Federal and State Tax Incentives for Alternative Vehicles and Fuels by Gail H

Emerging Issues Commentary July 2008

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

Background. 1 Trucks and automobiles run on gasoline and diesel produced from oil, and are a primary reason the U.S. consumes large quantities of fossil fuels. 2 Given the high levels of demand for fuel, federal and state governments have historically provided significant tax incentives to encourage fossil fuel production and lower the cost of gasoline for consumers.

As the scarcity of oil is appreciated, however, the demand for a change in energy policy increases. For example, in response to the OPEC oil embargo and oil crisis in the early 1970s, which many people remember most vividly because it resulted in long lines at gas stations, Congress began to consider the need for a shift from petroleum based transportation fuels and fossil fuel burning vehicles and enacted the first tax incentives to encourage the development and use of alternative fuel vehicles and fuel efficient vehicles.

Today, the tax code has made little progress in keeping up with technology or the demand for alternatives to fossil fuel and fossil fuel burning vehicles. Since their introduc- tion 30 years ago, federal income tax provisions for alternative fuels have not been meaningfully updated to compete with the tax incentives provided to fossil fuels. 3 As a result, alternative fuels have not yet significantly affected U.S. energy independence or energy security, nor have they resulted in clear, positive environmental effects. 4

Given the recent focus on the increasing cost of oil and carbon dioxide emissions (the transportation industry, including both commercial and personal vehicles, is responsible for approximately one-third of all carbon dioxide emissions), 5 there has been increasing demand for finding a replacement for fossil fuels and fossil fuel burning vehicles. Most commentators agree that without significantly increasing the federal and state tax benefits for the types of alternative fuels that are the most promising alternative sources (or reducing existing tax benefits for fossil fuels), thereby encouraging significant research

1. This article is intended to be a companion piece to the authors’ March-April 2008 article, Federal and State Tax Incentives for Renewable Energy , 2008 Emerging Issues 221 , which reviewed tax incentives for the fossil fuel industry as well as other topics that will be discussed in less detail in this paper.

2. Mona Hymel, The United States’ Experience with Energy-Based Tax Incentives: The Evidence Supporting Tax Incentives for Renewable Energy , Arizona Legal Studies Discussion Paper No. 06-21 (Apr. 2006), at 2.

3. Roberta Mann & Mona Hymel, Getting into the Act: Enticing the Consumer to Become “Green” Through Tax Incentives , 36 Envtl. L. Rep. 10419, 10422 (2006).

4. U.S. General Accounting Office, Effects of the Alcohol Fuels Tax Incentives (March 1997), at 19–20.

5. Energy Information Administration, U.S. Department of Energy, U.S. Carbon Dioxide Emissions from Energy Sources (May 2007), available at http://www.eia.doe.gov/oiaf/1605/flash/flash.html (last visited June 24, 2008).

Copyright © 2008, Matthew Bender & Company, Inc., a member of the LexisNexis Group. LexisNexis and the Knowledge Burst logo are registered trademarks of Reed Elsevier Properties Inc., used under license. 1 July 2008

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

and investment in alternative fuels, alternative fuels are unlikely to overcome the incentives provided to fossil fuel production.

This article will describe the federal and state tax incentives for fuel efficient and alternative fuel vehicles and the prospective efficacy of such incentives.

Federal Fuel Efficiency and Alternative Motor Vehicles Tax Incentives. Governments have often provided income and excise tax subsidies to achieve social, economic, or po- litical goals. 6 Fossil fuel producers have long received income tax incentives in the form of percentage depletion and intangible drilling cost expensing. 7 Prior to 1978, there were no tax incentives that encouraged energy conservation or fuel efficiency. In that year, along with tax credits designed to encourage investment in alternative energy sources that were passed in the wake of the OPEC oil crisis, Congress passed the “Gas Guzzler” excise tax to encourage the production of fuel efficient vehicles.

The Gas Guzzler tax is imposed today, but given the exclusion of vehicles over 6,000 pounds, which includes most SUVs and trucks, and the failure to increase fuel economy ratings, the tax has not encouraged the design and manufacture of increasingly fuel efficient vehicles. Structurally, the tax is passed on to the consumer at the time of the vehicle’s first sale (or first lease) by a manufacturer or importer based on the fuel economy rating of the vehicle. 8 A vehicle achieving fuel economy of at least 22.5 miles per gallon is not subject to the tax; vehicles with a fuel economy rating of less than 12.5 miles per gallon are subject to the highest tax rate at $7,700. 9 The fuel economy ratings have not changed since 1990.

