Utility Groups Seek Clarity Under Bonus Depreciation Regs

October 8, 2018

CC:PA:LPD:PR (REG-104397-18)
Courier's Desk
Internal Revenue Service
1111 Constitution Avenue N.W.
Washington, D.C.

The Honorable David Kautter
Assistant Secretary (Tax Policy)
United States Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington D.C. 20220

William M. Paul, Esq.
Acting Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

The Honorable Charles Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Dear Messrs. Kautter, Rettig and Paul:

The Edison Electric Institute and the American Gas Association want to express our gratitude for the careful thought and attention that went into the development of the Notice of Proposed Rulemaking regarding §168(k) of the Internal Revenue Code of 1986 (“Code”) as amended by the Tax Cuts and Jobs Act (P.L. 115-97) (the “TCJA”), published on August 8, 2018 (the “NOPR”). The NOPR allows for the submission of comments. We herewith offer our comments that address the guidance regarding the changes made to the additional first-year depreciation deductions allowed by the Code for qualified property acquired and placed in service after September 27, 2017. Because of the specific rules that apply to regulated public utility trades or businesses as defined in Code § 163(j)(7)(A)(iv) and the ineligibility of property used in a regulated utility trade or business for the 100-percent additional first year depreciation deduction under Code § 168(k)(9), we ask that our requested clarifications be included in final regulations and, where possible, illustrated by example to avoid mistakes or controversy in ratemaking proceedings and tax filings. With respect to the matters on which we are commenting, our members believe that the clarity of the rule can be more important than the rule's substance.

Property Described in Code § 163(j)(7)(A)(iv).

Code § 168(k)(9) provides in part: “The term “qualified property” shall not include — (A) any property which is primarily used in a trade or business described in clause (iv) of section 163(j)(7)(A), . . .” Code § 163(j)(7)(A)(iv) describes:

We will refer to such a trade or business as a “regulated utility business” and property used in that trade or business as “utility property.” Prop. Treas. Reg. § 1.168(k)-2(b)(2)(ii) includes as property not eligible for the additional first year depreciation deduction, property which is “[d]escribed in section 168(k)(9)(A) and placed in service in any taxable year beginning after December 31, 2017.” Thus, utility property is eligible for the 100-percent additional first year depreciation deduction if the property is acquired after September 27, 2017, and placed in service in a taxable year beginning before January 1, 2018. For a calendar year taxpayer this is utility property acquired after September 27, 2017 and placed in service before January 1, 2018, and for a fiscal year taxpayer this is utility property acquired after September 27, 2017 and placed in service before the start of its next fiscal year beginning after December 31, 2017.

The NOPR does not indicate whether utility property acquired by a regulated utility business before September 28, 2017, which is therefore ineligible for the 100-percent additional first year depreciation deduction, is eligible for any other additional first year depreciation deduction (e.g., 50-percent). We ask for clarification of this issue. For example, assume a calendar year regulated utility business entered into a binding contract to acquire long production period utility property prior to September 28, 2017, and placed the property in service in 2018.

The utility property is not eligible for the 100-percent additional first year depreciation deduction because it was acquired pursuant to a pre-September 28, 2017 binding contract and it was not placed in service before January 1, 2018. Under the prior additional first year depreciation deduction rules the property would have been eligible for the 50-percent additional first year depreciation deduction because it was long production period property acquired before January 1, 2020, and placed in service in 2018. Under the phase-down rules of Code § 168(k)(8) qualified property with a long production period acquired before September 28, 2017 and placed in service in 2018 generally is eligible for the 50-percent additional first year depreciation deduction, but it is unclear whether utility property placed in service by a calendar year regulated utility business is qualified property when it is placed in service after December 31, 2017. This is so because Prop. Treas. Reg. § 1.168(k)-2(b)(2)(ii)(F) states that property described in section 168(k)(9)(A) (utility property) and placed in service in any taxable year beginning after December 31, 2017 is not qualified. This provision does not say whether the reference to the additional first year depreciation deduction is limited to the 100-percent additional first year depreciation deduction or applies more broadly to all additional first year depreciation deductions. The Explanation of Provisions provides no more specificity. It provides:

Section 163(j) applies to taxable years beginning after December 31, 2017. Accordingly, the exclusion of property described in section 168(k)(9) from the additional first year depreciation deduction applies to property placed in service in any taxable year beginning after December 31, 2017.

