After President Obama was sworn into office, the renewable energy industry saw a boom in temporary tax incentives with the passage of the American Recovery and Reinvestment Tax Act of 2009. Almost 8 years later, the fate of renewable energy tax incentives under the Trump administration is uncertain. Trump’s transition team, his advisors, and President-Elect Trump have given mixed signals on their views on tax incentives for renewable energy. While some advisors have indicated that the credits will remain in place, others have called for a full repeal. Trump himself has reportedly called subsidies for renewable energy “a disaster,” while in other instances, he has included wind and solar in his “all-of-the-above” approach to energy production. He even went as far as to say that he was “okay” with the production tax credit for wind, but that was at a campaign stop in Iowa and thus may or may not provide meaningful information as to the future of renewable energy tax policy. Trump’s position is not the only determining factor in the fate of renewable energy tax incentives. Congress has already put forth tax reform plans that may give us some insight on the future of federal renewable energy tax policy.
This article describes current U.S. federal income tax incentives for the renewable energy industry. This article focuses solely on tax incentives for wind and solar energy, in part because Congress has allowed provisions to expire that provided tax credits for certain other renewable energy resources like geothermal, fuel cells, and hydropower. In addition, the article describes possible outcomes based on tax reform plans from Congress and statements by the Trump administration’s transition team.
Tax Credits Under Current Law
The Internal Revenue Code (the “Code”) allows certain renewable energy tax credits through provisions with sunset clauses, and Congress has periodically renewed these tax credits for short periods, although Congress has at times allowed renewable energy tax credits to lapse.
In December of 2015, Congress retroactively extended and modified wind and solar tax credits for an additional term (for wind projects, ramping the value of the credit down to zero over a multi-year phase out beginning in 2017 and for solar projects, subjecting the credit to reduction over a multi-year phase down beginning in 2020).
Under Section 45 of the Code, the production tax credit (“PTC”) allows a tax credit for 10 years after a qualified wind facility is placed in service for electricity produced and sold to an unrelated party. Construction of the qualified wind facility must begin before the end of 2019. Guidance from the Internal Revenue Service (the “Service”) has provided criteria for determining the beginning of construction date for wind facilities, which determines the maximum value of the credits for the 10 year period. For facilities that began construction before the end of 2016, the value of the PTC is currently worth 2.3 cents per kilowatt hour of electricity. For facilities the construction of which begins in 2017, the value is decreased to 80% of the full credit or 1.84 cents per kilowatt hour. In 2018, the value decreases again to 60% of the credit or 1.38 cents per kilowatt hour. In 2019, the value decreases to 40% of the full credit or 0.92 cents per kilowatt hour. The exact amount of the PTC for the tax years 2017-2019 will be adjusted for inflation by the Service in the respective tax years. The PTC sunsets at the end of 2019. The Service has issued guidance that provides a low threshold to qualify for the “beginning of construction.” Generally, under a financial safe harbor, only 5 percent of the total cost of the facility has to be spent in order to qualify satisfy the “beginning of construction” threshold. For a more detailed analysis of legislative changes and guidance from the Service on renewable energy tax credits, please see our blog posts from January 8, 2016 and May 13, 2016.
In addition to extending the PTC for wind, in December of 2015 Congress also revised and extended the investment tax credit (“ITC”) under Section 48 of the Code for solar projects. The value of the ITC for solar energy property is equal to 30 percent of the cost of the investment if construction begins in 2017, 2018, or 2019. The value of the ITC for solar decreases to 26 percent of the cost of the investment if construction begins in 2020, and to 22 percent if construction begins in 2021. The value of the credit is then reduced to 10 percent of the cost of the investment in perpetuity.
Depreciation Under Current Law
Beyond the tax credits, qualifying depreciable renewable energy property benefits from accelerated depreciation and bonus depreciation. Under Section 168(e)(3)(B)(vi) of the Code, most solar and wind energy property is classified as “5-year property” for purposes of accelerated depreciation. In addition, under Section 168(k) of the Code, 5-year property also qualifies for bonus depreciation, allowing taxpayers to deduct 50 percent of the cost of the qualified property in the first year it is placed in service and the remainder is deducted over the remaining depreciable life of the property. Bonus depreciation was previously scheduled to expire, but Congress extended bonus depreciation in 2015, subject to a phasedown. The percentage that can be expensed in the first year remains at 50 percent for qualified energy property that is placed in service before 2018. It is reduced to 40 percent for property placed in service in 2018 and further reduced to 30 percent for property placed in service in 2019. After 2019, bonus depreciation is scheduled to expire. Some estimates indicate that through combining the renewable energy tax credits with accelerated depreciation and bonus depreciation, more than half of the cost of these renewable energy projects can be financed through tax subsidies.
Possible Renewable Energy Tax Policy Outcomes
While there are mixed signals on how the Trump administration may deal with renewable energy tax credits and depreciation, Congress has put forth tax reform proposals that may shed more light on whether these tax incentives will continue.
On June 24, 2016, Republican House Speaker Paul Ryan released the House GOP “Blueprint” on tax reform. This was one of six pillars of Speaker Ryan’s agenda for a Republican-controlled Congress, which is titled “A Better Way.” The Blueprint outlines a tax reform plan that would revamp rather than amend our current system by restructuring major components of the Code.