In addition to the Gas Guzzler tax imposed on fuel inefficient vehicles, tax credits are available for alternative motor vehicles. There are five general types of alternative motor vehicles described in the tax code:

(1) electric battery vehicles that have electric batteries and are plugged in to be recharged;

(2) fuel cell vehicles that have electric batteries and are powered by hydrogen-based fuels that combine with oxygen to convert chemical energy into oxygen;

6. Roberta Mann, Ch. 16, “Subsidies, Tax Policy, and Technological Innovation,” 565, 565, in Global Climate Change and U.S. Law (Michael B. Gerrard ed., Am. Bar Ass’n 2007).

7. Mona Hymel, The United States’ Experience with Energy-Based Tax Incentives: The Evidence Supporting Tax Incentives for Renewable Energy , Arizona Legal Studies Discussion Paper No. 06-21 (Apr. 2006), at 19.

8. 26 U.S.C. § 4064 ; 26 U.S.C. § 4217 (e).

9. 26 U.S.C. § 4064 (a).

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

(3) hybrid vehicles that have an internal combustion or a heat engine as well as a rechargeable energy system, such as an electric motor;

(4) alternative fuel vehicles that have internal combustion engines but are at least partially run on alternative fuels, such as hydrogen, natural gas, or ethanol; and

(5) advanced lean burn technology vehicles that have an internal combustion engine that uses more air than is necessary for complete combustion of the fuel and meets certain fuel economy and emissions standards. 10

The first tax incentives for purchasing an alternative motor vehicle were enacted in 1992. In the wake of the Persian Gulf War, an income tax credit was permitted for 10% of the cost of any electric battery or fuel cell vehicle placed in service during the year, up to a maximum credit of $4,000. 11 Although the amount of the credit (and the $4,000 cap) was never increased, the provision was extended twice before being phased out at the end of 2006. 12

In 1992, Congress also enacted a provision which permitted immediate deductions for certain clean fuel vehicles. Clean fuel vehicles are vehicles that use clean burning fuels, such as natural gas, hydrogen, and fuel blends, at least 85% of which consists of methanol, ethanol, any other alcohol, or ether. 13 The amount of the deduction for most cars, such as the Toyota Prius, was limited to $2,000, but increased to $5,000 for vehicles weighing between 10,000 and 26,000 pounds and jumped to $50,000 for vehicles weighing over 26,000 pounds and buses with seating capacity for 20 adults. 14 (As a point of comparison, most of the largest SUVs — including the Hummer H2 — weigh less than 10,000 pounds.)

After these provisions were phased out in 2005, Congress introduced the alternative motor vehicle credit, which provides a tax credit for a greater range of vehicles, including fuel cell vehicles, hybrid vehicles, alternative fuel vehicles, and advanced lean burn technology motor vehicles (although electric battery vehicles are not covered). 15 The amount of the credit is the sum of the vehicle’s fuel economy credit and fuel conserva-

10. Roberta Mann, Ch. 16, “Subsidies, Tax Policy, and Technological Innovation,” 565, 575, in Global Climate Change and U.S. Law (Michael B. Gerrard ed., Am. Bar Ass’n 2007); Martin Sullivan, The Car Credit: How a Tax Break for Engineering Got En- gineered , Tax Notes 1245, 1245 (Mar. 11, 2002).

11. 26 U.S.C. § 30 (a), (b).

12. 26 U.S.C. § 30 (b).

13. 26 U.S.C. § 179A (c), (e).

14. 26 U.S.C. § 179A (a), (b)(1).

15. 26 U.S.C. § 30B (a).

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

tion credit, 16 increasing to as much as $40,000 for fuel cell vehicles and alternative fuel vehicles weighing over 26,000 pounds (such as a truck and trailer). 17 An otherwise eligible motor vehicle must also comply with applicable provisions of the Clean Air Act and certain safety requirements. 18 Reduced credits are available for vehicles that run on blended petroleum fuels. 19 The credits are phased out during the year after the manufacturer has sold its first 60,000 qualified vehicles, 20 and are scheduled to sunset begin- ning January 1, 2010.

