By Josh Moore, Partner
Tax credits for solar energy systems have been around for several decades and were recently overhauled as part of the Inflation Reduction Act of 2022 that was signed into law on August 16, 2022.
There are two tax credits that are applicable for business, and taxpayers can only elect one:
The first is the investment tax credit (ITC), which is paid up-front regardless of the amount of energy generated by a solar energy system.
The second is the production tax credit (PTC), which is paid over 10 years and is based on the energy generated by the solar energy system.
Generally, the PTC is more beneficial for large-scale projects in sunny places such as Arizona and Florida, and the ITC is more beneficial elsewhere, but the actual benefits are dependent on each project.
To claim the full credit for either option, certain labor requirements must be met. All wages for construction, alteration, and repair for the first five years of the project for the ITC and for the first 10 years of the project for the PTC must be paid at the prevailing rate as determined by the Treasury Department, and a certain percentage of the total construction labor hours for a project must be performed by an apprentice.
The base credit for the ITC is 30% of the project cost if the labor requirements are met and 6% of the project cost if they are not.
The base credit for the PTC is 2.6¢ per kilowatt-hour generated per year if the labor requirements are met and 0.5¢ per kilowatt-hour generated per year if they are not.
In addition to the base credit, a domestic content bonus credit is available if all steel and iron used in the project were produced in the United States and a “required percentage” of the total costs of manufactured products, including components of the facility, are mined, produced, or manufactured in the United States. The required percentage is currently 40% but is set to increase in 2025.
For the ITC, the domestic content bonus credit is 10% if the labor requirements are met and 2% if they are not. This brings the total credit to 40% of the project cost if the labor requirements are met and 8% of the project cost if the labor requirements are not met.
For the PTC, the domestic content bonus credit is 0.3¢ per kilowatt-hour generated per year if the labor requirements are met and 0.1¢ if they are not. This brings the total credit to 2.9¢ per kilowatt-hour generated per year if the labor requirements are met and 0.6¢ per kilowatt-hour generated per year if the labor requirements are not met.
There are additional bonus credits available for projects under five megawatts that are in low-income communities as defined by the New Markets Tax Credit.
The depreciable basis of the solar project is reduced by one-half of the amount of the credit claimed if the ITC is claimed. For example, if a credit of 30% is claimed, the depreciable bonus of the project will be reduced by 15% or one-half of 30%. There is no reduction in basis if the ITC is claimed. Bonus depreciation, which is currently 100% in 2022 and set to go to 80% in 2023, can be claimed on the project regardless of which credit is claimed.
The ITC vests at a rate of 20% per year, and if the project is sold before being fully vested, the amount of unvested credit is subject to recapture. For example, if a business claims the ITC and then sells a project two years later, only 40% of the ITC will be vested. The business will have to repay 60% of the ITC claimed. PTCs are not subject to recapture.
Our team at Market Street Partners is continually researching and studying new legislation as it is enacted to better understand the opportunities available for our clients. Please contact us if you have any questions or concerns about how any specific provisions affect your situation.