather than the 

fair market value of such property. 
57

B. Treatment of Certain Income of Cooperatives 

Present Law

In general

Under present law, an entity must be operated on a cooperative basis in order to be 

treated as a cooperative for Federal income tax purposes. Although not defined by statute or 

regulation, the two principal criteria for determining whether an entity is operating on a 

cooperative basis are: (1) ownership of the cooperative by persons who patronize the 

cooperative; and (2) return of earnings to patrons in proportion to their patronage. The IRS 

requires that cooperatives must operate under the following principles: (1) subordination of 

capital in control over the cooperative undertaking and in ownership of the financial benefits 

from the cooperative; (2) democratic control by the members of the cooperative; (3) vesting in 

and allocation among the members of all excess of operating revenues over the expenses 

incurred to generate revenues in proportion to their participation in the cooperative (patronage); 

and (4) operation at cost (not operating for profit or below cost).30

In general, cooperative members are those who participate in the management of the 

cooperative and who share in patronage capital. As described below, income from the sale of 

electric energy by an electric cooperative may be member or non-member income to the 

cooperative, depending on the membership status of the purchaser. A municipal corporation 

may be a member of a cooperative. 

For Federal income tax purposes, a cooperative generally computes its income as if it 

were a taxable corporation, with one exception--the cooperative may exclude from its taxable 

income distributions of patronage dividends. In general, patronage dividends are the profits of 

the cooperative that are rebated to its patrons pursuant to a pre-existing obligation of the 

cooperative to do so. The rebate must be made in some equitable fashion on the basis of the 

quantity or value of business done with the cooperative. 

Except for tax-exempt farmers’ cooperatives, cooperatives that are subject to the 

cooperative tax rules of subchapter T of the Code (sec. 1381, et seq.) are permitted a deduction 

for patronage dividends from their taxable income only to the extent of net income that is derived 

from transactions with patrons who are members of the cooperative (sec. 1382). The availability 

of such deductions from taxable income has the effect of allowing the cooperative to be treated 

like a conduit with respect to profits derived from transactions with patrons who are members of 

the cooperative. 

Cooperatives that qualify as tax-exempt farmers’ cooperatives are permitted to exclude 

patronage dividends from their taxable income to the extent of all net income, including net 

income that is derived from transactions with patrons who are not members of the cooperative, 

provided the value of transactions with patrons who are not members of the cooperative does not 

exceed the value of transactions with patrons who are members of the cooperative (sec. 521). 

 30 Announcement 96-24, Proposed Examination Guidelines Regarding Rural Electric 

Cooperatives, 1996-16 I.R.B. 35. 
58

Taxation of electric cooperatives exempt from subchapter T

In general, the cooperative tax rules of subchapter T apply to any corporation operating 

on a cooperative basis (except mutual savings banks, insurance companies, other tax-exempt 

organizations, and certain utilities), including tax-exempt farmers’ cooperatives (described in 

sec. 521(b)). However, subchapter T does not apply to an organization that is “engaged in 

furnishing electric energy, or providing telephone service, to persons in rural areas” (sec. 

1381(a)(2)(C)). Instead, electric cooperatives are taxed under rules that were generally 

applicable to cooperatives prior to the enactment of subchapter T in 1962. Under these rules, an 

electric cooperative can exclude patronage dividends from taxable income to the extent of all net 

income of the cooperative, including net income derived from transactions with patrons who are 

not members of the cooperative.31

Tax exemption of rural electric cooperatives

Section 501(c)(12) provides an income tax exemption for rural electric cooperatives if at 

least 85 percent of the cooperative’s income consists of amounts collected from members for the 

sole purpose of meeting losses and expenses of providing service to its members. The IRS takes 

the position that rural electric cooperatives also must comply with the fundamental cooperative 

principles described above in order to qualify for tax exemption under section 501(c)(12).32 The 

85-percent test is determined without taking into account any income from qualified pole rentals 

and cancellation of indebtedness income from the prepayment of a loan under sections 306A, 

306B, or 311 of the Rural Electrification Act of 1936 (as in effect on January 1, 1987). The 

exclusion for cancellation of indebtedness income applies to such income arising in 1987, 1988, 

or 1989 on debt that either originated with, or is guaranteed by, the Federal Government. Rural 

electric cooperatives generally are subject to the tax on unrelated trade or business income under 

section 511.