Federal Fuel-Based Tax Incentives. The federal income tax provisions include income tax credits for producers who blend alcohol fuels deriving from biological sources with gasoline or other types of motor fuel. Typically, these blends contain either methanol, which is typically produced from methane (a component of natural gas) although it can be produced from other organic or synthetic materials, or ethanol. The Food, Conservation and Energy Act of 2008 (also known as the Farm Bill) 21 that passed in May 2008 increased the amount of alcohol fuel that must go into a qualify- ing blended fuel from 95% to 98%. 22 The alcohol fuel credit is currently 60¢ for alcohol fuel that is at least 190 proof (or 6¢ per gallon), and 45¢ for fuels between 150 and 190 proof, although the credit has been lower for ethanol and was reduced by 6¢ per gallon under the Farm Bill. 23 The alcohol fuels credit is scheduled to expire December 31, 2010. In 2004, Congress enacted a similar credit for biodiesel fuels, an alternative fuel produced from vegetable oils or animal fats that meets certain federal regulatory requirements. 24 The credit is 50¢ per gallon, 25 but increases to $1.00 per gallon for producers of renewable diesel and agri-biodiesel, which is biodiesel derived solely

16. E.g. , 26 U.S.C. § 30B (b). The fuel economy credit reflects the amount the vehicle’s fuel efficiency exceeds the baseline fuel efficiency of a comparable 2002 model year non-alternative fuel vehicle, and the conservation credit estimates the lifetime fuel savings over a comparable (based on weight) 2002 model year non-alternative fuel vehicle, assuming a 120,000-mile vehicle life.

17. 26 U.S.C. § 30B (b)(1)(D), (e)(3)(D).

18. 26 U.S.C. § 30B (h)(10).

19. 26 U.S.C. § 30B (e)(5)(A).

20. 26 U.S.C. § 30B (f).

21. Pub. L. No. 110-234 , 122 Stat. 923 (2008).

22. H.R. 2419 , 110th Cong., § 15332 (2008).

23. 26 U.S.C. § 40 (b); U.S. General Accounting Office, Petroleum and Ethanol Fuels: Tax Incentives and Related GAO Work (Sept. 25, 2000), at 18; H.R. 2419 , 110th Cong., § 15331 (2008).

24. 26 U.S.C. § 40A (d)(1).

25. 26 U.S.C. § 40A (b).

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

from virgin vegetable oils and animal fats. 26 The biodiesel fuels credit is scheduled to expire on December 31, 2008. 27

In 1990, an additional 10¢ per gallon income tax credit was introduced for small ethanol producers. 28 A qualified “small ethanol producer” is a person who, at all times during the tax year, has a production capacity for alcohol that does not exceed 60 million gallons. 29 Small ethanol producers are not limited by the proof requirements of larger alcohol fuel producers. 30 The credit is only available for the first 15,000,000 gallons of production, 31 so the maximum amount of the credit is $1.5 million. The credit is set to expire Decem- ber 31, 2010.

The federal income tax provisions also provide a credit against the federal excise tax on motor fuels for alternative fuel producers. In 1978, Congress adopted an alcohol fuels credit that provided a partial exemption from the excise tax. 32 The excise tax credit provided a 5.4¢ tax exemption from the 18.4¢ per gallon federal excise tax for mixtures of 90% gasoline and 10% biomass alcohol derived from renewable resources. 33 The GAO estimated the partial exemption cost the federal government approximately $11 billion between 1979 and 2000 (adjusted to 2000 dollars). 34 This provision was the largest tax incentive for alternative fuels until 2004, when Congress repealed the excise tax exemption and adopted a system of excise tax credits instead. 35 The amount of the credit var- ies by fuel type, as does the date on which the credits are phased out. 36

The federal tax provisions provide a third tax incentive for alternative fuel producers for alternative refueling property — property used for the storage or dispensing of clean

26. 26 U.S.C. § 40A (b)(3), (5), (d)(2), (f).

27. 26 U.S.C. § 40A (g).

28. 26 U.S.C. § 40 (b)(4).

29. 26 U.S.C. § 40 (g)(1).

30. 26 U.S.C. § 40 (g)(1).

31. 26 U.S.C. § 40 (b)(4)(C).

