The recently enacted American Recovery and Reinvestment Act of 2009 (the “Stimulus Act”) contains significant tax incentives and grants for projects that produce electricity from specific sources of renewable energy. This includes certain projects that generate electricity from wind, biomass, solar energy, geothermal energy, municipal solid waste, hydropower production, and marine and hydrokinetic energy.
As explained below, the Stimulus Act expands significantly the federal income tax incentives available for renewable energy projects, including:
- Ability of certain renewable energy projects to qualify either for an investment tax credit (“ITC”) or a production tax credit (“PTC”);
- Creation of a federal income tax grant, payable in cash, that taxpayers may elect to receive in lieu of ITC or PTC;
- Extended “placed in service” dates for most renewable energy projects;
- Extension of “bonus depreciation” for certain property acquired in 2009, which may permit taxpayers to deduct 50% of total project costs up front if the project is timely placed in service;
- Expanded ability to pass tax incentives to project investors through either a sale/leaseback structure or a tax credit lease pass-through election; and
- Ability to claim ITC on property financed by subsidized energy financing or industrial development bonds.
The type and amount of incentives vary with the type of project. For example, wind, biomass, and solar energy facilities continue to receive more favorable incentives than microturbine property, combined heat and power systems, and certain geothermal property. Other types of renewable energy property, such as facilities that produce refined coal, received no extension of benefits under the Stimulus Act.
This summary focuses on the expanded tax benefits listed above. However, the Stimulus Act enacted a number of additional incentives, including an increase in available clean renewable energy bonds and qualified energy conservation bonds, incentives for carbon sequestration, a tax credit for qualified fuel cells, a tax credit for energy improvements to existing housing, a tax credit for property designed to manufacture equipment that utilizes renewable energy, and expanded loan guarantees by the U.S. Department of Energy for certain renewable energy projects.
Qualification of Projects for ITC, PTC, or New Federal Grant
Before enactment of the Stimulus Act, the tax incentives for renewable energy varied depending upon the type of energy source used by the taxpayer. Projects that utilized solar energy, for example, were entitled to an ITC equal to 30% of the basis of the qualified energy property (although certain projects, such as combined heat and power systems, were limited to a 10% credit). The ITC was claimed by the taxpayer in the year the property was placed in service.
Conversely, qualified production facilities that utilize other sources of energy, such as wind, biomass, and municipal solid waste (including landfill gas facilities), were not entitled to ITC prior to enactment of the Stimulus Act. Instead, such projects could qualify for a PTC based on the amount of electricity produced by the taxpayer and sold to an unrelated third party over a ten-year period. The PTC for wind and certain other renewable energy projects is equal to 1.5¢ per kilowatt hour, adjusted for inflation. In 2008, the inflation adjusted rate was 2.1¢ per kilowatt hour of electricity produced and sold. The PTC for projects that utilize open-loop biomass, municipal solid waste (including landfill gas), and certain other renewable resources is reduced by 50%, for an inflation adjusted rate of 1.0¢ per kilowatt hour.
The Stimulus Act allows certain renewable energy projects to qualify for one of three tax incentives: specifically, an ITC, PTC, or a new federal grant generally equal to the amount of ITC that could be claimed with respect to the project. In many respects, this new federal grant is the equivalent to an immediately refundable ITC. Qualified projects that generate electricity from wind, biomass, solar energy, and municipal solid waste are eligible for a new federal grant equal to 30% of the eligible expenditures, which equals the amount of ITC for which the project would otherwise qualify. Projects that utilize combined heat and power systems and certain other renewable energy sources are limited to a 10% federal grant, which again equals the equivalent ITC amount. The Stimulus Act requires the Secretary of the Treasury to pay the grant amount within 60 days after the taxpayer has applied for the grant or, if later, the date the specified energy property is placed in service.
Limits on Eligibility for ITC, PTC, and Grant Incentives
There are important limitations on the three tax incentives discussed above. First, taxpayers that own otherwise qualifying projects may claim only one of the three incentives. The Stimulus Act specifically prohibits taxpayers from claiming more than one such incentive.
Second, not all renewable energy projects will qualify for the three incentives. Some projects will qualify only for a single incentive (i.e., ITC), while others will qualify only for two of the listed incentives (i.e. ITC or the federal grant). For example, certain types of renewable energy projects, such as those which generate electricity from solar energy or combined heat and power systems, are not eligible for PTCs. These projects may qualify for ITC and, if they satisfy an abbreviated construction requirement, may qualify for the new federal grant in lieu of ITC.
