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While once dominated by traditional power suppliers and vertically integrated utilities, new producers and investors in the renewable technology sector are increasing rapidly. Historically, industry incumbents have had a thorough understanding of the energy tax credits and incentives available to them, as well as the nuances required to account for them. As more nontraditional players enter the market, their priority should be to have a thorough understanding of energy tax credits in order to drive growth, maximize shareholder value and solidify their standing in this once-siloed space.
A quick primer on energy tax credits
Traditionally, companies entering the renewables market have available to them either investment tax credits or production tax credits, each of which has specific accounting implications:
- Investment tax credits (ITCs) are incentives based on a percentage of the investment in eligible energy-related properties. When accounting for ITCs, entities can elect to employ the flow-through method – immediately recognizing the income tax benefit when it arises – or the deferral method – initially deferring the benefit and instead recognizing it over the productive life of the underlying asset.
- Production tax credits (PTCs) are incentives based on the amount of energy produced and sold using eligible processes. Entities generally recognize and account for PTCs in the year they arise and are earned.
While ITCs and PTCs have been around for many years, the passage of the Inflation Reduction Act (IRA) has extended and expanded existing credits both in the amount and scope of green energy that is incentivized. The IRA includes numerous energy- and climate-related provisions, including new energy tax credits for standalone energy storage and production of zero-emissions nuclear power, clean hydrogen and sustainable aviation fuel.
New entrants and current generators alike will benefit from getting up to speed on how to take advantage of the IRA’s provisions and the related financial reporting implications.
The IRA and the emergence of transferable and refundable credits
One of the fundamental changes the IRA introduced is transferable energy credits. Producers can now elect to sell certain tax credits – whether in full or in part – to third parties in exchange for cash. This is a potential game changer for financing renewables projects, which typically rely on tax equity today.
In addition to transferability, the IRA includes extensions for ITC and PTC projects, a new clean energy PTC and an ability to enhance the base credit by conforming to wage and workforce requirements, locating the project in an energy community and/or using domestic content in the building and maintenance of the project.
Direct pay is another potential opportunity included in the IRA. Under this provision, certain taxpayers can elect to receive a refundable direct payment of tax in lieu of claiming certain energy credits. While this has limited applicability for traditional wind and solar projects, it is a hallmark of other credits, such as carbon capture and sequestration and clean hydrogen production.
In the past, most ITCs and PTCs have been nonrefundable and nontransferable. So, the passage of the IRA brings new layers of complexity to the accounting process. While the accounting is not yet set in stone, KPMG believes that if the credit is refundable, companies will account for it as they would a government grant. This includes credits that are both refundable and transferable.
There are currently several views being considered on the accounting for transferable credits that are nonrefundable. Some believe the credits should be accounted for as income tax credits; others believe they are more akin to government grants. Still others argue that the accounting depends on the company’s intent. While all of these approaches may be acceptable, KPMG believes it most appropriate for companies to account for them as income tax benefits and to present the gain or loss on sale, if any, as part of income tax expense (benefit).
Energy tax credits incentivize innovation
Energy tax credits play an integral role in incentivizing the use of renewable energy. When the American Recovery and Reinvestment Act (ARRA) passed in 2009, it marked the first time that the government incentivized the production of renewable energy through a combination of credits, loan guarantees and research grants. The result was tremendous growth in both solar and wind energy.
Like the ARRA, the IRA has the potential to drive the evolution of energy innovation. It is expanding and modernizing the tax code’s definition of renewable energy, therefore incentivizing accelerated development and growth across the sector. In other words, current generators are encouraged to invest in emerging technologies, and new entrants are invited to claim a piece of the renewables pie.
The ability to monetize credits, either through transferability or refundability, may result in a change in the landscape of financing for green energy projects, especially for new and emerging technology. In turn, this could lead to more rapid development of that technology and the ability to bring those projects online more quickly.
Board and management alignment is critical to mitigating risk and capturing the opportunity
Navigating the Wild West of renewables is tricky, particularly for new entrants. The board and management should set the tone from the top, providing the support for finance leaders to mitigate risk and work efficiently. From there, it is up to finance leaders to work together to instill confidence in investors and other key stakeholders. A lack of coordination can quickly compound both audit and tax risks.
Increasing pressure from investors, regulators, customers and employees will continue to push more companies to take part in the decarbonization of the U.S. economy. Energy tax credits are poised to play a leading role in this process, and companies that fully understand how to employ and account for them will have a competitive advantage.
This op-ed draws in part from an audit insight and commentary from KPMG U.S.
Todd Fowler is National Audit Leader for Power & Utilities at KPMG U.S.
Kimberly Sucha is a Tax Partner and Renewables Leader at KPMG U.S.