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Smart Grid Grants: Not Currently Taxable, But There’s a Hitch By Guest Editorial Mar 12, 2010 - 8:41:58 AM
By James Atkinson At law firm Miller & Chevalier Chartered
Although largely favorable, the guidance is not as favorable as some in the industry had hoped. On one hand, the guidance shields from immediate taxation grants received under the Smart Grid Investment Matching Grant Program of 42 U.S.C. § 17386 (“SGIG”). Smart Grid grants received under a separate program for technology research, development, and demonstration are not eligible for the safe harbor, and potentially remain subject to immediate taxation. On the other hand, the IRS’s pledge that it “would not challenge” the treatment of SGIG payments as non-taxable capital contributions is not the permanent income exclusion for which many in the industry were hoping. Under the guidance, recipients must reduce the tax basis of tangible property by an amount equal to the grants that are excluded from income. The result is a reduction in tax benefits such as depreciation over the life of the property and higher taxable gain (or reduced losses) on its eventual disposition. As such, by treating the Smart Grid grants as capital contributions, the IRS effectively has permitted only a deferral of income, rather than a permanent exclusion.
This approach also arguably excludes from its scope grant recipients not organized as corporations. The IRS’s position is that section 118(a) of the tax code is the exclusive mechanism to exclude capital contributions from gross income. By its terms, that statutory provision is available only to corporations. In treating Smart Grid grants as capital contributions which only corporations can exclude from income, the IRS’s approach places non-corporate recipients at a disadvantage.
A broader concern is the procedural route taken by the IRS in announcing its position. Assuming Smart Grid grants are not otherwise excludible from gross income, the SGIG program appears to fall squarely within the scope of section 118(a) of the tax code. The terms of 42 U.S.C. § 17386 state that the grants are to be used for specified infrastructure improvements and not for routine operating expenses. In general terms, this is the benchmark normally used in distinguishing a non-taxable capital contribution from a taxable receipt. As such, it is troubling that the IRS did not state definitively that Smart Grid grants are non-taxable capital contributions, rather than taking the more equivocal approach of stating only that the IRS “will not challenge” that position.
The IRS’s unwillingness to state definitively that Smart Grid grants are non-taxable capital contributions as a matter of law reflects the IRS’s increasingly narrow approach to the treatment of capital contributions generally and the audit risks utilities now face in attempting to exclude government payments from income on that basis. The electric utility industry has long relied on section 118(a) of the tax code to exclude from income a variety of government payments, including payments to relocate or to bury existing transmission and distribution lines. The IRS’s increasingly narrow approach to the application of this section of the tax code raises concerns beyond the taxability of Smart Grid grants. As such, while the message provided in the Smart Grid guidance is favorable, the way in which it was delivered is troubling.
While not as favorable as perhaps many in the industry had hoped, the IRS’s announced treatment of Smart Grid grants nonetheless is more favorable than the immediate taxation of the grants that some had feared. Nonetheless, the IRS’s treatment of Smart Grid grants highlights the importance of ensuring that legislation providing targeted grants specifically provides for their exclusion from gross income. Otherwise, as seen in Revenue Procedure 2010-20, the intended incentive may be blunted administratively.
Attorney James Atkinson at law firm Miller & Chevalier Chartered practices in the area of federal income taxation, with a focus on tax accounting issues. He has significant policy-level experience with federal tax administration. Prior to joining Miller & Chevalier, Atkinson held a number of senior leadership positions with the Internal Revenue Service (IRS) National Office, including Assistant to the Commissioner and, most recently, Associate Chief Counsel (Income Tax & Accounting) . You might also be interested in … Whew! IRS Says it Won't Tax Smart Grid Stimulus Grants
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