32. Mona Hymel, The United States’ Experience with Energy-Based Tax Incentives: The Evidence Supporting Tax Incentives for Renewable Energy , Arizona Legal Studies Discussion Paper No. 06-21 (Apr. 2006), at 11.

33. U.S. General Accounting Office, Petroleum and Ethanol Fuels: Tax Incentives and Related GAO Work (Sept. 25, 2000), at 16.

34. U.S. General Accounting Office, Petroleum and Ethanol Fuels: Tax Incentives and Related GAO Work (Sept. 25, 2000), at 2.

35. Salvatore Lazzari, Alcohol Fuels Tax Incentives , CRS Report for Congress (June 23, 1999); Mona Hymel, The United States’ Experience with Energy-Based Tax Incentives: The Evidence Supporting Tax Incentives for Renewable Energy , Arizona Legal Studies Discussion Paper No. 06-21 (Apr. 2006), at 12.

36. 26 U.S.C. § 6426. For example, alcohol fuel mixtures that include ethanol are entitled to a credit of 51¢ per gallon, and other alcohol fuel mixtures to a credit of 60¢ per gallon, through December 31, 2010, but biodiesel fuel mixtures are entitled to an excise tax credit of 50¢ per gallon and agri-biodiesel mixtures are entitled to a credit of $1.00 per gallon through December 31, 2008.

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

burning fuel or for on-site recharging of electric vehicles. In 1992, Congress provided a deduction for clean fuel vehicle refueling property of up to $100,000. 37 After the phase- out of the deduction on December 31, 2005, 38 Congress enacted an income tax credit for 30% of the cost of any qualified alternative fuel vehicle refueling property placed in service during the tax year. 39 For this purpose, the original use of the qualified alternative fuel vehicle refueling property must begin with the taxpayer and the property must be used either for (1) storing and dispensing of clean-burning fuel, at least 85% of which consists of ethanol, certain forms of natural gas, liquefied petroleum gas or hydrogen any biodiesel mixture containing at least 20% biodiesel, or (2) recharging electric motor vehicles. 40 The maximum credit for depreciable property (i.e., property other than land) is $30,000 (although, if the property is installed on the taxpayer’s principal residence, the credit is limited to $1,000). 41

State Laws. The federal incentive scheme is focused on tax credits rather than deductions or other mechanisms to calculate taxable income. Federal credits do not flow through to the calculation of state taxable income. To provide state level incentives, states have enacted approximately 130 different tax incentives for alternative fuels and alternative fuel vehicles. 42 In addition to credits against income tax otherwise imposed for a certain percentage of the cost of purchasing an alternative fuel vehicle 43 or low- emissions vehicle 44 or converting an existing vehicle to an alternative fuel vehicle, 45 state laws run the gamut in terms of types of incentives they provide. For example, Ar- kansas provides an income tax credit for 50% of the amount spent during the tax year to purchase or construct a facility that designs, develops or produces electric vehicle equipment or fuel cells and a 30% income tax credit for the cost of buildings, equipment, higher education partnerships and purchasing, licensing, or protecting intellectual property necessary to manufacture advanced biofuels. 46 Colorado offers a credit against income tax for 35% of the cost of the construction, reconstruction, or acquisition of an alternative fuel refueling facility, which is increased by 0.25% if the facility will be accessi-

37. 26 U.S.C. § 179A (b)(2).

38. 26 U.S.C. § 179A (f).

39. 26 U.S.C. § 30C (a).

40. 26 U.S.C. § 30C (c).

41. 26 U.S.C. § 30C (b), (c)(2).

42. U.S. Department of Energy, Energy Efficiency and Renewable Energy, Alternative Fuels and Advanced Vehicles Data Center Incentive Table , available at http://www.eere.energy.gov/afdc/progs/in_matrx.php (content updated March 11, 2008; last visited June 24, 2008).

