Maryland Attorney General Opinion 95 OAG 056

56 [95 Op. Att’y

TAXATION

C ORPORATE INCOME TAX – W HETHER FEDERALSTIMULUS

GRANT RECEIVED BY A PUBLIC UTILITY WOULD BE

SUBJECT TO MARYLAND INCOME TAX

February 23, 2010

The Honorable Rona E. Kramer

Maryland Senate

You have requested our opinion as to whether federal stimulus

funds received as part of the American Recovery & Reinvestment

Act of 2009 (“ARRA”) by a Maryland public utility are subject to

state taxes. Specifically, you have asked if a federal stimulus

grant received by the public utility for up to 50% of the costs

of an Advanced Meter Infrastructure regulatory asset would be

subject to Maryland income tax.

For the reasons given below, it is our opinion that a

Maryland public utility receiving a grant for the costs of such a

regulatory asset under ARRA would be required to pay Maryland

income tax on the grant.

I

Federal Stimulus Funds

A. The Smart Grid Investment Matching Grant Program

In 2007, as a part of the Energy Independence & Security Act

of 2007 (“EISA”), Pub. L. No. 110-140, 121 Stat. 1492, Congress

established a Smart Grid Investment Matching Grant Program. The

statute directed the Secretary of Energy to set up a federal

matching grant program to encourage and assist public utilities in

upgrading the existing United States electric power grid by investing

in “Smart Grid” technology. EISA §1306, codified at 42 U.S.C.

§17386. Under the program as originally enacted, the Secretary

was directed to establish a fund and implement a grant program to

provide up to 20% of qualifying Smart Grid investments for public

utilities. Id. Pertinent to your inquiry, the legislation defined

Smart Grid investments as those in “metering devices, sensors,

control devices, and other devices integrated with and attached to

an electric utility

Gen. 56] 57

system or retail distributor or marketer of electricity that are capable

of engaging in Smart Grid functions,” as well as “transmission and

distribution equipment fitted with monitoring and communications

devices to enable smart grid functions.” 42 U.S.C. §17386(b)(3) &

(4). The legislation further directed the Secretary to set up grant

application procedures within one year of the date of passage of

EISA, anti-fraud and misfeasance safeguards, and procedures for

advance payment of up to the full amount of the grant award. 42

U.S.C. §17386(e).

B. American Recovery & Reinvestment Act

Two years later, in connection with the American Recovery &

Reinvestment Act of 2009, Pub. L. No. 111-5, 123 Stat. 115,

Congress made one substantive and several procedural modifications

to the Smart Grid Investment Matching Grant Program. See ARRA,

§405(5)-(8). Substantively, ARRA §405(5) significantly increased

the maximum size of the Smart Grid grants, from 20% of qualifying

investments to 50% of qualifying investments. Procedurally, section

405(8) reduced the Secretary’s implementation time from one year

to 60 days. See 42 U.S.C. §17386(a) & (e).

As we understand the proposal that prompted your inquiry, the

Maryland public utility has applied for a 50% matching grant under

the Smart Grid program, to support investment in an Advanced

Meter Infrastructure regulatory asset. The estimated cost of the

project is $90 million, for which the utility may be eligible for a

grant award of up to $45 million.

II

Income Tax Liability of a Corporation

A. The Federal Income Tax Law

The Maryland income tax law is “inextricably keyed” to the

federal income tax law. Comptroller v. Diebold, 279 Md. 401, 408,

369 A.2d 77 (1977); 66 Opinions of the Attorney General 242

(1981). In particular, the starting point for determining a

corporation’s Maryland tax base is its federal taxable income.

Comptroller v. Gannett Co., Inc., 356 Md. 699, 705, 741 A.2d 1130

(1999); Celanese Corp. v. Comptroller, 60 Md. App. 392, 397, 483

A2d 359 (1984) (Maryland law imposes tax on amount determined

to be corporation’s taxable income under Internal Revenue Code).

58 [95 Op. Att’y

Therefore, our analysis must begin with the concept of “taxable

income” under the Internal Revenue Code.

