Asumag 740 201303 Energypartnerships

Energy Partnerships

March 1, 2013
Tips for energy savings by creating partnerships and investigating tax credit options.

Entities such as schools that own education facilities but don’t pay federal income taxes can take advantage of federal tax credits for renewable energy installations that may lower costs by as much as 40 percent.

Even in tough economic times, great opportunities exist for governments, schools and tax-exempt organizations interested in using renewable energy to reduce operating costs. This is especially true for cities and schools where declining tax revenues and high operating costs are forcing employee and program cutbacks. Investments in renewable energy often can lower otherwise fixed operating costs. Renewables are a fiscally responsible solution that makes it possible for all involved to win, as long as they go about it the right way. 

In general, outright ownership of a renewable energy system, such as a solar-energy system, has a fully loaded upfront cost; this poses a challenge for tight budgets. School administrators need to solve the problem of meeting energy demands while managing and lowering energy costs. 

How it works

For the most part, renewable energy equipment, such as solar panels, qualifies for federal income-tax benefits that cover up to 30 percent of equipment costs; with professional financial structuring, these tax benefits often can generate up to 40 percent of the upfront cash needed to cover capital equipment costs. 

But governments and tax-exempt organizations do not need tax benefits, so when they purchase renewable energy equipment, they often pay more than taxable businesses. An education institution can overcome this obstacle by arranging a proper public-private partnership.

How? Simply by not owning or leasing the equipment, at least for the five-year period required by the U.S. tax code.  In short, if a tax-exempt entity allows a private partner to legally own the equipment and simply signs a five-year energy service agreement, or power purchase agreement (PPA), the tax benefits can be realized by the private partner and the school can take advantage of lowered energy costs because of savings passed on to the tax-exempt entity. 

Partnerships structured with the help of a renewable energy tax adviser also can help an education institution acquire renewable energy equipment. For example, ownership by the exempt through a so-called “blocker corporation” may allow tax-exempt entities to hold partial ownership of equipment.  Unfortunately, this isn’t a solution for most governments (only for pure tax-exempt entities) because of special federal tax rules.

But what can be done if the above still will not work? Focus on the federal tax law rather than just state law.

A new, some might say esoteric, federal income tax rule states that if a taxpayer, say a solar energy company, can establish ownership for federal income-tax purposes, it can in essence ignore state law legal ownership for federal income-tax purposes.

If the Internal Revenue Service agrees that based on all facts and circumstances of the transaction between the public and private parties, the private, non-exempt party to the contract is the tax owner of the equipment, even if there is a bona fide state-law lease or legal title held by an exempt entity, federal tax benefits may be realized by the private party. This allows the tax exempt entity to realize a reduction in energy costs. 

It is strongly recommended that schools seek expert tax advice before pursuing such matters. If they succeed in becoming a cooperative tax-exempt partner in order to take advantage of this type financing, it can pay off in energy cost savings.

This financing method has become known as the “Morris Model” of solar financing, because of its use in Morris County, N.J. The U.S. Department of Energy has endorsed the model on its website because schools make ideal structures for solar systems—school buildings tend to have expansive flat roofs.

In the summer, when solar panels produce the greatest amounts of energy, even when schools are closed, a school often can make money selling electricity into the power grid.

The “Morris Model”

The “Morris Model” essentially involves making a private solar development company the owner of a project for federal income-tax purposes, but a lessee for state law purposes. 

A solar power purchase agreement (PPA) financing structure has enabled schools in Morris County to save about 60 percent compared with their average utility rates. 

Since Morris County pursued its first project in 2010, this model was replicated and refined in Somerset County, N.J.

At least eight other New Jersey counties are setting up their own programs with a similar structure. Thirty-one public facilities in Somerset County, N.J. will pay 4.9 cents per kWh for their power starting last year, escalating to 7 cents per kWh in 2026. 

The overall benefit of this hybrid public-private tax financing approach enables state and local governments to bargain for better electricity rates using a solar PPA.  

The main negotiating point of the county is that it can contribute low-cost project capital through a debt issuance by the Improvement Authority, which is a entity separate from the schools.

In the case of Morris County, the county itself incurred no debt on the 3.2-megawatt project. This is because the county worked out an agreement with the Improvement Authority that will save its participants about $2 million over 15 years, or about 35 percent of its energy costs.

The Morris County Improvement Authority (MCIA) is a non-elected authority that issued exempt municipal bonds to finance major infrastructure projects. 

The Authority sought bids for a solar system based on a 15-year third-party PPA, including solar panel installation, operation and maintenance; tax ownership is conveyed by the authority to the private developer prior to the project being placed in service.

The developer ultimately becomes the long-term operations manager and asset owner, incorporating the best of both PPAs and lower-cost bond financing, making the system cost and LCOE per kWh lower as a result.

The debt will be repaid by the private sector (through lease payments made by developer as lessee) instead of the county government or school districts—all the program participants need to do is continue to pay their electric bills. 

The average interest rate from traditional financing sources ranges from 8 percent to 12 percent or higher and the interest rate on the MCIA bonds is 4.5 percent.

Simply by selling energy under contract where the contract is not characterized as either ownership of solar equipment or a lease for federal tax purposes, the federal (and maybe state) tax benefits stay with the private party.

As long as such sales of energy are allowed in your state, and you have a good partner, this public-private partnership can be a powerful solution to your school’s budget problems.

Peterson is a licensed attorney and senior manager for CohnReznick Group’s National Tax Practice. He also leads the firm’s Tax Research and Planning Department in Atlanta. 

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