Renewable energy tax incentives

Notice 2016-31 & Consolidated Appropriations Act '16

Publication May 2016

On December 18, 2015, the President signed into law the Consolidated Appropriations Act, 2016 (the "Omnibus Bill"), which included the Protecting Americans from Tax Hikes Act of 2015.  The Omnibus Bill enacts further extensions of and modifications to the Production Tax Credit ("PTC"), Investment Tax Credit ("ITC"), and Bonus Depreciation.  The Omnibus Bill applies retroactively to January 1, 2015.  On May 5, 2016, in response to questions raised following enactment of the Omnibus Bill, the IRS issued Notice 2016-31, 2016-21 I.R.B., corrected by the IRS on May 18, 2016 (the "Notice").1  The Notice updates safe harbors from previous guidance regarding beginning of construction for certain renewable energy projects.2  The Notice is applicable to any project for which a taxpayer claims the PTC or the ITC under Sections 45 and 48 of the Internal Revenue Code.3  Following is a summary of some of the most significant aspects of the Notice and the Omnibus Bill relating to wind and solar facilities.

Background on the PTC and ITC

In general, the PTC under Section 45 of the Internal Revenue Code includes an inflation-adjusted per-kilowatt-hour ("kWh") tax credit, currently $0.023/kWh, for electricity generated by qualified wind energy resources and sold by the taxpayer to an unrelated person during the taxable year.  The duration of the credit is 10 years after the qualifying facility is placed in service.

The ITC under Section 48 of the Internal Revenue Code is a 30% tax credit based on the total cost of qualifying energy property.  For this purpose, the total cost includes both equipment and labor, but generally does not include the building or structural components on which the equipment was placed.  For a 5-year compliance period, the ITC is subject to recapture if either (1) the property ceased to be a qualified energy property or (2) a change in ownership interest occurred.

Changes to the PTC and ITC for wind projects

Although the PTC was set to expire for wind facilities on January 1, 2015, the Omnibus Bill extends the PTC expiration date for wind facilities that begin construction before January 1, 2020, as well as the election for wind facilities to receive a 30% ITC in lieu of the PTC.  As set forth below, the Omnibus Bill includes a phase-down of both credits when construction of a wind facility commences after December 31, 2016.  The phase-down for wind facilities is described as a percentage reduction to the current $0.023/kWh PTC.4

Construction commenced The ITC Percentage reduction
to the PTC
 2017  24%  20%  $0.0184/kWh
 2018  18%  40%  $0.0138/kWh
 2019  12%  60%  $0.0092/kWh
 2020  0%  100%  $0/kWh

Other non-wind facilities such as biomass, waste heat-to-power, small irrigation, and hydropower are not granted the 5-year extension of the PTC under the Omnibus Bill.  The PTC expires and is not available for non-wind technologies if construction is commenced after December 31, 2016.

Changes to the ITC for solar projects

Under the Omnibus Bill, the 30% ITC for eligible solar properties such as solar photovoltaic systems, solar water heating, solar space heating/cooling, and solar process heat are extended "as is" through the end of 2019, and then will phase down through 2021.  After December 31, 2021, the ITC is scheduled to remain at 10%.  As shown below, the ITC percentage phase-down is based on a combination of when the solar facility is "placed in service" and when "construction commences."

Construction commenced Placed in service The ITC
 Prior to 2020  Prior to 2024  30%
 2020  Prior to 2024  26%
 2021  Prior to 2024  22%
 Prior to 2022  2024 – and After  10%
 2022 – and After  2022 – and After  10%

Accordingly, in order to receive an ITC greater than 10%, the solar energy property must be placed in service before January 1, 2024, and construction must commence prior to 2022.

Other alternative energy technologies are not granted as favorable, if any, ITC extensions under the Omnibus Bill.  The ITC for hybrid solar lighting, fuel cells, small wind turbines, geothermal heat pumps, microturbines, and combine heat and power systems expires after December 31, 2016.  Eligible geothermal systems are only granted a 10% ITC that has no expiration date. 

Safe Harbor for commencement of construction

The Notice assists taxpayers in determining whether they have "commenced construction" for purposes of qualifying for the PTC or ITC.  A taxpayer may establish the beginning of construction by either (1) starting physical work of a significant nature (the "Physical Work Test") or (2) paying or incurring 5% or more of the total cost of the facility (the "5% Safe Harbor").  Both methods require that a taxpayer make continuous progress towards completion once construction has begun (the "Continuity Requirement").  A safe harbor for satisfying the Continuity Requirement (the "Continuity Safe Harbor") will be met if a taxpayer places a facility in service by the later of (1) a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began or (2) December 31, 2016.5  The Continuity Safe Harbor begins upon the earlier of the start of the Physical Work Test or the satisfaction of the 5% Safe Harbor.  A taxpayer may not rely on the 5% Safe Harbor Test and the Physical Work Test in alternating calendar years to satisfy the Continuity Requirement.  

Changes to bonus depreciation

The bonus depreciation provisions permit a taxpayer to elect to claim an additional deduction for 50% of the cost (i.e. adjusted basis) of qualifying property in the year in which the qualifying property is placed in service.  Renewable energy equipment such as wind and solar facilities are qualifying property if the equipment is (1) placed into service in a trade or business, (2) original use begins with the taxpayer, and (3) otherwise eligible for modified accelerated cost recovery system ("MACRS").  Prior to the Omnibus Bill, bonus depreciation was only eligible for qualified property placed in service before January 1, 2015.

A 5-year extension for bonus depreciation is included under the Omnibus Bill, but the 5-year extension has a phase-down requirement attached for property placed in service after December 31, 2017.  The phase-down is detailed below:

Placed in service Bonus depreciation
 2015 50% 
 2016 50% 
 2017 50% 
 2018 40% 
 2019 30% 

1 On May 18, 2106, the IRS issued Notice 2016-31, 2016-23 I.R.B. to revise Notice 2016-31, 2016-21 I.R.B.  This Legal Update reflects such revisions. 

2 The prior guidance is set forth in Notice 2013-29, 2013-1 C.B. 1085; Notice 2013-60, 2013-2 C.B. 431; Notice 2014-46, 2014-2 C.B. 520; and Notice 2015-25, 2015-13 I.R.B. 814.

3 The Notice also states that the Treasury Department and the IRS anticipate issuing separate guidance addressing the extension of the ITC for solar properties.  

4 The exact amount of the PTC for the tax years 2017-2019 will depend on the inflation-adjustment factor used by the IRS in the respective tax years.

5 For example, if construction begins on a facility on January 15, 2016, and the facility is placed in service by December 31, 2020, the facility will be considered to satisfy the Continuity Safe Harbor. 

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