Chapter 8 Federal Tax 101: Wind and Solar Projects

• Jurisdiction: United States

Chapter 8 Federal Tax 101: Wind and Solar Projects

Kendall R. Fisher Dorsey & Whitney LLP Seattle, WA

KENDALL R. FISHER is a Partner with Dorsey & Whitney LLP in Seattle, Washington. Kendall's practice focuses on U.S. federal tax issues related to domestic and cross-border mergers, acquisitions and debt and equity financings, as well as inbound and outbound tax planning related to multinational structures, tax treaties, controlled foreign corporation issues, passive foreign investment company issues, the Foreign Account Tax Compliance Act (FATCA), and the Foreign Investment in Real Property Tax Act (FIRPTA). His practice also includes domestic business formations, joint ventures, acquisitions, combinations, sales, and general tax planning. He frequently advises on the development, tax equity financing, and purchase and sale of renewable energy projects including onshore wind, offshore wind and solar projects, as well as carbon sequestration projects. Kendall has assisted clients with incorporations, tax-free corporate mergers, asset purchases and sales, cross-border transactions, inversion transactions, Up-C transactions, and organizing and structuring joint ventures as well as REITS, general and limited partnerships, and limited liability companies. He also regularly advises on tax issues related to cooperative formations and restructurings. In addition, as an enrolled member of the Confederated Tribes of the Colville Reservation, he also counsels Indian tribes and tribal entities on a wide array of corporate and tax matters.

Introduction

Federal income tax incentives have long been critical to the growth and success of the wind and solar renewable energy industries. For many, the myriad of rules and exceptions applicable to such incentives have been confounding.

The aim of this paper is to summarize many of the fundamental rules and principles that apply to the federal income tax credits available to qualifying projects in these industries. This discussion is not exhaustive and does not constitute tax advice to any person, nor does it address any guidance or authorities issued on or after the date of this paper.

History of Wind and Solar Tax Credits

The first energy tax credit specifically made available to the wind and solar energy industry was enacted by the Energy Tax Act of 1978,¹ which allowed a refundable (i.e., generally eligible to be received as a payment from the United States Treasury Department even if the taxpayer did not otherwise have taxable income to offset) ten percent tax credit for business energy property and equipment using certain energy resources including wind and solar, but excluding oil or natural gas.² At the date of initial enactment, such tax credit was scheduled to expire on December 31, 1982.³ The Windfall Profit Tax Act of 1980⁴ extended such tax credit through 1985, increased the applicable credit percentage to fifteen percent, but made the credit nonrefundable (i.e., the credit was only available to offset other taxable income of the taxpayer).⁵

The Tax Reform Act of 1986⁶ substantially modified the Internal Revenue Code, including, as is relevant to this discussion, by extending the energy credit for solar energy property through December 31, 1988, albeit at a reduced rate of ten percent.⁷ The energy credit for wind property was not extended and, as a result, expired.⁸ A series of short-term extensions of the energy credit for solar property were enacted between 1988 and 1991.⁹

In 1992, the Energy Policy Act of 1992¹⁰ (the "1992 EPA") was enacted. In addition to making the investment tax credit (the "ITC") for solar energy property permanent, the 1992 EPA also enacted the renewable electricity production tax credit ("PTC").¹¹ The PTC initially expired in July 1999, but has been extended at least twelve times since 1999.¹² On several occasions, the PTC was allowed to lapse before

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being retroactively extended.¹³ In addition, the PTC has also been expanded over time to include additional qualifying technologies and energy sources.¹⁴

The Energy Policy Act of 2005¹⁵ (the "2005 EPA") increased the ITC for solar energy from ten percent to thirty percent and extended such credit to additional types of energy properties.¹⁶ The 2005 EPA also extended the PTC for two years through 2007 for all then-qualifying facilities other than solar and refined coal. Since the end of calendar year 2005, until the enactment of the IRA (as defined below), taxpayers have not been permitted to claim a PTC with respect to electricity produced from solar energies.

After a series of extensions, modifications and amendments to the existing authorities,¹⁷ the Inflation Reduction Act of 2022¹⁸ (the "IRA") was enacted on August 16, 2022. For the reasons discussed below, the changes to the renewable energy tax credits resulting from the enactment of the IRA are expected to fundamentally alter the way these credits will incentivize and impact the wind and solar renewable energy industries for the next decade (or longer).

