by Dean Zerbe, Former Senior Counsel to the U.S. Senate Finance Committee; alliantgroup National Managing Director
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There has recently been a fair amount of activity in the world of Section 179D – an important tax incentive for energy efficient building design. As background, in 2005, Congress enacted Section 179D of the Internal Revenue Code, – the energy efficient commercial building deduction – in an effort to impact the country’s largest consumer of energy, our buildings, and to encourage and incentivize the construction (including rehab) of greener buildings. The provision provided (until recently) for a $1.80 per square foot deduction for owners of buildings (and rehabs) that exceed certain ASHRAE thresholds. In addition, the provision encouraged greener buildings for government entities (federal, state and local) by allowing the government to allocate the deduction to the designer (architect, engineer, contractor), or designers (plural) if more than one entity was determined to be responsible.
Congress Expands Section 179D – More Green For Being Green
The Congress, in the recently passed Inflation Reduction Act (IRA) included a number of significant expansions to Section 179D as part of the overall provisions seeking to address climate concerns and encourage energy conservation and independence.
The biggest one is that the deduction per square foot has gone from $1.80 per square foot to up to $5.00 per square foot depending on the amount of energy efficiency. And again, as a reminder, a building owner may qualify for a partial benefit depending on the level of energy savings achieved.
In addition, the IRA legislation expanded the number of entities that are covered by Section 179D – to include tax-exempts and Indian tribes. So for example, in the past, while a public university building could qualify for the 179D deduction – a private university, place of worship, or homeless shelter could not qualify. Now they all can qualify – and look to allocate the benefit to their designer (see below). Good news indeed.
Finally, the legislation for 179D does impose requirements on prevailing wage; apprentice programs, etc. for entities looking at maximizing the tax benefit. The lord giveth . . .
Senator Cardin Makes Clear – No Kickbacks For Allocation Letters To Designers
The great champion of Section 179D in the Senate is Senator Cardin (D-MD) who has done so much to ensure that Section 179D was included in the IRA and the expansions were put in place. Also of importance, the Senator has been tireless in ensuring that the designers of government (and now tax-exempt) buildings receive the benefit to which they are entitled under the statute.
In an August 6, 2022 statement in the Congressional Record (S 4167) during consideration of the Inflation Reduction Act, Senator Cardin made the following comments:
I have been made aware of a discouraging trend among those who use Section 179D that some entities attempt to receive payments in exchange for providing Section 179D allocation letters to private sector building designers.
As I have said before, entities seeking to avail themselves of the tax benefits of section 179D cannot seek, accept, or solicit payments from designers in exchange for providing section 179D allocation letters. . . .
As section 179D is rightly expanded in the legislation being considered in the Senate, it must be reaffirmed that it is congressional intent that entities cannot seek, accept, or solicit payments in exchange for providing 179D allocation letters.
Welcome news indeed for architects, engineers and contractors who are providing green design work that is helping significantly lower energy costs for government entities and tax exempts. A win for designers and building owners.
Tax Court – Big Win For Designers And Claiming 179D
The Tax Court in a recent decision Johnson v. CIR, 160 TC 2 (2023) provided a strong win for designers – and especially contractors as designers – in claiming the Section 179D tax benefit. The opinion also addressed (and knocked down) a number of arguments the IRS has been raising in examinations of Section 179D. Full disclosure — the taxpayer was represented by partners of my law firm Zerbe, Miller, Fingeret, Frank & Jadav and the taxpayer’s 179D study was performed by Houston-based tax services firm alliantgroup (one of my other hats).
The case involved a contractor – Edwards – that is in the business of designing and installing heating ventilation and air conditioning (HVAC) systems and process systems. The case focused on the work of Edwards upgrading and improving the HVAC system at a VA hospital in Illinois.
The headline of the case is the Tax Court affirming that Edwards’ work as a contractor qualified as a designer – finding that “. . . the work Edwards performed with respect to the projects at issue involved more than mere installation, repair, or maintenance.” The Court noted that Edwards in replacing and installing automation and temperature control systems had to analyze the system as a whole, including the original sequence of operations to determine how the existing systems were intended to operate, while inspecting the exiting systems to determine how they actually operated in comparison to the original sequence and modified sequence of operations as necessary to better operate the systems.