This quoted explanation only refers to when the property is placed in service and provides no distinction with respect to the date on which the property was acquired.

We ask that the final regulations address the eligibility for any special allowance under Code § 168(k) under the facts in the following examples:

Self-Constructed Property Binding Contract Rule.

The TCJA amended Code § 168(k) for property acquired and placed in service after September 27, 2017. If a taxpayer manufactures, constructs, or produces property for use by the taxpayer in its trade or business or for its production of income, the property is treated as acquired when the taxpayer begins physical work of a significant nature in the manufacturing, constructing, or producing of the property. This is described as a facts and circumstances determination. In lieu of making the facts and circumstances determination the NOPR provides a safe harbor. Under Prop. Treas. Reg. § 1.168(k)-2(b)(5)(iv)(B)(2) a taxpayer may choose to determine that physical work of a significant nature begins at the time the taxpayer incurs (in the case of an accrual basis taxpayer) more than 10 percent of the total cost (with certain exclusions) of the property. Prop. Treas. Reg. § 1.168(k)-2(b)(5)(iv)(C) provides that any acquired component used by a taxpayer in the self-construction of a larger self-constructed property is treated as acquired when the taxpayer enters into a binding contract to acquire the component. It also provides that a binding contract to acquire one or more components of a larger self-constructed property will not preclude the larger self-constructed property from being acquired after September 27, 2017. We ask that you clarify whether and when the cost of a component acquired under a binding contract entered before September 28, 2017 is taken into account under the safe harbor rule to determine when self-construction begins.

This issue is illustrated (but not resolved) in Example 1 of Prop. Treas. Reg. § 1.168(k)-2(c)(3)(iv). In that example, MM entered into a binding contract to acquire a component part of a larger property on August 15, 2017 at a cost that was 9 percent of the total cost of the property. The manufacture of the part began in 2018, and in 2020 MM received the part and began construction on the larger property. The example concludes that MM is not eligible for the 100-percent additional first year depreciation deduction on the cost of the part, but is eligible for the 100-additional first year depreciation deduction on the cost of the larger property in excess of the cost of the part. The example clearly illustrates the point that the cost of the component part acquired under a pre-September 28, 2017 binding contract is not eligible for 100-percent additional first year depreciation and that the larger project is eligible for 100-percent additional first year depreciation. It is not clear, however, whether the balance of the cost of the larger self-constructed asset is eligible for the 100-percent additional first year depreciation deduction under the facts of the example because (1) the component part cost is not more than 10 percent of the self-constructed property cost; (2) the component part cost is not taken into account in determining when more than 10 percent of the larger self-constructed property cost has been incurred under the safe harbor rule, or (3) the component part cost is not taken into account under the safe harbor rule until its cost is incurred with respect to the larger self-constructed property at the time the part is received in 2020.

The relevance and significance of the 9 percent in the example is unclear. For example, if the component part is 11 percent of the total cost of the property, would MM be treated as having incurred more than 10 percent of the total cost of the larger property (and thus having started physical work under the safe harbor) on August 15, 2017 (the date the binding contract for the component part was signed), even though MM, as an accrual basis taxpayer, would not incur the cost of the component under Code § 461 until it receives the component in 2020? If Code § 461 is the appropriate standard, the percentage would not be relevant with respect to the commencement of construction prior to September 28, 2017 (because no costs would have been incurred prior to delivery in 2020). A way to reconcile the binding contract event with respect to the component with the measurement of costs under the safe harbor rule is to conclude that the binding contract on the component makes the component ineligible for the 100-percent additional first year depreciation deduction, but that the cost of the component part is not taken into account for determining when construction of the larger self-constructed property has begun under the safe harbor rule until the cost of the component is incurred at the time of its delivery. Consistent with this approach Example 1 would read as follows:

