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Tax Credits Will Refuel the Growth of Solar Installations

March 25, 2022, 8:45 AM

Despite impressive growth and declining installation prices over the last decade, supply chain issues have plagued the solar industry over the last two years, reversing price trends and slowing installations. A recent analysis by Wood Mackenzie, for example, cut outlooks on solar installations in 2022 by roughly a quarter—over 7 gigawatts. In the face of constraints and downgraded forecasts, the proposed Build Back Better, or BBB, legislation promised to ease recent pressures and expedite solar’s growth into a substantial percentage of the U.S. generation resource mix. Although an omnibus BBB proposal resembling last year’s bill appears unlikely at this point, President Joe Biden and Sen. Joe Manchin (D-W.Va.) both have acknowledged publicly that portions of the bill could be passed independently, including one addressing energy and climate.

By many accounts, the renewable energy tax credit, or RETC, provisions are the least controversial of the BBB energy proposals and likely would constitute a significant portion of any pared-down legislation targeting climate change. There are at least two significant reasons for receptivity. First, set against the backdrop of an ambitious and occasionally unprecedented agenda—12 weeks paid leave, free community college, etc.—RETCs are a familiar and tested method of promoting solar development. Second, RETCs incentivize rather than penalize, a key consideration in today’s legislative climate. Given the optimism that some form of updated RETCs may become law soon, this article examines the existing and proposed RETCs, addressing the implications of expanded RETCs for the solar market.

What Are RETCs, and How Do They Work?

RETCs allow owners of renewable generation facilities to claim a tax credit based on either a percentage of the energy property in the facility—the Section 48 Investment Tax Credit, or ITC—or a fixed rate per megawatt hour generated by the facility—the Section 45 Production Tax Credit, or PTC—paid for 10 years. There is also a residential ITC found in Section 25D that mirrors the rates under the commercial ITC. Because these credits are not refundable, owners must either have sufficient tax liability and qualify as one of a few eligible entities or must receive outside investment from an eligible entity with sufficient tax appetite—a tax equity investor—to take advantage of them.

RETCs date back roughly 30 years to the Energy Policy Act of 1992, which introduced the PTC. Although solar facilities were eligible for the PTC through the end of 2005, the PTC has primarily benefited wind development. The meaningful credit for solar has been the ITC, which replaced the PTC for solar facilities in 2006. The ITC has been a primary driver of solar adoption, lowering project costs and creating jobs in the industry’s fledgling years. Initially, the ITC provided a tax credit on federal income tax equal to 30% of the cost of a solar project that commenced construction in the applicable year. For residential, it is system installation. It stepped down to 26% in 2020. Absent legislative action, the commercial ITC will step down again to 22% in 2023, 10% in 2024, and then phase out entirely.

How Would the BBB Proposals Alter or Expand the Existing RETCs?

Any independent energy and climate bill will attempt to build on the success of the RETC structure by providing key increases in credit amounts and extended timelines for eligibility. RETC provisions from BBB applicable to solar that are likely to be in any subsequent tax credit legislation include:

  • Reinstatement of the 30% commercial ITC and extended eligibility until Dec. 31, 2031, provided that solar developers and contractors must pay prevailing wage and offer qualified apprenticeship programs to qualify for the full credit.
  • Introduction of 10% bonus credits for meeting certain domestic manufacturing requirements and constructing in low-income or “energy community” locations.
  • Reintroduction of the PTC for solar facilities, offering an alternative to the ITC.
  • Introduction of a 30% ITC for standalone storage facilities. Introduction of incentives targeting the domestic manufacturing of panels, inverters, and trackers. The credits would be component-specific and begin phasing out in 2027.
  • Reinstatement of the Section 25D residential ITC through 2031 at the 30% rate, also qualifying standalone storage facilities.
  • Possible introduction of a direct-pay provision, applicable to each of the credits above. Such a provision would essentially make the credits refundable and treat the amount of the tax credit earned as tax paid by the project owner, whether residential or commercial.

How Could the BBB RETC Proposals Affect Market Participants?

Implementing those changes will undoubtedly bolster solar deployment but will affect solar industry members differently. For instance, developer-owners will see increased available capital and lower project costs due to the increased duration and amount of the credits. Those certainties will lower transaction costs and provide supply chains with the opportunity to meet demand. Together, those gains will facilitate significant pipeline growth. Developers will also focus more resources on storage development, retrofitting storage capabilities for existing solar facilities, and constructing free-standing storage facilities.

On the flip side, developers will also face new decisions and uncertainties. For instance, reintroduction of the PTC presents a meaningful choice of which credit to take. Although the ITC has been irreplaceable in helping to scale solar and offset high installation costs associated with its early adoption, the absolute value of the ITC likely will fall over time, as the cost of installation resumes its decline and solar technology continues to become more efficient. For instance, distributed generation and smaller utility-scale facilities will cost less to construct but remain subject to nameplate capacity limitations of state regulators and interconnecting utilities, hampering developers’ abilities to monetize the efficiency gains under the ITC. The PTC, which rewards production on a constant basis per megawatt hour produced, may prove to be more beneficial for a given project, depending on its placement-in-service date, tax equity investors’ expectations, and other variables. Developers will also bear increased compliance and verification obligations related to prevailing wage, apprenticeship, and location-based credit—low-income and energy communities—requirements. Finally, although the domestic sourcing bonus may be available shortly after the legislation passes, it’s unclear how quickly domestic manufacturing can ramp up to meet demand.

For non-developer owners, the RETCs provide mostly opportunities. Small businesses and nonprofits that want to install and own their rooftop solar facilities now will be able to do so, as more entity structures may be eligible for RETCs. The direct-pay provisions would allow the realization of the credits’ benefits for those without requisite income tax liability. That change could be transformative for government and educational institution ownership of solar facilities.

Utilities mostly stand to benefit as well. They likely will gain some bargaining power on power purchase agreement rates from independent power producers, given the ITC rates. They also may take advantage of the solar PTC. Although it is unclear if any proposed legislation will alter normalization for the ITC, the PTC is not subject to normalization, so utilities could develop their own solar facilities, as they have with wind for some time. Coupled with the possible direct-pay provision, this could encourage utilities to pursue solar project development and make approval before their state utilities commission less burdensome. The largest challenge for utilities will be handling interconnection queues. Even with RETCs phasing down over recent years, many utilities have had difficulty keeping up with developer requests involving small to medium-size projects.

Tax equity investors likely will see increased demand for investment, as developers will continue to seek tax equity financing to fund their projects. Likewise, the 30% ITC rate, the extension on project eligibility into 2031, and the other economic benefits from these investments should continue driving investor interest in the solar industry. Additionally, the reintroduction of the PTC will provide another option to investors. Accordingly, there will likely continue to be growing interest from tax equity investors. Despite the increased interest for tax equity funding, traditional tax equity investors may face competition from new entrants in the tax equity market. Depending on the final terms of any direct-pay provision, tax-exempt entities that historically have been unable to invest in renewable generation projects—such as pensions and endowments—may have an interest in becoming tax equity investors.

Conclusion

RETCs offer a significant opportunity to leverage existing structures that have been successful to date. Passing legislation that strengthens these proven methods of spurring renewable energy development is low risk, with significant upside potential. As momentum for standalone energy legislation builds, market participants should watch closely to determine which of the various proposals become law and, ultimately, how those proposals will impact their outlook for this year, the next decade, and beyond.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Micah J. Revell is a partner in Stinson LLP’s Minneapolis office.

Kevin P. Savory is a partner in Stinson LLP’s Omaha office.

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