With certain exceptions not relevant here, federal taxable

income of a corporation is calculated in two steps. First, and most

importantly, all accretions of wealth received, generated, or acquired

by the corporation during the corporation’s annual tax year, and over

which the corporation has complete dominion, are totaled. The

annual aggregation of wealth accumulated during the tax year is

termed “gross income” and includes “income from whatever source

derived.” 26 U.S.C. §61; 26 C.F.R. §1.61-1(a). The catch-all

phrase, “from whatever source derived,” was used by Congress to

exert “the full measure of its taxing power” and covers all realized

accessions to wealth, regardless of source, unless specifically

excluded by statute. Commissioner v. Kowalski, 434 U.S. 77, 82

(1977); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 429-30

(1955); Simmons v. United States, 308 F.2d 160, 168 (4th Cir. 1962);

Joseph M. Dodge, The Story of Glenshaw Glass, in Tax Stories 30

(Paul L. Caron ed., 2003).

In the second step, gross income is reduced by subtracting

certain deductions. 26 U.S.C. §63. These deductions are authorized

by section 63 and enumerated in 26 U.S.C. §§161 through 199.

Common deductions for corporations include compensation paid to

officers and workers, expenses for repairs and maintenance, taxes,

licenses, depreciation and depletion, and advertising. The result of

this subtraction from gross income is referred to as the corporation’s

“taxable income.” 66 Opinions of the Attorney General 242.

B. The Maryland Income Tax Law

As explained above, the starting point for determining a

corporation’s Maryland income tax liability is the corporation’s

federal taxable income. Comptroller v. Gannett Co., Inc., 356 Md.

at 705; Celanese Corp. v. Comptroller, 60 Md. App. at 397. Under

Maryland law, the corporation’s federal taxable income is used as

the Maryland tax base, and then is modified by adding to or

subtracting from it certain items specified in the income tax chapter

of the Tax-General article. Annotated Code of Maryland, Tax

General Article (“TG”), §10-304(1).

The prescribed “addbacks” and “subtractions” applied to the

corporation’s federal taxable income are specifically enumerated in

TG §§10-305 through 10-308. The figure resulting from the

modification of the corporation’s federal taxable income by the

Gen. 56] 59

Maryland addbacks and subtractions is the corporation’s “Maryland

modified income.” TG §10-304(1). Maryland modified income is

defined as the corporation’s Maryland taxable income, TG §1-301,

and the State income tax is imposed upon the corporation’s

Maryland taxable income, TG §10-102.

III

Analysis

The sweeping and all-inclusive language of the Internal

Revenue Code’s definition of “gross income” clearly includes funds

received from the federal government in the form of a federal grant,

so long as the corporation obtains complete dominion over the

proceeds of the grant. Bailey v. Commissioner, 88 T.C. 1293, 1301-

02 (1987), citing Baboquivari Cattle Co. v. Commissioner, 135 F.2d

114, 115 (9th Cir. 1943); Lykes Bros. S.S. Co. v. Commissioner, 126

F.2d 725, 727 (5th Cir. 1942); Dubay v. Commissioner, T.C. Memo.

1979-418 (1979); Harding v. Commissioner, T.C. Memo. 1970-179

(1970); Driscoll v. Commissioner, T.C. Memo. 1944-021, aff’d in

part and rev’d in part on unrelated issues, 147 F.2d 493 (5th Cir.

1945); see Rev. Rul. 84-67, 1984-1 C.B. 28. Federal grants and

subsidies of all types received by individuals and corporations,

unless specifically exempted by statute, are included in gross

income. Id. Thus, federal soil conservation aid, postal shipping

subsidies, a dam construction grant, Great Plains Conservation

Program payments, and forestry cost-sharing incentives, all have

been held taxable to the recipients. Baboquivari Cattle Co. v.

Commissioner, 135 F.2d at 115; Lykes Bros. S.S. Co. v.

Commissioner, 126 F.2d at 727; Dubay v. Commissioner, T.C.

Memo. 1979-418; Harding v. Commissioner, T.C. Memo. 1970-179;

Driscoll v. Commissioner, T.C. Memo. 1944-021; Rev. Rul. 84-67.