On June 1, 2017, MM decided to construct property described in section 168(k)(2)(B) for its own use. However, one of the component parts of the property had to be manufactured by another person for MM. On August 15, 2017, MM entered into a written binding contract with NN to acquire this component part of the property for $100,000. NN began physical work of a significant nature in the manufacturing of the component part on September 1, 2018, and MM received the completed component part on February 1, 2020, at which time MM incurred the cost of the component part, which is 11 percent of the total cost of the property to be constructed by MM. MM placed this property, including all component parts, in service on November 1, 2021. Pursuant to paragraphs (b)(5)(iv)(C)(1) and (c)(1) of this section, the component part of $100,000 manufactured by NN for MM is not eligible for the 100-percent additional first year depreciation deduction because the written binding contract to acquire such component part was entered into before September 28, 2017. This is so even though MM did not incur the cost of the component part until February 1, 2020. However, pursuant to paragraph (c)(3)(i) of this section, the cost of the property described in section 168(k)(2)(B), excluding the cost of the component part of $100,000 manufactured by NN for MM, is eligible for the 100-percent additional first year depreciation deduction, assuming all other requirements are met, because construction of the property began on February 1, 2020, which is after September 27, 2017, and before January 1, 2027, and the property described in section 168(k)(2)(B) was placed in service by MM before January 1, 2028.

Elections Under Prop. Treas. Reg. § 1.168(k)-2(e).

Code § 168(k)(7) allows a taxpayer to elect out of the additional first year depreciation deduction with respect to any class of property for any taxable year. Code § 168(k)(10) allows a taxpayer to take the 50-percent additional first year depreciation deduction instead of the 100-percent additional first year depreciation deduction for qualified property placed in service during the first taxable year ending after September 27, 2017. The NOPR requires these elections to be made by the due date, including extensions, of the Federal tax return for the taxable year in which the qualified property is placed in service by the taxpayer. Based on our reading of the statute we did not expect the 100-percent additional first year depreciation deduction for property acquired after September 27, 2017, and placed in service in a taxable year beginning before January 1, 2018. However, the NOPR is clear that a calendar year regulated utility business is eligible for the 100-percent additional first year depreciation deduction for the period September 28, 2017 through December 31, 2017. For fiscal year taxpayers the period is longer. The NOPR was announced by the Internal Revenue Service on August 3, 2018, and published in the Federal Register on August 8, 2018, which dates were several months after the April 15, 2018 original due date for 2017 calendar year federal income tax returns. Taxpayers who filed their returns before the issuance of the NOPR plus a reasonable administrative period should be permitted to make these elections on amended returns. In our view, your permission to allow these elections on amended returns should be granted to all taxpayers who filed timely 2017 returns (including extensions) on or before October 15, 2018. This would cover all calendar year taxpayers, as well as those that filed before the NOPR was issued and had no opportunity to consider these elections.

The Internal Revenue Service seems to be aware of this issue. Its news release announcing the issuance of the NOPR includes the statement:

IRS Statements and Announcements, IR-2018-159 (Aug. 3, 2018).

While this statement reflects an acknowledgment of the issue, it does not address the election to claim the 50-percent additional first year depreciation deduction in lieu of the 100-percent additional first year depreciation deduction, nor does it provide sufficient time to file an amended return. Furthermore, the statement appears to conflict with the requirements of the NOPR.

We appreciate your consideration of these comments and are available to answer any questions. If you have any questions or need additional information please contact our tax counsel, Alex Zakupowsky, Miller & Chevalier, at 202-626-5950.

Sincerely,

Thomas R. Kuhn
President
Edison Electric Institute

Dave McCurdy
President
American Gas Association