Many wonder about the impact the new solar tax law actually has on financing solar.
Our friends at Belvedere Solar Finance provided us with the following facts that may help you in your decision for financing solar. Please feel free to contact us directly should more questions arise, or if you are ready for solar financing.
There has been a lot of commentary about the 2017 Tax Cuts and Jobs Act passed by Congress in December, but nothing that explains the impact of the new law on the cost of financing solar.
The new tax law did not change the 30% energy credit, but it did affect the cost of solar financing in three ways:
System depreciation. The cost of a solar system may be expensed in the year it is placed in service instead of being depreciated over five years. If the depreciation can’t be fully utilized in the first year, it can be carried forward or the user can elect to use a more conservative depreciation method. There is one exception. If there was a binding contract in place before September 27, 2017, bonus depreciation is limited to 40%.
Corporate tax rates are down. The federal tax rate for “C” corporations (corporations that pay taxes at the corporate level) was cut from 34% (35% for very large corporations) to 21% and corporations may continue to deduct state taxes from their federal taxable income. The net result is that the combined federal/California tax rate for corporations has dropped from 40% to 28%.
Individual tax rates are mixed. Individual federal tax rates were reduced. In addition, 20% of the income received by individuals from pass-through entities – partnerships, LLC’s and “S” corporations – is exempt from federal tax, but that exemption does not apply to income from most professional firms. Unfortunately, these rate reductions were offset by eliminating the deduction of state taxes from federal taxable income. The net result is that combined federal/California taxes may be a little higher or a little lower, depending on the taxpayer’s new tax bracket.
The impact of these changes depends on three things:
- Whether the financing is structured as a lease or a loan.
- Whether the equipment user is a corporate or an individual taxpayer.
- Whether savings from solar are assumed to generate a tax liability.
If the system user can’t fully use the tax benefits, a lease is the best financing approach. The lessor owns the system and passes the tax benefits through to the lessee in the form of lower payments. The lessee acquires the system at the end of the lease term.
The cost of lease financing increases under the new tax law. The lessor can now expense the system rather than depreciating it over five years, but depreciation is worth less to the lessor because its combined tax rate has dropped from 41% to 30%.
As a result, the cost of a typical lease financing increases by about 7%. That’s an increase in financing cost of about $55,000 for a $1 million system. While an increase in financing cost is a negative, it’s nominal when compared to projected savings over the system life, which are typically $3 to $4 million.
Companies usually choose lease financing because they don’t have taxable income. This analysis assumes that the system user will not have taxable income over the life of the system, in which case the only impact of the new tax rates is the increased cost of the lease financing.
If the system user has enough tax liability to use the tax benefits, debt financing is the best option.
Under the old tax law, combined tax rates were similar for corporate and individual taxpayers. Under the new tax law, the combined tax rate for corporate taxpayers has dropped from 40% to 28%, but the combined tax rate for most individual taxpayers hasn’t changed very much and in many cases has increased. As a result, the new tax law has a significantly different impact on corporate taxpayers and individual taxpayers.
Let’s look at corporate taxpayers first.
The cost of financing.
The new tax law hasn’t affected interest rates, but that doesn’t mean that the cost to the user hasn’t changed. Under the old tax law, the system user could claim the energy credit, depreciate the system and expense interest on the debt. At a 40% combined tax rate, the tax savings reduced the net cost of the financing to about 52% of the system price. That translates to a net financing cost of $523,000 for a $1 million system,
Under the new tax law, the same deductions are available – and the ability to expense the system accelerates those deductions – but at a 28% combined tax rate, the tax savings reduce the net cost of the financing to about 66% of the system price. That translates to a net financing cost of $656,000 for a $1 million system.
In other words, although interest rates haven’t changed, the after-tax cost of debt financing for a corporate taxpayer has increased about 25% – $133,000 for a $1 million system. While that’s not a good thing, it’s not much when compared to projected savings over the system life which are typically $3 to $4 million.
Most solar analyses assume that electricity cost savings do not increase taxable income. In that case, the only impact of the new tax law on total benefit is the increased cost of the financing.
If you assume that taxable income increases because the tax deduction for electricity expense has decreased, the new tax law dramatically increases the total benefit over the system life because the tax rate on the income is much lower. For example, if the projected savings from a $1 million system are $3.5 million, the lower tax rate increases the total benefit by over $400,000.
The impact is quite different for individual taxpayers.
The cost of financing.
Unlike corporate tax rates, individual tax rates have not changed significantly. Therefore, the impact of the new tax law on the cost of financing typically is nominal for an individual taxpayer.
As is the case with corporate taxpayers, most solar analyses assume that electricity cost savings do not increase taxable income. In that case, the only impact of the new tax law on total benefit is a nominal change in the cost of financing.
Even if savings are assumed to increase taxable income, the impact of the new tax law on total benefit will be nominal, because individual tax rates haven’t changed very much.
The Bottom Line
- There has been a modest increase in the cost of lease financing, but the increase has a minor impact on the total benefit of solar over the system life.
- Interest rates on debt financing haven’t changed, but the after-tax cost of debt financing for corporate taxpayers has increased because deductions are worth less at lower tax rates. There isn’t much impact on the after-tax cost of debt financing for individual taxpayers.
- Whether the user is a corporate taxpayer or an individual taxpayer and, if they are an individual taxpayer makes a big difference. Therefore, understanding the tax position of the system user is critical in structuring and presenting solar financing to the user.
Call us today with remaining questions, or to discuss financing your next commercial solar project at 510.845.2997.