43. See, e.g. , S.C. Code Ann. § 12-6-3377.

44. See, e.g. , Ga. Code § 48-7-40.16.

45. See, e.g. , Mont. Code Ann. § 15-30-164.

46. Ark. Code §§ 2-8-109 ; 15-4-2104 .

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

ble for use by persons in addition to the person claiming the credit or uses fuels derived from a renewable energy source. 47 In Hawaii, alcohol fuels are currently exempt from state excise tax. 48 Florida has a generous hydrogen and biofuels investment tax credit, which includes a significant incentive for research and development costs. 49 Other states’ programs are proving so successful, they are becoming too expensive for states on a tight budget to continue. For example, Illinois had a rebate program for purchases of hybrid or fuel efficient vehicles, but it was suspended on May 15, 2008, due to the fact that the $2,000,000 cap was reached. 50

Effectiveness of Tax Incentives. In 2004, the U.S. consumed 140 billion gallons of gasoline, only 2.5% (3.4 billion gallons) of which was ethanol. 51 Of the 40 billion gallons of diesel consumed in 2004, only 75 million gallons (less than 0.2%) were biodiesel. 52 As these numbers illustrate, alcohol fuels represent a small share of the overall market, and to date they have not significantly affected U.S. energy independence or energy security, 53 nor have they had significant positive environmental effects. 54

The efficacy of the incentives is challenged by the fact that not all alternative fuels are viable alternatives to gasoline and diesel. Ethanol (the second-most consumed alternative fuel 55 ) is not an environmentally-friendly alternative to fossil fuel because the production of ethanol creates emissions that are reported to be more polluting than those produced by conventional fuels. 56 In addition, ethanol cannot be transported using the existing fuel distribution infrastructure (pipelines) because it absorbs water, and so must be transported by truck, barge or rail. 57 Moreover, at this point, ethanol cannot be used

47. Colo. Rev. Stat. § 39-22-516 (2.7).

48. Haw. § 2, enacted by L. 2007, Act 209 (effective through June 30, 2009).

49. Fla. Stat. § 220.192 .

50. Green Rewards, http://www.treasurer.il.gov/programs/cultivate-illinois/green-rewards.aspx (last visited June 24, 2008).

51. U.S. Department of Energy Office of Science, Biofuels for Transportation , http://genomicsgtl.energy.gov/biofuels/ transportation.shtml (last visited June 24, 2008).

52. U.S. Department of Energy Office of Science, Biofuels for Transportation , http://genomicsgtl.energy.gov/biofuels/ transportation.shtml (last visited June 24, 2008).

53. U.S. General Accounting Office, Effects of the Alcohol Fuels Tax Incentives (March 1997), at 19-20.

54. U.S. General Accounting Office, Effects of the Alcohol Fuels Tax Incentives (March 1997), at 14.

55. U.S. Department of Energy, Alternative Fuels & Advanced Vehicles Data Center , available at http://www.eere.energy.gov/ afdc/data/docs/alternative_fuel_consumption.xls (last visited June 24, 2008).

56. Timothy Searchinger et al., Use of U.S. Cropland for Biofuels Increases Greenhouse Gases Through Emissions from Land-Use Change , 319 Science 1238 (Feb. 29, 2008).

57. U.S. Department of Energy Office of Science, Biofuels for Transportation , http://genomicsgtl.energy.gov/biofuels/ transportation.shtml (last visited June 24, 2008); Robert Bryce, Corn Dog: The ethanol subsidy is worse than you can imagine , Slate (July 19, 2005).

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

effectively without blending in cold climates. 58 A more viable alternative fuel is compressed natural gas, which is currently consumed about three times more than ethanol. 59 Compressed natural gas is domestically produced and has lower emissions than gasoline, although the fuel (and prices) are still tied in to traditional fossil fuels. 60

Moreover, even with tax incentives, there are infrastructural impediments to large-scale conversions to alternative fuel motor vehicles, creating additional impediments to the overall effectiveness of the current incentive structure. 61 There are just over 5,500 refueling stations for alternative fuel vehicles (almost 900 of which are in California, and not all of which include every type of alternative fuel) in the U.S., 62 compared with 167,000 traditional fueling stations, representing 3.3% of all refueling stations. 63 To overcome the logistical problem many potential alternative motor vehicle owners would face, ex- panded tax subsidies for infrastructure to support alternative fuel vehicles are needed. The current deduction for investments in alternative fuel refueling property is unlikely to induce investors to make significant additional investments in alternative fuel refueling property because of its short duration; for property not related to hydrogen, it is set to expire on December 31, 2009. 64 However, under recently proposed legislation, this date may be extended. 65

In addition, there are aspects of the current tax incentive structure that may undercut the potential benefit. First, the fuel economy measure is skewed. Fuel economy is based on a weighted average of city and highway driving established by the Environ- mental Protection Agency (EPA). As has been much discussed, the EPA’s fuel economy standards for conventional and hybrid vehicles are often unrealistically optimistic, 66 and would therefore provide greater tax benefits than vehicles “deserve.” Partially in response to criticism, the EPA added additional tests in 2008, including one that requires

58. U.S. Department of Energy Office of Science, Biofuels for Transportation , http://genomicsgtl.energy.gov/biofuels/ transportation.shtml (last visited June 24, 2008).

