Businesses that power their facilities with solar energy can take advantage of federal tax credits to offset their installation costs. In this article, we’ll provide valuable information about federal solar tax credits for businesses.
Business Tax Credits Overview
There are two tax credits available for businesses, nonprofits, and local governments:
- The Investment Tax Credit (ITC) reduces the federal income tax liability for a percentage of commercial solar system installation costs during that year.
- The Production Tax Credit (PTC) is a per kilowatt-hour (kWh) electricity generation incentive for the first 10 years of a system’s operation that reduces federal income tax liability and is inflation-adjusted each year.
To promote the adoption of renewable energy, the US government offers tax credits to project owners who invest in solar energy. However, co-located systems like solar panels and battery storage may be eligible for different credits depending on future guidance from the IRS. This means that project owners who invest in co-located systems may be able to claim both the ITC and PTC, increasing their potential tax savings.
Solar energy systems placed in service between 2022 and 2033 qualify for a 30% ITC or 2.6¢/kWh, whichever is greater. To qualify for the PTC, a project must meet the Treasury Department’s labor requirements or be under 1 megawatt (MW) in size.
What Projects are Eligible for the ITC or PTC?
To qualify for the ITC or PTC, the commercial solar system:
- Must be located in the US or in US territories
- Use new and limited used equipment.
- While it can’t be leased to a tax-exempt entity (such as a school), tax exempt entities can qualify for the ITC themselves in the form of a direct payment.
Which is Right for My Business – the ITC or PTC?
Choosing between the Investment Tax Credit (ITC) and Production Tax Credit (PTC) can be a challenging decision for solar project owners. The ITC provides an upfront tax credit for solar investments, while the PTC allows for a more gradual return on investment. The choice between the two credits depends on several factors, including cost, sunlight availability, and additional tax credits eligibility.
The ITC is a tax credit that remains constant regardless of system performance. In contrast, the PTC provides a more attractive cash flow because it allows you to earn back your investment as the system produces electricity. Factors like project size, financing structure, and available tax credits can influence which credit is a better fit for your solar project.
Overall, the ITC is often a more popular option for smaller-scale photovoltaic (PV) and CSP projects because it can be combined with a low-income bonus. However, the PTC can be a more attractive option for larger projects or projects in regions with high sunlight availability, as it allows for a more gradual return on investment. However, as PV and CSP systems become cheaper or more efficient in generating electricity, qualifying for the PTC may become more attractive for all sectors.
What Expenses are Eligible for the ITC?
To qualify for the Investment Tax Credit (ITC) for your commercial solar system, it’s crucial to understand the expenses that are eligible. Eligibility is based on the overall cost of building the system, and it’s calculated by multiplying your “tax basis” (the amount spent on eligible property) by the applicable tax credit percentage.
Eligible properties for solar tax incentives include:
- Photovoltaic (PV) solar panels, inverters, racking and balance-of-system equipment, along with sales and use taxes on the equipment;
- CSP equipment that generates electricity for heating or cooling a structure;
- Installation costs and prorated indirect costs;
- Step-up transformers, surge arrestors, and circuit breakers;
- Energy storage batteries with a capacity rating of 5 kilowatt hours or greater (including those not charged with solar).
- For solar projects smaller than 5 MW, the owner’s property costs for electricity distribution and transmission can be included in the tax basis, even if they’re incurred after the property is interconnected to a system.
Furthermore, the incremental costs (or the cost you would have spent if the roof wasn’t used for solar) can be included. For instance, the price of solar shingles, tiles, or installing a reflective roof membrane to increase electricity generation are eligible for tax credits. However, the total cost of a solar panel system is generally not eligible for tax credits.
What are the Labor Requirements for Projects?
To qualify for the full ITC or PTC, solar projects must meet the Treasury Department’s labor requirements, which include paying prevailing rates for all construction wages, alterations, and repairs. ITC labor requirements are in place for the first five years of the project, while PTC labor requirements are in effect for the first ten years. It’s essential to meet these requirements to avoid any penalties or interest fees.
Additionally, there’s a specific percentage of total labor hours that must be completed by an apprentice. This percentage increases over time, starting at 10% for projects that started construction in 2022 and increasing to 12.5% in 2023 and 15% for projects that start construction after 2023.
If a project doesn’t meet prevailing wage requirements, it can correct this by paying back wages plus interest to employees. You’ll also need to pay $5,000 in fees to the Labor Department to correct prevailing wage requirement failures.
To comply with apprenticeship requirements, a good faith effort must be made. If a penalty payment is made to the Treasury, an amount of $50/hour for each hour of non-compliance can satisfy the requirement. However, if the requirements are ignored, both penalties will increase.
When Will the ITC and PTC Phase Out?
As of now, the Investment Tax Credit (ITC), Production Tax Credit (PTC), and bonuses are set to phase out by 2032, unless Congress extends them or there’s a 75% reduction in greenhouse gas emissions from U.S. electricity production.