The federal Smart Grid grant closely resembles and fits comfortably

within the range of federal subsidies and grants described in the

cited cases.

Only if the Smart Grid matching grant were to be encumbered

by such conditions as would render it not within the Maryland public

utility’s control, would the grant be excluded from the corporation’s

gross income. Bailey v. Commissioner, 88 T.C. at 1301-02, citing

Glenshaw Glass, 348 U.S. at 431. In this regard, the United States

Tax Court has held that a federal historical “facade grant” was not

with the dominion and control of a taxpayer-recipient when the grant

was paid directly to a contractor selected by the grantor agency, in

an amount of no prior knowledge to the recipient, and that required

60 [95 Op. Att’y

a reciprocal 30-year indenture and easement by the grant recipient in

favor of the grantor agency to insure future compliance with the

terms of the grant. Bailey v. Commissioner, 88 T.C. at 1295-96. On

these unique and rather extreme facts, the Tax Court concluded that

the taxpayer lacked sufficient dominion and control over the

proceeds of the grant to require the funds to be included in his gross

income. Bailey, 88 T.C. at 1301.

There are no remotely similar restrictions in the Smart Grid

matching grant program. Upon award of the grant, the recipient

corporation must simply use the funds for the Smart Grid investment

specified in the application. See 42 U.S.C. §17386(b)(3).

Consequently, we conclude that the Maryland public utility would

exercise dominion and control over the expected Smart Grid

matching grant.

Nor does the Internal Revenue Code contain any exemption

from gross income for the Smart Grid matching grants. See 26

U.S.C. §§63, 161-199.1 Likewise, the implementing statutes

themselves, EISA and ARRA, contain no provisions excepting or

exempting the matching grants from gross income. Therefore, the

Smart Grid matching grants are includible in the corporation’s gross

income in the year of receipt.

1

There is, however, a provision for accelerated depreciation of

Smart Grid equipment. In section 306 of the Emergency Economic

Stabilization Act of 2008, Pub. L. No. 110-343, 122 Stat. 3765, Congress

amended section 168 of the Internal Revenue Code to permit depreciation

of “qualified smart electric grid systems” on an accelerated basis. See 26

U.S.C. §168(e)(3)(D)(iv) (2006 ed. Supp. II 2008). Thus, once the Smart

Grid equipment were placed in service, the Maryland public utility might

be able to depreciate it on an accelerated schedule. We express no opinion

concerning qualification of the Maryland public utility’s Smart Grid

equipment for accelerated depreciation under this provision.

It is also worth noting that, regardless whether this particular Smart

Grid equipment would qualify for accelerated depreciation under section

168, as amended, the inclusion of such equipment in the accelerated

depreciation provision strongly indicates that Congress assumed that the

Smart Grid matching grants would be included in gross income. It would

be very unusual for Congress to provide tax preference treatment, such as

accelerated depreciation, for an item not included in the taxpayer’s gross

income.

Gen. 56] 61

Similarly, neither of the Maryland statutes enumerating and

authorizing subtractions from federal taxable income contains any

provision concerning federal grants in general or the Smart Grid

matching grants in particular. See TG §§10-307, 10-308. As a

result, the company’s Maryland taxable income must include any

funds received from the Smart Grid matching grant, if and when

received. The Maryland corporate income tax then will be imposed

on that amount.

As a result, we can state with a high degree of confidence that

any Smart Grid matching grant received by the Maryland public

utility must be included in the company’s federal gross income and

that no federal exemptions or exclusions for such a grant would

remove it from the company’s federal taxable income. Furthermore,

there exist no Maryland laws that would authorize subtraction of the

grant from the company’s Maryland modified income. Therefore,

Maryland income tax would be imposed upon the full amount of the

grant received by the company.

IV

Conclusion

For the reasons stated, it is our opinion that a Smart Grid

Investment Matching Grant received by a Maryland public utility

would be subject to income tax in Maryland, in the year of receipt.

Douglas F. Gansler

Attorney General

Michael J. Salem

Assistant Attorney General

Robert N. McDonald

Chief Counsel

Opinions & Advice