Description of Proposal

Treatment of income from open access transactions

The proposal provides that income received or accrued by a rural electric cooperative 

from any “open access transaction” (other than income received or accrued directly or indirectly 

from a member of the cooperative) is excluded in determining whether a rural electric 

cooperative satisfies the 85-percent test for tax exemption under section 501(c)(12). The term 

“open access transaction” is defined as-- 

(1) the provision or sale of electric energy transmission services or ancillary services 

on a nondiscriminatory open access basis: (i) pursuant to an open access 

transmission tariff filed with and approved by the Federal Energy Regulatory 

Commission (“FERC”) (including acceptable reciprocity tariffs), but only if (in 

the case of a voluntarily filed tariff) the cooperative files a report with FERC 

 31 See Rev. Rul. 83-135, 1983-2 C.B. 149. 

32 Rev. Rul. 72-36, 1972-1 C.B. 151. 
59

within 90 days of enactment of this provision relating to whether or not the 

cooperative will join a regional transmission organization (“RTO”); or (ii) under 

an RTO agreement approved by FERC (including an agreement providing for the 

transfer of control--but not ownership--of transmission facilities);33

(2) the provision or sale of electric energy distribution services or ancillary services 

on a nondiscriminatory open access basis to end-users served by distribution 

facilities owned by the cooperative or its members; or 

(3) the delivery or sale of electric energy on a nondiscriminatory open access basis, 

provided that such electric energy is generated by a generation facility that is 

directly connected to distribution facilities owned by the cooperative (or its 

members) which owns the generation facility. 

For purposes of the 85-percent test, the proposal also provides that income received or 

accrued by a rural electric cooperative from any “open access transaction” is treated as an 

amount collected from members for the sole purpose of meeting losses and expenses if the 

income is received or accrued indirectly from a member of the cooperative. 

Treatment of income from nuclear decommissioning transactions

The proposal provides that income received or accrued by a rural electric cooperative 

from any “nuclear decommissioning transaction” also is excluded in determining whether a rural 

electric cooperative satisfies the 85-percent test for tax exemption under section 501(c)(12). The 

term “nuclear decommissioning transaction” is defined as-- 

(1) any transfer into a trust, fund, or instrument established to pay any nuclear 

decommissioning costs if the transfer is in connection with the transfer of the 

cooperative’s interest in a nuclear powerplant or nuclear powerplant unit; 

(2) any distribution from a trust, fund, or instrument established to pay any nuclear 

decommissioning costs; or 

(3) any earnings from a trust, fund, or instrument established to pay any nuclear 

decommissioning costs. 

Treatment of income from asset exchange or conversion transactions

The proposal provides that gain realized by a tax-exempt rural electric cooperative from a 

voluntary exchange or involuntary conversion of certain property is excluded in determining 

whether a rural electric cooperative satisfies the 85-percent test for tax exemption under section 

501(c)(12). This provision only applies to the extent that: (1) the gain would qualify for 

deferred recognition under section 1031 (relating to exchanges of property held for productive 

use or investment) or section 1033 (relating to involuntary conversions); and (2) the replacement 

 33 Under this provision, references to FERC are treated as including references to the 

Public Utility Commission of Texas or the Rural Utilities Service. 
60

property that is acquired by the cooperative pursuant to section 1031 or section 1033 (as the case 

may be) constitutes property that is used, or to be used, for the purpose of generating, 

transmitting, distributing, or selling electricity or natural gas. 

Treatment of cancellation of indebtedness income from prepayment of certain loans

The proposal provides that income from the prepayment of any loan, debt, or obligation 

of a tax-exempt rural electric cooperative that is originated, insured, or guaranteed by the Federal 

Government under the Rural Electrification Act of 1936 is excluded in determining whether the 

cooperative satisfies the 85-percent test for tax exemption under section 501(c)(12). 

