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Inward Investment Guides

Primer: Tax Credits Designed to Incentivize Corporate Green Practices

A company can recoup some of the costs of "going green" through Renewable Energy Credits as well as Investment Tax Credits, among others.

Warren Kirshenbaum, Founder, The Cherrytree Group (August 2012)
For a company considering implementing green business practices, it's not surprising that one of the biggest concerns is the financial cost of such practices. The amount of money that will be spent "going green" is not insubstantial, and it can take years before a return on investment is realized through greater energy efficiency and lower utility costs. In this economy, that can be just too long for some organizations to wait.

However, through state and federal government programs, companies don't necessarily have to wait years before feeling at least somewhat rewarded for their decision to lessen the impact of their operations on the environment. Instead, they can take advantage of the various tax credits and incentives offered for sustainable industrial facility development.

These tax credits have been designed to "incentivize" the development, deployment, and production of renewable energy technology. Federal tax incentives for renewable energy projects are designed to improve the economics of renewable energy technology by subsidizing the costs of construction of these facilities; to stimulate the economy by creating jobs in renewable energy exploration; to encourage investment in socially responsible forms of energy production; and to encourage investment in renewable energy research and development.

Understanding Tax Credits

To maximize these incentives, it is important to understand what kinds of benefits tax credits can offer. Tax credits work like a form of payment of taxes, as they allow a dollar-for-dollar offset against taxes due. (Tax credits should not be confused with tax deductions, which work to reduce adjusted gross income and can lessen the tax amount due. Additionally, tax credits are typically transferable, whereas a deduction is specific to the individual.) Recipients of tax credits can either use the credit to offset taxes, or sell the credit for income. Whether there are any restrictions, limitations, or compliance obligations of the tax credit, as well as whether the tax credits are transferable, is dependent on the type of tax credit.

Tax credits can be earned in a variety of ways: through the creation of renewable energy, the rehabilitation of historical structures, and the remediation of contaminated properties, just to name a few. Buyers of tax credits not only receive use of the tax credit, but they buy the credit at a discount, reaping tax savings on the purchase. The existence of buyers and sellers of tax credits has created a marketplace that provides income, reimbursement, or a financing source for sustainable industrial facility development projects that otherwise would not exist, while offering tax benefits to the buyers of the credits.

Renewable Energy Credits (RECs)

As more businesses search for options to support sustainability goals and initiatives, one viable solution is to purchase renewable energy credits (RECs). RECs give developers of renewable energy a market-based, financial incentive to build wind, solar, and other forms of renewable energy, and provide businesses with the opportunity to support greener practices. However, many businesses don't realize that these opportunities exist, and, consequently, don't necessarily understand how to capitalize on them.

Renewable energy credits are a corporate tax credit. They are a per-kilowatt-hour (KWH) tax credit for electricity generated by a qualified producer and sold to an unrelated person in a given tax year. RECs are available to specific renewable technologies, such as biomass, hydroelectric, and wind, among others. The credit allows a certain payment per KWH for a number of years based upon the particular technology, such as 2.2 cents per KWH for wind, geothermal, and closed-loop biomass, and 1.1 cent per KWH for other technologies.

The tax credits are for either a five-year period (such as open-loop biomass) or a 10-year period (such as wind or closed-loop biomass). Usually a producer of the renewable energy can sell the RECs after they have been issued. Buyers will pay less than face value for them, using the credit against taxes for the full value of the credit. It is also possible to pre-sell the credits by calculating a credit flow stream based upon the output of the facility, the nature of the renewable energy, and the amount of the credit, and by selling the RECs not yet received at a further discount with the obligation that they will be delivered to the buyer once earned and received.

The idea behind RECs is that they are transferable to buyers in a stable marketplace, and the buyers - who will pay less than the face value of the REC - will be able to use the full value of the REC to offset a portion of their tax obligation. The purchased RECs can be used all in a single tax year, if that is possible, based upon the taxpayer's tax situation, or unused credits may be carried forward for up to 20 years or carried back one year if the taxpayer files an amended return.

Businesses can purchase RECs from power companies, brokers or syndicators. When buying an REC, the purchaser should be sure that he will receive the full value of the REC. Also, the REC is a federal credit. There are state credits as well, but these differ from state to state.

In addition to supporting and meeting sustainability goals and initiatives within the company, the purchase of RECs creates value in the eyes of the general public and the business community, by sending a message that a company is supporting efforts toward greener practices. A strong company reputation for social responsibility goes a long way toward creating a competitive advantage.

Investment Tax Credits (ITCs)
Also associated with renewable energy are investment tax credits (ITCs), which result from investing in the technology, equipment, or facilities that create renewable energy. Unlike RECs, which are production credits, ITCs are credits for capital investments in renewable energy equipment and facilities. This type of credit is earned when the equipment is placed into service. ITCs help offset the upfront investment in renewable energy projects and provide an economic incentive to develop and deploy more capital-intensive renewable energy technologies such as solar systems, geothermal HVAC, and other energy-efficient utilities, as well as automotive fuel cells.

Like RECs, ITCs can be sold in order to receive revenue for the producer of the renewable energy. This source of revenue subsidizes the investment in a renewable energy facility. ITCs typically amount to about 30 percent of the cost of construction and equipment used in renewable energy facilities.

The renewable energy producer will need to choose whether to claim RECs or the ITC, as both cannot be taken. Generally, the analysis is dependent on the timing, i.e., whether funds are needed to get the project off the ground (rather than as a reimbursement), or a comparison as to which credit ends up providing more financial resources.

Additional Credits
Some other common tax credits that businesses are taking advantage of in their efforts to work within a sustainability framework for their industrial facility development projects include brownfields tax credits, historic rehabilitation tax credits, and low-income-housing tax credits. The brownfields tax credit encourages the reclamation of polluted property, as well as enhances economic growth by fostering the rehabilitation of abandoned properties, which in turn creates jobs and generates property, excise, and income taxes. Historic rehabilitation tax credits help to promote the rehabilitation of historic buildings by the private sector. Low-income-housing tax credits benefit developers in structuring the financing of these projects, while allowing for a far lower equity contribution.

Understanding and taking advantage of these types of tax credits ensures completion of important sustainable industrial facility development projects that might not otherwise occur. When considering such an undertaking, it's incredibly helpful to seek information about the tax credit process before commencing the project, as this can allow for the development of the potential tax credit equity into a proposed budget or development pro-forma, which can lead to more control over financing costs.
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