Are Investment Tax Credit Changes in Store for Energy Storage?

The US energy storage industry is experiencing rapid growth, with approximately 3.5 gigawatt hours (GWh) of energy storage installed in 2020, which is greater than the aggregate 3.1 GWh of energy storage installed from 2013 through 2019. In 2021, the annual deployment of energy storage in the United States is expected to reach nearly 4 GW as a result of large-utility scale procurements, and this number is expected to grow to nearly 7 GW by 2025.[1]

In the United States, the energy storage industry looks poised for even more rapid growth with a number of federal legislative efforts seeking to expand and make the federal investment tax credit (ITC) available for standalone energy storage systems. This article provides a summary of the current availability of the ITC for energy storage as well as the proposed legislation.

Current ITC Available for Energy Storage

Under current statutory and administrative law and guidance, standalone energy storage facilities are not eligible for the ITC. However, battery storage integrated into an otherwise ITC-eligible wind or solar power electric generation facility may be eligible so long as it satisfies certain requirements. For eligible solar plus storage systems, the current ITC percentage for projects beginning construction in 2021 or 2022 is 26%, while the percentage for projects beginning construction in 2023 is scheduled to step down to 22% (in each case assuming that the requirements for beginning construction are met and the applicable project is placed in service for tax purposes prior to 2026).[2] Any project that begins construction after 2023 or is not placed in service for tax purposes prior to 2026 is subject to a 10% ITC percentage.

In computing the ITC, only the tax basis of qualifying energy property is taken into account and, accordingly, a critical issue is whether a specific class of property is ITC energy property. Under the current Treasury regulations, which have not been updated in more than 30 years, the list of qualifying solar and wind energy properties explicitly includes “storage devices.”^[3] In prior nonbinding private letter rulings, the IRS has taken the view that battery storage integrated into an otherwise ITC-eligible solar or wind facility may be eligible for the ITC subject to certain requirements because this type of battery storage constitutes a “storage device” and does not constitute transmission equipment.

One of these requirements is the so-called “75% cliff” rule. Specifically, the battery system must be charged at least 75% of the time by the solar facility rather than from the grid, over the course of a year, in order to be eligible for the ITC. The regulations treat battery storage systems as dual use equipment, and the ITC-eligible basis for the battery system as dual use equipment is reduced to the extent that the battery system is charged from the grid with the ITC completely disallowed if the charging from the grid exceeds 25% of its total energy input. These dual use equipment rules apply both for initial ITC eligibility and for ITC recapture purposes.

However, these private letter rulings provide only limited guidance. For example, they do not address whether the ITC would be available if a storage system were retroactively added to a solar facility that has been operating for more than one year or if the battery system and related solar facility were not co-located together. Moreover, although these private letter rulings are viewed by the industry as providing guidance on the Internal Revenue Service’s (IRS’s) position on ITC eligibility for energy storage, they technically apply only to the applicants receiving the rulings and do not legally bind the IRS to make similar determinations in the future.

Proposed Federal Legislation

The energy storage industry has long advocated for expanding ITC incentives so that energy storage has access to the same incentives currently available for other renewable energy technologies such as solar and wind systems, and there are a number of federal legislative proposals looking to expand the ITC accordingly as further described below.

In addition to making standalone storage systems eligible for the ITC, many developers have sought a “direct-pay” option for the ITC. A direct-pay election would allow developers of qualifying projects to treat the credit as a payment on their tax return and receive a refund for the amount by which such credit exceeds the developer’s tax liability. Currently, without a direct-pay provision, the ITC is not refundable, and this limits the value of the ITC to the tax liability of a developer and often results in the actual ITC being less than the potential maximum value of the ITC. Developers have been able to lessen the effects of this limitation by obtaining investment from tax-equity investors who have a greater tax capacity, which increases the amount of the ITC that can be monetized for their projects. However, the inclusion of a tax equity investor generally adds complexity and cost to the development of an energy system and there is typically a limited number of large investors who have the tax appetite and can make these tax equity investments. As a result, adding a direct payment election for the ITC would expand the availability of the ITC.

Efforts to expand the ITC for energy storage appear to be gaining support from the federal government with a number of legislative proposals pending in Congress or proposed by the Biden-Harris administration that address energy storage. These include the following:

• Energy Storage Tax Incentive and Deployment Act: This bill was introduced in the House of Representatives and the Senate on March 9, 2021 by a bipartisan group of lawmakers. The proposed legislation expands the existing ITC to apply to standalone storage systems with a capacity of at least 5 kilowatt-hours, which would be available at the currently existing rates and planned stepdown for solar energy facilities. The types of standalone storage systems proposed to be eligible for the ITC include batteries, compressed air, pumped hydropower, hydrogen storage, thermal energy storage, regenerative fuel cells, flywheels, capacitors, and superconducting magnets. The ITC would be available for utility-scale, commercial, and residential storage systems, and owners could opt to take the ITC as a direct payment rather than as a credit.
• American Jobs Plan: Proposed by the Biden-Harris administration, this bill contemplates a $2 trillion investment in infrastructure. The bill includes provisions for energy storage, including a 10-year extension and phase down of the ITC, an expansion of the ITC for standalone storage, and the availability of a direct pay election.
• Other Legislative Efforts: Other legislative efforts that include the expansion of the ITC for energy storage systems include the following: (i) the Growing Renewable Energy and Efficiency Now (GREEN) Act, introduced in the House of Representatives, which also contemplates an option to elect direct payment in lieu of a tax credit, (ii) the Clean Energy for America Act, which is a comprehensive energy tax credit reform proposal and contemplates a 30% ITC for qualifying energy storage projects as well as other incentives to boost investment in net-zero-emission energy generation and related infrastructure, and (iii) the Renewable Energy Investment Act, which would make the ITC eligible for an irrevocable election to be received as a direct payment.

While it remains to be seen what provisions would be included in any final legislation, the current legislative activity demonstrates a greater focus on the promotion of clean energy, including energy storage. It is important to note that a number of states have been and continue to be advancing clean energy policies that are driving the momentum behind the growth of energy storage in the United States. Such legislation and policies are coming at a time when price declines in the cost of lithium-ion battery energy storage have already made energy storage a price-competitive grid alternative. As a result, it is possible that future incentives could create a “tipping point” for massive energy storage growth.