The Court noted the IRS argument that Edwards utilized a subcontractor to assist in performing some of the work. The Court dismissed this argument recognizing that while the subcontractor participated in some of the work and programming, Edwards retaining the services of a subcontractor did not mean Edwards was not a “designer.” The Court concluded that Edwards was a “designer” within the meaning of Notice 2008-40.
The IRS argued that to qualify for 179D Edwards needed to install the HVAC equipment as “part of a plan” to improve energy efficiency. The quoted language from 179D(c)(1)(D). The IRS essentially argued that the installation of the HVAC system that achieved energy savings was not the subject of forethought or design. Edwards argued that a “plan” does not require subjective intent to achieve the energy savings target. The Tax Court rules for the designer finding that in reading the relevant IRS Notice – that there is nothing that requires intent and forethought to qualify for Section 179D.
The Tax Court then addressed concerns of how energy efficiency should be measured to qualify for 179D for improvements to a preexisting building. The Court found that the IRS Notice 2006-52 contemplates a comparison between the proposed building as it stands and the reference building. The significance of this finding as that the building as it stands should be modeled and not single component parts. For example, if a Designer creates technical specifications for a new controls system and installs it – the entire building as it stands is still modeled including existing energy efficient windows, installation and lighting. This ruling makes sense as Designers who are trying to remodel an existing building to make it energy efficient would only focus on the inefficient aspects to create an overall efficient building. As a limitation already exists in the law to limit the deduction to the amount of Energy Efficient Commercial Building Property (EECBP), the IRS argument to limit the model to only newly designed efficient parts was properly rejected by the Court.
The IRS then argued that the certification of the building was insufficient because it didn’t list the energy efficient features and that the required field inspection was not performed properly. The Tax Court disagreed with both arguments – bringing a commonsense approach to the requirements of certification as well as field inspections. Essentially the Court pointed out that the IRS’s own guidance addressed the contemplated energy efficient systems including building envelope, heat/cooling, and lighting, thus there was no need for further specificity from the taxpayer.
The Court then considered a number of procedural or technical issues raised by the IRS regarding the allocation letter provided by the government official to the taxpayer. In short, the Court provided a practical real-world review of what is required for an allocation letter and who can sign an allocation letter – finding in favor of the taxpayers. All good news for taxpayers. Finally, it should be noted that an argument about costs that should be counted for the deduction was raised by the IRS and agreed to by the Tax Court which did reduce the deduction by the taxpayers – that was specific to the facts in this case.
Overall, this case was a big win for designers – – and especially contractors. The Tax Court provided clear pro-taxpayer guidance that is good news for those looking to benefit from the tax incentives provided for energy efficient buildings under Section 179D. This Tax Court win coupled with the recent expansion of Section 179D by the Congress provides the possibilities of significant opportunities for tax savings for those engaged in the design and construction of energy efficient buildings.
And One Truth – Must Reduce Wage Deductions by Amount Of ERC
The IRS is clearly concerned (raised in their press release) – and we see in our own work when asked to review work from accountants other tax providers supporting ERC calculations – that the taxpayer is not told that wage deductions claimed on the business’ federal income tax return must be reduced by the amount of the employee retention credit.
Porridge Just Right
Like most tax incentives and credits provided by Congress – the ERC is a keep-your-feet-on-the-floor exercise. Not being so blinked that you don’t look hard as to whether your business can qualify for this good incentive that Congress provided to help businesses keep their doors open and employees on payroll. But not so naive that you believe without question the voices telling you it’s a “whiskers-on-kittens” give away.
The IRS — not Santa — is in charge of reviewing requests for the ERC – and you need to look closely at the requirements of the law and relevant government orders – and then document and detail how your business qualifies and meets the necessary tests as outlined by the IRS.
About the Author
Dean Zerbe is alliantgroup’s National Managing Director based in the firm’s Washington D.C. office. Prior to joining alliantgroup, Mr. Zerbe was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance. He worked closely with then-Chairman and current Ranking Member of the Finance Committee, Senator Charles Grassley (R-IA), on tax legislation. During his tenure on the Finance Committee, Mr. Zerbe was intimately involved with nearly every major piece of tax legislation that was signed into law – including the 2001 and 2003 tax reconciliation bills, the JOBS bill in 2004 (corporate tax reform), and the Pension Protection Act. Mr. Zerbe is a frequent speaker and author on the outlook for short-term and long-term changes in tax policy, as well as ways accounting firms can help their clients lower their tax bill. He holds an LL.M. in Taxation from NYU and a J.D. from George Mason University.