Between a rapidly changing planet, generous federal tax incentives, and high demand, wind and solar projects are experiencing a major growth spurt. In the summer of 2010, the United States had a total net capacity of 39,134.5 megawatts in utility-scale wind energy. By the summer of 2020, that number climbed to 118,378.7 megawatts, more than a 200% increase in just ten years. Similarly, in the summer of 2010, the United States had a total net capacity of just 393.4 megawatts in utility-scale solar energy. Ten years later, however, that number reached 46,306.2 megawatts, a gigantic 11,600% increase. As wind and solar continue to grow, state taxing authorities are examining, and reexamining, how best to tax these unique projects.
This article addresses current trends in state and local taxation of utility-scale wind and solar projects. It provides a short background on the components that make up wind and solar projects, summarizes commonly applicable taxes, including property tax and sales and use tax, and concludes with a brief discussion of why developers should care about state and local taxation.
I. What Are They?
Before diving into the tax, a brief background on the components that make up utility-scale wind and solar projects is necessary.
First, the terminology. Developers often speak of wind and solar projects in terms of their “nameplate capacity.” Roughly speaking, nameplate capacity is how much electricity a generator can produce when operating at full power, usually in terms of megawatts. For example, most wind turbines today have at least a 1.5-megawatt nameplate capacity. Because wind and solar projects cannot operate at 100% year-round, however, developers usually apply a “capacity factor,” a percentage, to estimate how much electricity a project will actually produce. Last, “utility-scale” wind and solar projects, depending on the state, usually means high-capacity projects that transfer generated electricity to the power grid (as opposed to an individual consumer).
Second, the components. Most people know that the primary component of a wind project is its turbines, and the primary component of a solar project is its solar panels. Few may realize that wind and solar projects are vast networks that often span hundreds, if not thousands, of acres. They can include a variety of other property, such as inverters and substations, underground cabling, operations and maintenance buildings, transmission lines, and battery storage systems. Additionally, most land-based wind and solar projects are constructed on vacant or active farmland.
Each of these components presents its own property tax and sales and use tax issues. For example, an underlying question in any property tax or sales and use tax discussion is whether property is real or personal. In Oklahoma, wind turbines are classified as personal property. In contrast, Texas classifies wind turbines located within the ERCOT (Electric Reliability Council of Texas) operating area as real property. Given the nature of wind turbines, anchored to deep concrete foundations but with clearly movable blades, you can understand the arguments for both real and personal property. While states are certainly not uniform in their taxation of wind and solar projects, or their components, they tend to adopt similar mechanisms.
II. Current Taxation Trends
As states continue to consider how best to tax wind and solar projects, they generally end up taking one of several paths. This is true for both property tax and sales and use tax.
A. Property Tax
In general, property tax is imposed on wind and solar projects in one of three ways:
- value-based (ad valorem) tax,
- generation tax on the electricity generated by the project, or
- nameplate capacity tax (a set rate per megawatt).
Because property tax is generally based on some type of value (usually market value), the second and third tax mechanisms are often referred to as “payments in lieu” of property tax. However, some states provide for a fourth option, a statutory “payment in lieu.” In those situations, the local taxing authorities and the project may reach a mutual agreement on an appropriate fee, compensation, or other “tax” to help maintain local public infrastructure or services. Without legislative authorization, however, developers and local authorities should be wary of these types of agreements.
For value-based taxes, the process is generally like a typical ad valorem tax system: a property is assessed, and local tax rates applied. While value-based taxes are usually imposed on some variation of market value, states often advise or instruct local assessors to follow certain guidelines for valuing wind and solar projects. For example, Michigan imposes a value-based personal property tax on “Solar Energy Systems.” In that case, a preset depreciation factor is applied to a project’s original cost to reach the “true cash value,” which is ultimately subjected to local property tax rates. Similarly, counties in Iowa that adopt a special valuation methodology for wind projects follow a set formula, resulting in lower assessed values during the first several years of a project, but significantly higher values during the later years.
For generation taxes, state legislatures identify a set rate and impose the rate typically on the annual electricity generated by a project. For example, Minnesota imposes a wind energy production tax and a solar energy production tax at the rate of $1.20 per megawatt-hour produced. Iowa, unlike its wind projects, imposes a generation “replacement” tax on solar projects based on how many kilowatts of energy the project produces in a year.
