On December 27, 2020, Congress passed an omnibus spending and COVID-19 relief bill. It provides new tax credit extensions to a few renewable energy projects, such as solar, wind, and carbon capture.^[1] These new extensions will relieve developers of the time pressure to begin their work, but allow them to gain  the benefits of the tax credits. For example, the bill provides a two-year extension to the Code Section 45Q carbon capture and sequestration tax credit so that a taxpayer can begin construction at any time before January 1, 2026 and still qualify for the credit.^[2]

In this blog post, I provide a general overview of the energy-related tax credits to give readers a fuller understanding of the subject.

The U.S. implemented three main tax credits for renewable projects: production tax credits (“PTCs”), investment tax credits (“ITCs”), and a separate standalone tax credit for carbon capture, the carbon oxide sequestration tax credit. Most U.S. renewable projects can qualify for PTCs and ITCs. All three credits are dollar-for-dollar reductions in the amount of federal income tax owed by a taxpayer. However, none of them is refundable. The PTC is granted based on the amount of electricity the renewable energy facilities produce and sell to third parties, while the ITC is granted based on the amount spent on building renewable energy projects.^[3] The amount of the tax credit for carbon capture “depend[s] on how many metric tons of carbon oxide a taxpayer captures, stores or puts to use in a given year.”^[4]

All these credits aim to incentivize large renewable energy projects, and the new bill sounds like a great relief for many developers. The extension might especially benefit carbon recapture projects. Even though the prior carbon recapture credit expanded to $50 per metric ton of carbon capture (from $20) in 2018 and many expected to see a rise in carbon capture projects, none of the projects has been launched.^[5] According to the Bloomberg Law report, the credit only applies to projects that begin construction by 2023, but it usually takes about an average of five years to get permitting to start the construction.^[6] With COVID uncertainty, many carbon capture projects in development stages are facing abandonment. Therefore, the two-year extension will give the developers more confidence in investing in the carbon recapture projects.

However, will these extensions of credits significantly boost renewable energy market investors or carbon recapture projects? In other words, is granting credits an effective method to boost or help the renewable energy/carbon recapture industry in the era of COVID?

Generally, if a taxpayer does not have sufficient tax liability, a taxpayer does not need to use tax credits to offset its liability. In this case, a taxpayer will usually find a third party to invest in projects as equity owners.^[7] Usually, a small group of financial institutions and corporations with huge tax burdens will finance the project in exchange for tax credits and will become the equity owners in this case.^[8] However, because of the pandemic, the risks of investing in these projects are higher, and financial institutions and corporations might not even generate sufficient taxable income to use the tax credits. As a result, it becomes more difficult for renewable energy project developers to find tax equity investors.^[9] The disappearing tax equity market was also corroborated by several big bank managers.^[10] You might question: why don’t developers just use the credits against their own tax liabilities? They are unlikely to have enough taxable income during the pandemic, and consequently would not be able to take advantage of the benefits from the tax credits. Then, what would be some alternative methods to support the renewable energy industry other than granting non-refundable tax credits? A Congressional Research Service report on tax equity financing introduces different alternatives and their pros and cons.^[11] I will evaluate two other options within the context of COVID-19.

Refundable Tax Credit

Making a tax credit refundable would reduce the concerns of having too little taxable income, either for developers or third-party investors. They will still receive refunds if they do not have sufficient tax burdens that year. However, a refundable tax credit means more revenue loss or tax expenditure for the federal government. Usually, tax credits for renewable energy projects are huge and very expensive for the government.^[12] Another concern for this alternative is that refundable tax credits like the earned income tax credit (“EITC”) are usually granted to low-income individuals as income support.^[13] It would be a concern to provide income support for big corporations and developers. To alleviate part of the concern, the government can grant a partially refundable tax credit (there is a limit on the maximum amount of credits that can be refunded) or a refundable tax credit with a temporary duration of around two years. In this way, the costs of granting refundable credits will be more limited and more affordable for the government.