Treatment of income from load loss transactions

Tax-exempt rural electric cooperatives.–The proposal provides that income received or 

accrued by a tax-exempt rural electric cooperative from a “load loss transaction” is treated under 

501(c)(12) as income collected from members for the sole purpose of meeting losses and 

expenses of providing service to its members. Therefore, income from load loss transactions is 

treated as member income in determining whether a rural electric cooperative satisfies the 85-

percent test for tax exemption under section 501(c)(12). The proposal also provides that income 

from load loss transactions does not cause a tax-exempt electric cooperative to fail to be treated 

for Federal income tax purposes as a mutual or cooperative company under the fundamental 

cooperative principles described above. 

The term “load loss transaction” is generally defined as any wholesale or retail sale of 

electric energy (other than to a member of the cooperative) to the extent that the aggregate 

amount of such sales during a seven-year period beginning with the “start-up year” does not 

exceed the reduction in the amount of sales of electric energy during such period by the 

cooperative to members. The “start-up year” is defined as the calendar year which includes the 

date of enactment of this provision or, if later, at the election of the cooperative: (1) the first year 

that the cooperative offers nondiscriminatory open access; or (2) the first year in which at least 

10 percent of the cooperative’s sales of electric energy are to patrons who are not members of the 

cooperative. 

The proposal also excludes income received or accrued by rural electric cooperatives 

from load loss transactions from the tax on unrelated trade or business income. 

Taxable electric cooperatives.–The proposal provides that the receipt or accrual of 

income from load loss transactions by taxable electric cooperatives is treated as income from 

patrons who are members of the cooperative. Thus, income from a load loss transaction is 

excludible from the taxable income of a taxable electric cooperative if the cooperative distributes 

such income pursuant to a pre-existing contract to distribute the income to a patron who is not a 

member of the cooperative. The proposal also provides that income from load loss transactions 

does not cause a taxable electric cooperative to fail to be treated for Federal income tax purposes 

as a mutual or cooperative company under the fundamental cooperative principles described 

above. 
61

Effective Date

This proposal is effective for taxable years beginning after the date of enactment.
62

C. Sales or Dispositions to Implement Federal Energy Regulatory Commission 

or State Electric Restructuring Policy 

Present Law

Generally, a taxpayer recognizes gain to the extent the sales price (and any other 

consideration received) exceeds the seller’s basis in the property. The recognized gain is subject 

to current income tax unless the gain is deferred or not recognized under a special tax provision. 

Description of Proposal

The proposal permits a taxpayer to elect to recognize gain from a qualifying electric 

transmission transaction ratably over an eight-year period beginning in the year of sale. A 

qualifying electric transmission transaction is the sale or other disposition of property used by the 

taxpayer in the trade or business of providing electric transmission services, or an ownership 

interest in such an entity, to an independent transmission company34 prior to January 1, 2008. 

A taxpayer electing the provisions of the proposal is required to attach a statement to that 

effect in the tax return for the taxable year in which the transaction takes place in the manner as 

the Secretary shall prescribe. The election shall be binding for that taxable year and all 

subsequent taxable years. 35

Effective Date

The proposal is effective for transactions occurring after the date of enactment.

 34 In general, an independent transmission company is defined as: (1) a regional 

transmission organization approved by the FERC; (2) a person (i) who the FERC determines 

under section 203 of the Federal Power Act is not a “market participant” and (ii) whose 

transmission facilities are placed under the operational control of a FERC-approved regional 

transmission organization before the close of the period specified in such authorization, but not 

later than January 1, 2007; or (3) in the case of facilities subject to the exclusive jurisdiction of 

the Public Utility Commission of Texas, a person who is approved by that commission as 

consistent with Texas state law regarding an independent transmission organization. 

35 The proposal also provides that the installment sale rules shall not apply to any 

qualifying electric transmission transaction that elects the provisions of this proposal. 
63

VII. ADDITIONAL PROVISIONS 

A. Extension of Accelerated Depreciation and 

Wage Credit Benefits on Indian Reservations 

Present Law

Present law includes the following tax incentives for businesses located within Indian 

reservations. 