On the individual side, the Blueprint consolidates the current 7 tax brackets for individuals into 3 tax brackets – 12%, 25%, and 33% rates (although certain low-income taxpayers would be taxed at a 0% rate). However, the Blueprint proposes a new business tax rate structure for small businesses that are organized as sole proprietorships or pass-through entities. The active business income of businesses organized as pass-through entities and sole proprietorships would no longer be subject to the top individual tax rate (33% is the proposed top individual rate in this Blueprint). Instead, such income would be subject to a maximum tax rate of 25%. While an individual might fall in the 33% top tax bracket, because the active business income will be taxed at maximum rate of 25%, the value of any tax credits that would be passed along to partners in a partnership would decrease for those individuals.
Another proposal in the Blueprint “will eliminate special-interest deductions and credits in favor of providing lower tax rates for all businesses and eliminating taxes on business investment.” The Blueprint does not specify which deductions and credits would be eliminated. However, the Blueprint would lower the corporate tax rate to 20% and tax active business income of sole proprietorships and pass-through entities at a 25% rate, in addition to providing immediate expensing for investments. Given that the Blueprint “envisions tax reform that is revenue neutral,” actually enacting the proposed rate reductions and immediate expensing of investments in a revenue neutral fashion would require that lost revenue be obtained from other sources, such as through the elimination of most, if not all, tax credits and deductions. This would include renewable energy tax credits.
Although the renewable energy tax credits for wind and solar are set to be phased down, the Ways and Means Committee could propose ending the tax credits before they are currently scheduled to sunset. This would depend in part on the amount of revenue needed to offset other proposals contained in the tax reform plan in order to make the plan revenue neutral. Considering that a substantial amount of the cost in foregone revenue for the wind and solar tax credits will start in 2020 and increase through 2025, early repeal may be proposed. The Joint Committee on Taxation estimates project over $11 billion in forgone revenue over the course of 2020 through 2025 associated with the PTC. That is nearly 80 percent of the total projected cost of the extension of the PTC for wind projects. In addition, estimates project nearly $2 billion in foregone revenue associated with the ITC for solar from 2020 through 2025. The cost of the wind production tax credit is largely due to the 10 year credit period that is initiated once the project has been placed in service.
The above estimates do not take into consideration the amount of additional revenue that could be raised through the repeal of bonus depreciation or accelerated depreciation, which the current Code generally allows for depreciable solar or wind energy property in conjunction with the renewable energy tax credits. However, this may be a moot point because the Blueprint proposes to allow for immediate expensing, essentially getting rid of depreciation altogether, and the repeal of accelerated depreciation or bonus depreciation would not raise additional revenue if the new tax laws allowed taxpayers to deduct these costs on an even more accelerated timetable.
The Blueprint is the most drastic proposal for renewable energy tax policy. It is likely a starting point rather than enacted as actual law. That is in part because the next step in tax reform will be the Senate process.
The Senate has yet to release any tax reform plan as robust or comprehensive as the House’s Blueprint. However, in December 2014, Senate Finance Committee Chairman Orrin Hatch released a book titled “Comprehensive Tax Reform for 2015 and Beyond.” While the book does not make any concrete proposals, it does analyze various options for tax reform. Many speculate that Senator Hatch will put forth a plan centered around corporate integration, which is the elimination of the double taxation of corporate income. This could be achieved through a dividends paid deduction for corporations coupled with an increase in the tax on dividends at the shareholder level.
Senator Hatch’s plan, unlike the House’s Blueprint, leaves open the opportunity to incorporate tax incentives for renewable energy. If Republicans want a bipartisan tax reform bill, renewable energy tax provisions is one area that could be open to compromise. In September 2015, Senate Finance Committee Ranking Member Ron Wyden (who is a Democrat) backed a proposal that would create a “technology-neutral” standard for supporting energy. While Senator Wyden, who is the former Chairman of the Senate Energy and Natural Resources Committee, proposed a unified tax incentive that purportedly would have promoted energy without discriminating among the sources of the energy, the credit was calculated in a way that was more valuable for cleaner energy than it was for fossil fuels. The amount of the credit was based upon the amount of carbon emissions (or rather the lack thereof). The more carbon the technology emitted, the lesser the amount of the credit. Some argued that this calculation was not “technology-neutral.”
The last piece of this renewable energy tax reform puzzle is President-Elect Donald Trump’s stance on renewable energy tax policy. As mentioned above, statements by Trump and his advisors vary. Advisors include ideological purists who are uniformly opposed to any tax expenditure to sway energy policy. On the other hand, there are advisors from Wall Street who have invested heavily in the renewable energy markets and developed property and have taken advantage of the renewable energy tax credits. There is a diversity of opinions among Trump’s advisors. In the end, the position of the executive branch will be up to President-Elect Trump, but it is likely that he will pay close attention to how Congress proceeds.
If you would like to discuss the tax reform proposals their potential impact, please contact one of the following members of Bracewell’s tax team:
Curtis Beaulieu (Senior Counsel) – firstname.lastname@example.org or +1.202.828.5806
Vivian Ouyang (Senior Counsel) – email@example.com or +1.212.508.6406
Anne Holth (Associate) – firstname.lastname@example.org or +1.212.508.6157