59. U.S. Department of Energy, Alternative Fuels & Advanced Vehicles Data Center , available at http://www.eere.energy.gov/afdc/ data/docs/alternative_fuel_consumption.xls (last visited June 24, 2008).

60. U.S. Department of Energy, Alternative Fuels & Advanced Vehicles Data Center , available at http://www.eere.energy.gov/ afdc/fuels/natural_gas.html (last visited June 24, 2008).

61. Mona Hymel, The United States’ Experience with Energy-Based Tax Incentives: The Evidence Supporting Tax Incentives for Renewable Energy , Arizona Legal Studies Discussion Paper No. 06-21 (Apr. 2006), at 23.

62. U.S. Department of Energy, Alternative Fuels & Advanced Vehicles Data Center , available at http://www.eere.energy.gov/ afdc/fuels/stations_counts.html (last visited June 24, 2008).

63. U.S. Department of Energy, Alternative Fuels & Advanced Vehicles Data Center , available at http://www.eere.energy.gov/ afdc/data/docs/gasoline_stations_state.xls (last visited June 24, 2008).

64. 26 U.S.C. § 30C (g).

65. H.R. 2419 , 110th Cong. (2008).

66. See, e.g. , HowStuffWorks, “How EPA Fuel-Economy Testing Works,” http://auto.howstuffworks.com/28004-epa-fuel-economy- explained2.htm (last visited June 24, 2008).

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

use of the vehicle’s climate control system and one that entails testing the vehicle at cold temperatures. This change should reduce some of the problem for standard cars, but the SUV and truck loophole will not be affected.

Second, the current tax credit system rewards purchases of larger vehicles. For example, the Gas Guzzler tax is intended to encourage fuel economy. However, it does not impose any tax on the loophole for the largest polluters — vehicles weighing over 6,000 pounds (including most luxury cars and SUVs) — which renders moot much of potential benefit of the tax. 67 In addition, vehicles weighing over 6,000 pounds that qualify as business expenses are eligible for accelerated depreciation. 68 Additionally, the conservation component of the alternative motor vehicle credit increases the amount of the credit for alternative vehicles when the conventional model of the same vehicle is less fuel efficient. Thus, the conservation credit for buying a hybrid SUV will be greater than the conservation credit for buying a hybrid compact car, because the conventional SUV consumes more fuel than the conventional compact car. Similarly, because the current subsidies provide greater deductions and accelerated depreciation for heavier vehicles, they may actually encourage taxpayers to purchase heavier (and more polluting) vehicles.

Third, the current incentive structure phases out the alternative fuel motor vehicle credit after a manufacturer has sold its first 60,000 vehicles, and includes all years and all models. Therefore, the tax credit penalizes those who would be considered industry leaders in alternative fuel vehicles, such as Toyota, by measuring volume of sales but does not adversely affect manufacturers who remain in the development stage on alternative fuel vehicles.

Finally, alternative fuels and alternative motor vehicles are highly complex, and at- tempting to determine the most fuel efficient and cost effective types through tax subsidies for specific types of fuel has been questioned as an effective mechanism to encourage creativity in the industry. 69 Moreover, the minimal tax benefits that have been won in hard-fought negotiations, many of which expire in just a few years, ap- pear not to have created much incentive for significant investment in the industry. In- stead, more effective approaches to increase the use of alternative fuels and alternative motor vehicles might be to eliminate tax provisions that subsidize fossil fuel producers or to greatly increase the fuel efficiency standards set by the Environmental Protection Agency.

67. 26 U.S.C. § 4064 (b)(1)(A)(ii).

68. 26 U.S.C. § 179 .

