Originally established in 2005, the investment tax credit (ITC) is a federal policy allowing owners of new solar projects to deduct over a quarter of the cost of installing the system from federal taxes. This tax shield provides a powerful incentive to install solar and has been critical to bringing down installation costs and accelerating adoption. The higher the tax shield, the more attractive new projects are to investors and the more affordable energy ultimately is for the customer, helping solar phase out legacy fossil fuel-based generation.
The program has proved so popular that its expiration date has been extended by Congress multiple times, with the credit currently planned to phase out in 2024. The ITC is currently set at 26% for projects starting construction between 2020 and 2022, stepping down to 22% in 2023 and 10% after 2024. But with Biden’s infrastructure package providing major incentives for renewables and grid modernization, the picture could change entirely.
As the Biden administration’s proposed $2 trillion infrastructure bill makes its way through negotiations with the House and Senate, the future of the ITC is on the line. The first draft of the American Jobs Plan, which emphasizes green energy and decarbonization, proposed a 10-year extension of the ITC at 30% through 2026 before phasing down to zero over five years. This would continue to keep solar an attractive investment opportunity as energy rates continue to fall.
The plan also includes a game-changing proposal to elect a cash payment of the ITC value rather than as a tax payment– a direct pay option to owners that would bypass the need for tax equity. As developers and solar owners typically don’t have enough taxable income to absorb the full value of the ITC, they partner with banks or insurance companies who do have enough tax appetite. Through a tax equity partnership, those banks contribute upfront cash in exchange for recognizing the value of the ITC, as well as a share of the project’s cash distributions and other advantageous tax attributes. Tax equity is a key component of renewable project finance, accounting for up to 45% of the capital stack and broadening the investor set for solar projects.
The tax equity market has been constrained over the past year as headwinds from COVID-19 have made traditional tax equity providers hesitant to commit due to uncertainty about their tax capacity. Direct pay would give equity investors certainty in receiving ITC value without the hassle of tax equity. There would be no need for the investor to have large tax liabilities to offset– just a direct pass through of the value.
Also new is a proposal for ITC for standalone storage. Previously, the cost of storage systems could only be recouped as part of a combination with a generating renewable asset, often limiting the feasibility of battery investments to greenfield solar projects. A standalone storage tax credit would spur expansion of storage across the country, crucial as renewables continue to penetrate the grid and storage is needed to manage timing imbalances between supply and demand. The storage industry has long pushed for standalone storage ITC, arguing that it puts batteries on a level playing field with other technologies and will spark interest in improvements in duration and efficiency.
Though it’s unclear how many of these policies will make it into the final package, strong interest in boosting renewables makes a change from the status quo likely. At Crossover, we’re focused on how the ITC picture is changing and how it affects both individual project economics and the renewable and storage landscape as a whole. Although the ITC risk often stays with the project owner during construction and operations, the pre-FNTP execution risk is a major concern to most clients. The capacity to raise tax equity in this changing environment is a key evaluation criterion to clients managing renewable procurement RFP processes, and the Crossover team has deep experience in navigating the market’s ever-evolving landscape.
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