Convert to Direct Grants

Why can’t the government just directly grant money to renewable energy projects? Under direct grants, developers no longer need to consider whether they have sufficient taxable income or not. Nor would there be any tax equity investors. Tax equity investors are always biased towards larger-scale projects and changing to direct grants will eliminate the bias and allow more small-scale projects to receive benefits.^[14] A potential problem with this method is that without tax equity investors monitoring the projects, a rise in project failure will occur.^[15] To offset the problem, the government would need more administrative staff to oversee the projects, which would incur more costs. During the pandemic, the question is: should the government allocate more money to the renewable energy industry compared to the healthcare industry? With limited resources, a direct grant policy might not be an optimal choice. However, a moderate approach like direct grants mixed with tax credits can be considered. In this way, tax equity investors can keep an eye on the projects so the developers and the investors do not need to worry too much about not having positive taxable income.

To conclude, extending the tax credits deadline will provide relief to developers but cannot significantly boost renewable energy projects during the pandemic. Other alternatives like refundable tax credits and direct cash grants, or a moderate mixed approach, should be considered.

^[1] Kathryn M. Sutton et al., Congress Updates US Energy Policy, Incorporates Energy-related Tax Provisions Through Consolidated Appropriations Act, 2021, Morgan Lewis: LAWFLASH (Dec. 29, 2020), https://www.morganlewis.com/pubs/2020/12/congress-updates-us-energy-policy-incorporates-energy-related-tax-provisions-through-consolidated-appropriations-act-2021.

^[2] Id.

^[3] Jenna Goodward & Mariana Gonzalez, Bottom Line on Renewable Energy Tax Credits, World Res. Inst. (Oct. 2010), https://www.wri.org/publication/bottom-line-renewable-energy-tax-credits#:~:text=What%20are%20the%20Production%20Tax,Investment%20Tax%20Credit%20(%20ITC%20)%3F&text=The%20Investment%20Tax%20Credit%20(%20ITC%20)%20reduces%20federal%20income%20taxes%20for,equipment%20is%20placed%20into%20service.

^[4] Scott W. Cockerham, Coronavirus Relief Package Implications for Renewables: Offshore Wind Wins Big and Other Renewable and Carbon Capture Projects See Extensions, Kirkland & Ellis: Blog Post (Dec. 22, 2020), https://www.kirkland.com/publications/blog-post/2020/12/covid-relief-package-implications-for-renewables.

^[5] Leslie Kaufman, Covid Stimulus Could Help Boost Carbon Capture, Bloomberg Law: Environment & Energy Report (Jan. 4, 2021, 6:00 AM), https://www.bloomberglaw.com/product/blaw/document/X91FE364000000?bna_news_filter=environment-and-energy&jcsearch=BNA%252000000176cd23d224a9ffed67aa460003#jcite.

^[6] Id.

^[7] Alexandra L. Mertens & Joseph E. Nussbaum, Project Finance for Solar Projects, in The Law of Solar: A Guide to Business and Legal Issues 9 (Stoel Rives 5th ed. 2017), https://www.stoel.com/legal-insights/special-reports/the-law-of-solar/project-finance-for-solar-projects.

^[8] Id.

^[9] Cockerham, supra note 4.

^[10] Keith Martin, Disappearing Tax Equity, Project Fin. NewsWire, (Norton Rose Fulbright), Aug. 2020, https://www.projectfinance.law/media/5568/pfnw0820.pdf.

^[11] Mark P. Keightley et al., Cong. Rsch. Serv., R45693, Tax Equity Financing: An Introduction and Policy Considerations (2019), https://www.everycrsreport.com/files/20190417_R45693_01142998298c9e6feec6aba5c48b6ff238a58886.pdf.

^[12] Id. at 10.

^[13] Id. at 11.

^[14] Id. at 12.

^[15] Id.