69. Martin Sullivan, The Car Credit: How a Tax Break for Engineering Got Engineered , Tax Notes 1245, 1245 (Mar. 11, 2002).

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

Practice Pointers

• Due to their short periods of enactment, tax incentives for alternative fuels change and expire frequently, requiring alternative fuel producers and their advisors to pay close attention to this area of tax law.

• In response to rapidly-increasing gas prices, several proposals are currently being debated that would enact a tax holiday from the federal excise tax on gasoline. These proposals generally decrease the cost of fuel, benefiting traditional fossil fuel producers by encouraging greater consumption. The alternative fuels industry might encourage other proposed legislative responses to increase investment in alternative fuel projects.

• Biodiesel, ethanol, and other alternative fuels derived from food sources are using increasing percentages of farmers’ fields, contributing to the current high food prices and shortages worldwide. Biofuel producers will be seeking incentives in non-food renewable resources, and face the likeli- hood that food-based incentives might be reduced or eliminated outright. For example, the Food, Conservation and Energy Act of 2008 that was passed over the President’s veto on May 22, 2008, decreased the amount of the ethanol tax credit by 6¢ per gallon and added a tax credit for the production of cellulosic biofuels, which are derived from agricultural waste and nonfood parts of plants, such as the leaves, stems and stalks.

For a related article by the same authors, entitled “Jenner & Block: Federal and State Tax Incentives for Renewable Energy,” go to 2008 Emerging Issues 221 .

About the Authors. Gail H. Morse , a partner in Jenner & Block Tax Practice and is Chair of her Firm’s State and Local Tax Practice and Co-Chair of its Tax Controversy Practice . She is also a member of the Firm’s Climate and Clean Technology Law Practice .

Ms. Morse’s national tax practice focuses on both federal, and state and local tax matters, including state franchise, income, sales, use, personal and real property, gross receipts and a variety of local taxes. She frequently works with clients in managing federal and state tax audits, and represents clients before the IRS and state tax administrative agencies and tribunals. She also counsels clients on legislative and regulatory matters involving federal and state tax issues.

Ms. Morse began tax practice as an attorney advisor in the Legislation and Regu- lations Division of the Internal Revenue Service’s Office of Chief Counsel, where

Jenner & Block: Federal and State Tax Incentives for Alternative Vehicles and Fuels By Gail H. Morse and Alexandra E. Dowling

she practiced upon graduating cum laude, from the University of San Diego School of Law in 1982 and was a member of the San Diego Law Review. Ms. Morse earned a Masters of Law in Taxation from the Georgetown University Law Center in 1986. She is a member of the state bars of California, Colorado, the District of Columbia and Illinois, as well as the United States Supreme Court, the United States Tax Court and numerous other federal district and appellate courts.

Alexandra E. Dowling is an associate in Jenner & Block’s Chicago office. She is a member of the Firm’s Tax , Tax Controversy , Climate and Clean Technology Law , Private Equity/ Investment Management and Real Estate Securities Prac- tices . Her recent work has included tax shelter litigation, bankruptcies and re- structurings, and private equity fund, hedge fund formation, and private offerings. Ms. Dowling is also interested in attorney-client privilege, tax patents, and ethical issues arising in tax practice. Ms. Dowling graduated from the University of Chi- cago College in 2001 with a degree in Spanish. She received her J.D. in 2006 from The University of Chicago Law School. Ms. Dowling worked throughout her law school career, first at the University of Chicago’s MacLean Center for Clinical Medical Ethics where she coordinated the center’s academic programs, and then also as a law clerk at Jenner & Block’s Chicago office.

About Jenner & Block. Jenner & Block LLP is a national law firm with over 450 lawyers experienced in virtually every area of the law. Jenner & Block’s repu- tation as one of the country’s most successful law firms has been established by consistently delivering excellent legal counsel to clients in the boardroom and the courtroom, from the trial level through the United States Supreme Court. In keeping with the Firm’s tradition of proactively addressing the needs of the global business community, Jenner & Block’s Climate and Clean Technology Law Prac- tice takes a unique, holistic and cross disciplinary approach to addressing its clients’ needs in this rapidly evolving area of the law.

Emerging Issues Commentaries are editorially created by legal experts, and are not intended to provide legal advice but to provide information on legal matters. This commentary is current as of July 2008.