- For projects starting construction in 2033, the tax credits and bonuses will stay at 100% for the full value for one more year. However, the 1.8 GW low-income program will end.
- In the second year of the phaseout period, for projects starting construction in 2034, the credits and bonuses will be reduced to 75% of their full value. For example, the ITC will be worth 22.5%, and the PTC will be worth 2.0 ¢/kWh (adjusted for inflation). Here’s how to calculate the ITC and PTC:
- ITC: 75% x 30% = 22.5%
- PTC: 75% x 2.6 ¢/kWh (inflation adjusted) = 2.0 ¢/kWh (inflation adjusted)
- For projects starting construction in 2035, the third year, only 50% of the business tax credits and bonuses will be available.
- After the third year, there will be no credits or bonuses available for new projects.
Solar projects greater than 1 MW that don’t meet the Treasury’s labor requirements and start more than 60 days after guidelines are released are subject to an 80% reduction in domestic content & energy bonus. Here’s an example calculation:
- ITC: (30% + 10%) / 5 = 8%
- PTC: (2.6¢/kWh + 0.3¢/kWh) / 5 = 0.6¢/kWh)
How Can Tax-Exempt Organizations Benefit?
Nonprofits and local governments can obtain tax credits through direct pay, which involves receiving a check from the federal government with your tax refund, or a transfer of credit.
Direct pay option: Tax-exempt organizations (such as non-profits), state, city or rural electric cooperatives qualify for an IRS refund for projects placed in service after 2022. Any projects that start construction in 2024 or solar energy systems that exceed 1 MW in size have new domestic content requirements to meet. Otherwise, they might only qualify for a 90% tax credit.
- If you begin constructing a solar project in 2025, you can qualify for an 85% tax credit that year. However, this tax credit will decrease to 0% after 2025. If the IRS asks you to pay more than necessary, you may incur a 20% penalty.
- Both individuals and for-profit corporations can qualify for the ITC and PTC. However, it’s important to note that these credits can only be used to offset federal income tax liabilities and aren’t refundable, but you may carry them forward.
- Transfer of credit: If you can’t receive direct payments, you can sell some or all of your tax credits to someone else. The buyer must pay in cash and cannot take a tax deduction for the payment. The seller does not have to pay taxes on the payment received. However, claiming too many credits on your return may result in a 20% penalty.
- If a non-profit that’s eligible for direct payments partners with a for-profit company (that’s eligible for transfer of credit), neither can receive payments or transfer credits related to that project.
Are There Other Incentives for Solar Panel Systems? How Do They Change Tax Credit Calculations?
For information on incentives and other resources relevant to your business needs, see the Database of State Incentives for Renewables and Efficiency (DSIRE).
Electric Utility and State Government Rebates
Utility and state government rebates for solar systems are generally considered taxable income by the IRS, which does not change a system’s tax basis when calculating ITC benefits.
Suppose a business installs a PV solar energy system with a $1 million initial cost, finishes construction in 2022, and places it in service within four years. The state government offers a one-time rebate of $100K. In this case, the ITC would be calculated as follows:
0.3 * $1,000,000 = $300,000
If you install or purchase a solar panel system at your home and receive a utility rebate, it’s an exception to the general rule. In this scenario, the utility rebate is subtracted from the tax basis, resulting in a reduction in the amount of ITC you can claim. However, it’s important to note that the rebate is not considered taxable income.
To calculate the ITC for a $1 million PV system installed in an apartment complex with a $100,000 rebate, construction starting in 2022 and completion within four years, use this formula:
0.3 * ($1,000,000 – $100,000) = $270,000
The accelerated depreciation schedule for the solar ITC tax credit allows business owners to deduct more of their installation costs early, reducing the overall cost. Since depreciation is an expense, businesses will generally have a lower income tax bill if they are able to claim a larger amount of depreciation.
While the ITC is a tax credit, it’s important to note that depreciation is a deduction. This means that it will only reduce the business’s taxes by the amount of depreciation multiplied by their tax rate (see example below).
By claiming the ITC, businesses can benefit from accelerated depreciation rules. These rules permit businesses to depreciate a full tax basis, minus half of the ITC, over a period of five years using a half-year convention. This means that taxpayers can deduct a larger portion of the cost in the early years, reducing their immediate federal tax liability. Unused depreciation can also be carried forward indefinitely, which gives businesses additional tax benefits.
Businesses that install a solar PV system between January 1, 2018 and December 31st 2022 are eligible for 100% bonus depreciation. Starting in 2023, the amount of capital equipment a business can expense immediately drops by 20% per year. This will reduce to 80% in 2023, 60% in 2024 and reduce to 0% at the end of 2027.
A solar panel system can be a smart investment for your business. With many benefits, including steady financial returns and the ability to lock in low energy rates against rising costs, it’s a great way to boost your bottom line.
If you’re ready to change the way you power your business, contact us today for a free solar analysis that includes costs, finance options, ROI and more.