Finally, a nameplate capacity tax is the most predicable of these tax mechanisms. In these states, a preset rate is applied to the nameplate capacity of the project. For example, in Nebraska, a tax of $3,518 per megawatt of capacity is applied to wind and solar projects. Notably, South Dakota imposes both a nameplate capacity tax ($3.00 per kilowatt of nameplate capacity) and a generation tax on wind and solar projects.
Developers and project owners should also consider how states treat the underlying land for property tax purposes. Some states continue to separately tax the land subject to general ad valorem principles while others exempt project land and consider it part of the project itself. Additionally, most states have separate transmission-related taxes: whether a project is subject to them often depends on how states define the boundaries of a project, including the location of certain components (such as the inverter). Finally, as battery energy storage systems become more commonplace, some states have developed differentiating factors to determine whether storage systems should be separately taxed. For example, some states (such as Michigan) consider the storage system’s location, and others (like Iowa) whether the system is part of the project’s operating property. Some states may also consider whether systems pull electricity from the power grid during off-peak or low surge hours.
B. Sales and Use Tax
Like property tax, most states follow similar paths for sales and use tax. It is important to understand that, unlike property tax which generally does not take full effect until a project is operational, sales and use tax impacts the entire life cycle of a wind or solar project. In development, for example, sales and use tax can mean big dollars: some jurisdictions have a combined state and local rate over 9%, for example. These sales and use taxes should be fully considered when preparing financing estimates, negotiating contracts (such as Turbine Supply Agreements, Full Service Agreements, Base of Plant or EPC contracts, or construction contracts), and even when selling electricity. Further, the sale of a fully constructed or operational project can trigger sales and use tax issues. For example, in those states that classify turbines as tangible personal property and do not otherwise exempt them (or have exemptions for occasional or isolated sales), the entire purchase price could be subject to sales tax.
Lucky for wind and solar projects, many states do provide explicit exemptions from sales and use tax for equipment and other tangible personal property used in a solar or wind project. The following are just a few examples.
- Iowa exempts the sale of “wind energy conversion property” and sales of “the materials used to manufacture, install, or construct” it;
- Iowa exempts the sale of “solar energy equipment”;
- Minnesota exempts “wind energy conversion systems” that are “used as an electric power source” and “the materials used to manufacture, install, construct, repair or replace them”; and
- Minnesota exempts “solar energy systems.”
While not as explicit, some states have other exemptions that may apply. For example, Michigan’s sales and use tax chapters provide mirroring exemptions for “industrial processing.” While there is no direct mention of wind or solar in either statute, Michigan case law suggests that the exemption could apply to various aspects of wind and solar projects. Even in those states that offer no possible exemption, tax incentives may still play a role. The South Dakota Governor’s Office of Economic Development, for instance, offers reinvestment payments wherein qualifying companies are reimbursed for sales tax costs associated with relocating, expanding operations, or upgrading equipment in the state.
Additionally, while sales and use tax is usually applicable to tangible personal property, many states also tax services associated with developing and operating a wind or solar project. This can be particularly tricky to navigate when contracts involve sales of taxable and non-taxable services (not to mention taxable and exempt tangible personal property). Furthermore, because wind and solar projects are relatively new to state revenue departments, future audits could be a lengthy process with little precedent for guidance.
III. Why State and Local Tax Matters
State and local taxation matters for many reasons, especially for understanding the impact these taxes can have on a project’s lifespan.
First, state and local tax revenue, particularly that which is generated by property taxes, can be very impactful in obtaining the necessary permitting from local county or state boards. This is no mere feat, especially because most land-based wind and solar projects are constructed on vacant or active farmland, and local municipalities have a vested interest in ensuring the developers (and eventual project owners) will be good corporate citizens and community members. Without the necessary permitting, a project will never get off the ground. Second, part of the permitting process often involves educating local government and assessors on how projects will be taxed and how revenue will be distributed. Third, as projects age, it is important to know whether repowering or replacing certain equipment will trigger additional taxes. And fourth, perhaps most obvious, properly estimating expenses down the line helps maximize potential profits. Therefore, in the grand scheme of things, state and local taxes can be very impactful on a project’s lifespan.