Accelerated depreciation

With respect to certain property used in connection with the conduct of a trade or 

business within an Indian reservation, depreciation deductions under section 168(j) will be 

determined using the following recovery periods: 

3-year property................................... 2 years 

5-year property................................... 3 years 

7-year property................................... 4 years 

10-year property................................. 6 years 

15-year property................................. 9 years 

20-year property................................. 12 years 

Nonresidential real property .............. 22 years 

“Qualified Indian reservation property” eligible for accelerated depreciation includes 

property which is (1) used by the taxpayer predominantly in the active conduct of a trade or 

business within an Indian reservation, (2) not used or located outside the reservation on a regular 

basis, (3) not acquired (directly or indirectly) by the taxpayer from a person who is related to the 

taxpayer (within the meaning of section 465(b)(3)(C)), and (4) described in the recovery-period 

table above. In addition, property is not “qualified Indian reservation property” if it is placed in 

service for purposes of conducting gaming activities. Certain “qualified infrastructure property” 

may be eligible for the accelerated depreciation even if located outside an Indian reservation, 

provided that the purpose of such property is to connect with qualified infrastructure property 

located within the reservation (e.g., roads, power lines, water systems, railroad spurs, and 

communications facilities). 

The depreciation deduction allowed for regular tax purposes is also allowed for purposes 

of the alternative minimum tax. The accelerated depreciation for Indian reservations is available 

with respect to property placed in service on or after January 1, 1994, and before January 1, 

2004. 

Indian employment credit

In general, a credit against income tax liability is allowed to employers for the first 

$20,000 of qualified wages and qualified employee health insurance costs paid or incurred by the 

employer with respect to certain employees (sec. 45A). The credit is equal to 20 percent of the 

excess of eligible employee qualified wages and health insurance costs during the current year 

over the amount of such wages and costs incurred by the employer during 1993. The credit is an 
64

incremental credit, such that an employer’s current-year qualified wages and qualified employee 

health insurance costs (up to $20,000 per employee) are eligible for the credit only to the extent 

that the sum of such costs exceeds the sum of comparable costs paid during 1993. No deduction 

is allowed for the portion of the wages equal to the amount of the credit. 

Qualified wages means wages paid or incurred by an employer for services performed by 

a qualified employee. A qualified employee means any employee who is an enrolled member of 

an Indian tribe or the spouse of an enrolled member of an Indian tribe, who performs 

substantially all of the services within an Indian reservation, and whose principal place of abode 

while performing such services is on or near the reservation in which the services are performed. 

An employee will not be treated as a qualified employee for any taxable year of the employer if 

the total amount of wages paid or incurred by the employer with respect to such employee during 

the taxable year exceeds an amount determined at an annual rate of $30,000 (adjusted for 

inflation after 1993). 

The wage credit is available for wages paid or incurred on or after January 1, 1994, in 

taxable years that begin before December 31, 2003. 

Explanation of Provision 

Accelerated depreciation

The provision extends the accelerated depreciation incentive for one year (to property 

placed in service before January 1, 2006). 

Indian employment credit

The provision extends the Indian employment credit incentive for one year (to taxable 

years beginning before January 1, 2006). 

Effective Date

The provision is effective on the date of enactment. 
65

B. GAO Study 

Present Law

Present law does not require study of the present law provisions relating to clean fuel 

vehicles and electric vehicles. 

Description of Proposal

The proposal directs the Comptroller General to undertake an ongoing analysis of the 

effectiveness of the tax credits allowed to alternative motor vehicles and the tax credits allowed 

to various alternative fuels under Title II of the bill and the tax credits and enhanced deductions 

allowed for energy conservation and efficiency under Title III of the bill. The studies should 

estimate the energy savings and reductions in pollutants achieved from taxpayer utilization of 

these provisions. The studies should estimate the dollar value of the benefits of reduced energy 

consumption and reduced air pollution in comparison to estimates of the revenue cost of these 

provisions to the U.S. Treasury. The studies should include an analysis of the distribution of the 

taxpayers who utilize these provisions by income and other relevant characteristics. 

The proposal directs the Comptroller General to submit annual reports to Congress 

beginning not later than December 31, 2004. 

Effective Date

The proposal is effective on the date of enactment.