Different Types of Tax Credits

Section 38(a) of the Code permits a taxpayer to claim as a credit against the taxes imposed on that taxpayer for a taxable year an amount equal to the sum of: (i) the business credits for that taxable year plus, (ii) the business credits carried forward or backward to that taxable year.¹⁹ For purposes of Section 38(a) of the Code, "current year business credits" includes both the PTC²⁰ and the ITC²¹ in addition to a number of other credits.²² The focus of this paper is on the PTC and the ITC, as well as the "clean energy" PTC and "clean electricity" ITC (each of which will be effective for qualified facilities or energy projects placed in service after December 31, 2024, see the discussion below under the heading "Clean Energy Production Tax Credit and Clean Electricity Investment Tax Credit (Post-2024)"), as they relate to wind and solar energy industries.

Production Tax Credit General Rules

Section 45(a) of the Code permits a taxpayer to claim the PTC, a per-kilowatt-hour tax credit for electricity produced by the taxpayer from "qualified energy resources" at a "qualified facility" during the ten-year period beginning on the date the facility is originally placed in service.²³ In order to be eligible for the PTC, the electricity produced by a qualified facility must also be sold during the taxable year to an unrelated person in the United States or a possession thereof.²⁴

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Generally, the taxpayer that owns the qualified facility is eligible to claim the PTC.²⁵ When more than one taxpayer has an ownership interest in a qualified facility, except to the extent provided in Treasury Regulations or other administrative guidance, production from the facility is allocated among the owners in proportion to their ownership interests in gross sales of electricity from the qualified facility.²⁶ In light of these rules, taxpayers and tax professionals have developed numerous structures to enable taxpayers to secure project financing by effectively transferring tax credits generated by qualified facilities to investors in exchange for financing proceeds (see the discussion below under the heading "Transferring Tax Credits and Related Monetization Strategies"). Special rules apply to the passing-through of PTCs from estates and certain trusts²⁷ , as well as by certain agricultural cooperative associations to their patrons in a patronage-based manner.²⁸

Prior to the enactment of the IRA, the "base amount" of the PTC was $0.15 per-kilowatt-hour. For qualified facilities placed in service after December 31, 2021, the "base amount" per-kilowatt-hour has been reduced to $0.03 per-kilowatt-hour, but taxpayers are eligible to multiply the base amount by five (in effect, remaining eligible for the previously effective "base amount") if they satisfy certain prevailing wage and apprenticeship requirements when they become applicable, as discussed below under the heading "Base Amount Increase Provisions"). The PTC "base amount", both prior to and following the enactment of the IRA, is indexed to inflation and is subject to certain phase-outs, limitations and increases, all as discussed below.

For these purposes, the term "qualified energy resources" includes wind and solar energy.²⁹ Prior to the enactment of the IRA, qualified facilities using solar energy were not eligible for the PTC (such facilities were only eligible for the ITC).

In addition, in the case of a facility using wind to produce electricity, the term "qualified facility" means any facility owned by the taxpayer which is originally placed in service after December 31, 1993, and the construction of which begins before January 1, 2025.³⁰ However, a qualified facility does not include any facility with respect to which any qualified small wind energy property expenditure (as defined in Section 25D(d)(4) of the Code) is taken into account in determining the credit under Section 25D(d)(4) of the Code.³¹

In the case of a facility using solar energy to produce electricity, the term "qualified facility" means any facility owned by the taxpayer which is originally placed in service after August 16, 2022 (the date of the enactment of the IRA) and the construction of which begins before January 1, 2025, but does not include any "energy property" described in Section 48(a)(3) of the Code for which an ITC is claimed under Section 48(a) of the Code.³² As discussed above, prior to the enactment of the IRA, the term "qualified facility" had not included any facility using solar energy to produce electricity for more than fifteen years.³³

In lieu of claiming a PTC, a taxpayer can irrevocably elect to treat any qualified property that is part of a qualified investment credit facility as energy property for purposes of claiming an ITC in lieu of a PTC.³⁴ The ITC is discussed below under the heading "Investment Tax Credit".

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Base Amount Phase-Out and Limitation Provisions

Section 45(b)(1) of the Code contains a PTC...