Internal Revenue Code Section 45 Orphaned Technologies: Is 2020 the End of the Line? Will They Be Orphaned Once Again?

Published by Tong Tran on Thursday, August 6, 2020
Journal Cover Thumb August 2020

In the renewable energy industry, it’s crucial to stay informed of legislation changes, as it gives developers and investors the opportunity to manage the construction of renewable energy projects efficiently and the ability to maximize governmental incentives (i.e., tax credits).

In some instances, tax credits can make or break the viability of renewable energy projects, especially those outside of traditional wind and solar projects.

Let’s consider production tax credits (PTCs) under Internal Revenue Code (IRC) Section 45, particularly as it relates to the “orphaned technologies” (outside of wind) listed below:

  • open/closed-loop biomass,
  • geothermal energy,
  • landfill gas,
  • municipal solid waste,
  • qualified hydropower facilities, and
  • marine and hydrokinetic renewable energy.

So why are these types of projects referred to as the “orphaned technologies?” To answer that question, we have to roll the clock back and get a quick overview of the extension history of the PTC.

The PTC was introduced by The Energy Policy Act of 1992 (P.L. 102-486) as a tax credit earned based on the amount of kilowatt-hours produced by certain renewable technologies identified in IRC Section 45. To qualify for the PTC, the energy produced by the taxpayer had to be sold to an unrelated party. The PTC was intended to be a temporary tax credit and was set to expire July 1, 1999. As you probably guessed, it was extended beyond that date. As a matter of fact, the PTC was extended 12 times since being enacted.

At the end of 2015, the Protecting Americans from Tax Hikes (PATH) Act of 2015 passed, extending and phasing down the investment tax credit (ITC) under IRC Section 48 and PTC for solar and wind, respectively. It did not, however, provide the same extension/phasedown for the technologies mentioned above. As such, professionals in the renewable energy industry referred to these technologies, as the “orphaned technologies.”

It is important to note that there were other orphaned technologies eligible for the ITC under IRC Section 48 that were left out of the PATH Act extensions which are not discussed in detail here (i.e., fuel cell, small wind, fiber-optic, combined heat and power, geothermal heat pump and micro-turbines), as they are subject to the ITC phasedown. The 2017 tax year brought no new news of an extension of the PTC for the orphaned technologies. The Bipartisan Budget Act of 2018 (H.R. 1892) passed and provided a retroactive extension to qualify the PTC orphaned technologies that had begun construction before 2018. This rewarded developers who took the risk of starting construction on orphaned technologies in 2017 with no guarantee that the PTC would be available.

So where are things now in 2020? And what are some planning opportunities?

Good news came at the end of 2019 with the passing of the Consolidated Appropriations Act of 2020, which brought the PTC back to life for the orphaned technologies so long as they “begin construction” before Jan. 1, 2021. Generally, there are two ways to show that a project has begun construction:

  1. by starting work of a significant nature and
  2. by meeting the 5 percent safe harbor test.

Both methods are discussed in detail in IRS Notice 2013-29. Using either method, the taxpayer must also demonstrate that continuous progress is being made toward the completion of the project. Whether continuous progress is being made is subject to the facts and circumstances. Luckily, there is a continuity safe harbor which considers a taxpayer to have made continuous progress if the project is placed 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) Dec. 31, 2018. Note that for projects that begun construction in 2016-2017, IRS Notice 2020-41 modifies the “four calendar years…” to “five calendar years…” to compensate for construction delays due to COVID-19.

An additional planning opportunity in connection with the orphaned technologies is the option for a taxpayer to elect the ITC (equal to 30 percent of the eligible cost of the property) in lieu of the PTC. There are a few key technical things to note about this. Firstly, the ITC election appears to allow for the full 30 percent ITC with respect to the orphaned technologies, which is more favorable than the 18 percent ITC for qualifying wind projects that begin construction after Dec. 31, 2019, and before Jan. 1, 2021. A big win for the orphaned technologies. Secondly, we previously mentioned that in order to qualify for the PTC, the energy produced by the taxpayer had to be sold to an unrelated party. When using the ITC election however, this criterion does not appear to be necessary, since the PTC is no longer being claimed. Lastly, the full 30 percent ITC extension provides further incentive to elect the ITC, given the 50 percent PTC reduction for orphaned technologies. The PTC likely only makes sense for those technologies/projects with a high electrical production relative to cost ratio, which we typically do not see outside of wind.

Needless to say, the end of 2020 is going be a busy time for orphaned technology developers. A less than one-year extension is a short time horizon. Will this be the end of the line for orphaned technologies or will history repeat itself with yet another extension? No one can say for sure so it is important to stay up to date with what is happening in Washington, D.C. This article discusses the tax rules at a high level only. Please reach out to your tax advisors to avoid pitfalls in planning for your particular projects. ;