Third, although the Stimulus Act extends the date by which most qualifying facilities must be placed in service, taxpayers must continue to adhere strictly to these dates. The requisite placed in service date continues to vary depending on the type of renewable energy and the tax incentive desired. For example, wind projects designed to qualify either for ITC or PTC must be placed in service before January 1, 2013, which represents a three-year extension from prior law. Other renewable energy projects, such as biomass, geothermal energy, and municipal solid waste must be placed in service before January 1, 2014 (again, a three-year extension from prior law), regardless of whether they are intended to qualify for ITC or PTC. Solar energy projects, however, will qualify for ITC so long as they are placed in service before January 1, 2017.
Fourth, the new federal grant is subject to a special placed-in-service requirement. To qualify for the grant, the qualifying property must be placed in service during 2009 or 2010, or alternatively, construction of the property must begin during 2009 or 2010 and the property must be placed in service before the “credit termination date” (which generally mirrors the extended placed-in-service dates described above).
Fifth, ITC and the federal grant are subject to a percentage recapture if the underlying energy property is disposed of or otherwise ceases to be energy property with respect to the taxpayer before the end of its five-year recapture period (starting from the year the property was placed in service). Thus, for example, if ITC property is disposed of (or ceases to qualify as energy property) in the fourth year after it was placed in service, the recapture amount would be 40% of the ITC taken.
Taxpayers should select a particular tax incentive based on their project-specific requirements. For example, new renewable energy projects with high levels of electric generation may benefit most significantly from PTCs, especially where the electric output is relatively high when compared to the facility’s construction cost. Conversely, renewable energy projects with higher construction costs may benefit most significantly from the ITC or, perhaps more advantageous, the federal grant in lieu of ITC or PTC, which provides immediate cash to the project and its owners. A further consideration in selecting a particular tax incentive, especially as between ITC and PTC, pertains to the taxpayer’s intended use of the generated electricity. Taxpayers intending to sell the generated electricity to an unrelated person may qualify either for ITC, PTC, or the federal grant (assuming all other requirements are satisfied). However, a taxpayer that intends to use the generated electricity in its own trade or business will be limited to ITC or the federal grant.
Additional Tax Incentives Under Stimulus Act
In addition to permitting taxpayers to select alternatively the ITC, PTC, or the new federal grant, the Stimulus Act provides other important tax incentives for renewable energy projects. For example, the Stimulus Act extends the availability of “bonus depreciation” for certain property acquired in 2009, which may permit taxpayers to deduct 50% of total project costs up front if the project is timely placed in service. The Stimulus Act also contains certain beneficial non-tax provisions, including a new $6 billion loan guarantee program for renewable energy projects.
A lesser recognized but significant tax incentive results from the ability of certain renewable energy projects to now qualify for ITC. As noted above, wind, biomass, municipal solid waste, and certain other projects previously were ineligible for ITC. (Such projects instead were limited to PTC.) By extending ITC eligibility to these renewable energy projects, Congress increased the ability of taxpayers to utilize sale-leaseback and tax credit lease pass-through structures to monetize tax benefits — and thereby increase project capitalization (these financing structures have been and remain generally unavailable in PTC energy projects). To utilize these structures, however, certain requirements must be satisfied.
Most notably, sale-leasebacks or tax credit lease pass-throughs to lessees require, at a minimum, that the lease be recognized as a “true lease” for tax purposes. There is no statutory or regulatory definition of a true lease; substance rather than form is controlling. Neither the form of the transaction as a lease nor legal title to property is determinative. In general, the IRS and the courts require that the lessor possess sufficient benefits and burdens of ownership for an arrangement to be treated as a lease rather than a financing or other arrangement for tax purposes. Current tax law authority limits the ability of an investor to mitigate the risks of ownership of the leased property through the economic terms of the lease. Thus, an investor must incur significant economic risk in order to obtain the tax benefits of a lessor under a true lease. In certain instances, a partnership “flip” structure or the new federal tax grant program may enable taxpayers to more efficiently monetize tax benefits and fund project capital.
An additional tax incentive afforded by the Stimulus Act permits taxpayers to claim an ITC or, if the project otherwise qualifies, the new federal grant, on project costs funded by subsidized energy financing or industrial development bonds. Previously, such costs were ineligible for the ITC. The Stimulus Act removed this limitation, which will benefit projects eligible for tax-exempt financing (such as municipal waste and landfill gas) as well as projects that receive subsidized energy financing from various federal, state, and local programs designed to conserve or produce energy.
The Stimulus Act contains a more comprehensive and useable program of tax incentives for renewable energy projects. Taxpayers unable to use the old incentives may be able to benefit from the new incentives, thereby increasing the development of renewable energy projects. Our chart briefly outlines the energy incentives contained in Subtitle B of the Act (American Recovery and Reinvestment Act of 2009: Subtitle B – Energy Incentives).