Prepaid power contracts

Prepaid power contracts

December 18, 2018 | By Keith Martin in Washington, DC

Prepaid power contracts are harder to make work after the US tax reforms last December.

The IRS said in October that it plans formally to withdraw the part of its regulations that let an electricity generator report the prepayment as taxable income over the same period the prepaid electricity is delivered.

In some power purchase agreements, the utility taking the electricity pays in advance for a share of the electricity to be delivered over time. The structure is used mainly where electricity is being sold to a municipal utility or electric cooperative. It is also used to supply natural gas to such utilities.

The generator or gas supplier reports the advance payment as income over the period the electricity or gas is delivered.

Prepayments are also common in the solar rooftop market.

The tax reform bill last December requires such prepayments to be reported immediately as income or, at best, partly in the year the prepayment is received and the balance the year after.

The change was effective in tax years starting after 2017.

Generators that received prepayments before the change must report the remaining balance as income in 2018, according to tax experts in Congress who had a hand in drafting the new law.

An electricity or gas supplier who wants to use the structure in the future would have to structure the prepayment as a loan that is repaid in kind with electricity or gas. In order for the loan characterization to work, ideally the supplier should have the option to make loan payments in cash and the electricity or gas should be credited against the loan balance at its market value at time of delivery.

The fact that a 100% “depreciation bonus” can now be claimed on any new power plant used to supply the electricity may help shelter the prepayment. A 100% depreciation bonus means that the full cost of the power plant can be deducted as depreciation in the year the project is put in service. In a solar project where a 30% investment tax credit is also claimed on the project, only 85% of the project cost can be deducted as depreciation.