Customers often ask us if their Illinois solar incentive is taxable. We believe the correct answer is ‘yes’. It comes down to how four key sections of the Internal Revenue Code:
- Section 61 defines gross income as all income that isn’t specifically excluded elsewhere in the Code.
- Section 136 allows for an exclusion from gross income of the “value of any subsidy provided (directly or indirectly) by a public utility to a customer for the purchase or installation of any energy conservation measure.”
- Section 63 defines taxable income as gross income less allowable deductions.
- Section 167 allows for depreciation deductions, but only for property used (1) in a trade or business, or (2) held for the production of income.
Are Illinois Solar Incentives Nontaxable Subsidies?
The IRS has issued two Private Letter Rulings that seem to come to conflicting conclusions about whether incentive payments such as those under Illinois Shines are subsidies that should be excluded from gross income under Section 136.
2010 Private Letter Ruling
In Private Letter Ruling 201035003 the IRS responded to a question from a residential taxpayer about the payments the taxpayer received under a state program that was almost identical to the Illinois Shines program. In that case, the state required utilities to get a certain portion of their electricity from renewable sources and required that a portion of their compliance be through the purchase of renewable energy credits (“RECs”) derived from distributed solar. Utilities established programs in which they offered to purchase RECs in return for an up-front payment.
The IRS concluded that the utilities’ payments were not a subsidy of the purchase price of a solar system, but the exchange of money for property (or property rights). Therefore, they concluded, the taxpayer must include the money received in gross income and pay taxes on the incentive.
2016 Private Letter Ruling
The IRS issued Private Letter Ruling 201607004 in response to a question from a state organization that oversaw two residential solar incentives. In this case, utilities collected funds for the incentives via a surcharge on utility bills and then transferred the funds to the state organization. The organization then sent those funds to contractors to be applied as reductions in the price of the solar systems. As a condition of receiving the subsidy, customers had to agree that the state organization was entitled to receive any RECs produced by their systems.
The IRS concluded that the state organization’s payments to contractors were a subsidy of the purchase price of systems. Therefore, the payments did not need be included in consumers’ gross income, and thus taxes were not owed on the incentive.
Illinois Solar Incentives are Taxable
It is confusing that although the two situations above are similar, the IRS came to a different conclusion in each. We believe the facts in Illinois, however, are more closely aligned with those in the 2010 PLR than the 2016 PLR. In the 2010 assessment, the customer is explicitly receiving money for the RECs, which is also the case with Illinois Shines. In the 2016 case, however, a subsidy is being applied as a reduction in the price of the system paid to the contractor and the transfer of RECs seems to be more incidental. Therefore, we believe Illinois solar incentives are taxable.
It Doesn’t Really Matter Much
One thing that is abundantly clear in Section 136 is that if any incentive is a subsidy (and therefore not taxable), the taxpayer must use the net cost of the system — after deducting the subsidy — as the basis for any 30% federal tax credit claimed on the system. As a result, whether or not these incentive payments are taxable ends up having a pretty small effect on the taxpayer’s overall financial situation.
Consider this example of a $30,000 system with a $10,000 Illinois Shines incentive:
(We assume a 26.95% combined federal and state marginal tax rate here. Which scenario results in a lower net cost depends on whether the taxpayer’s combined tax rate is less than or greater than 30%. However, the differences are fairly small.)
Asserting that the payment is not taxable would only make a significant financial difference if a taxpayer inappropriately ‘forgot’ to reduce his or her tax credit basis by the amount of any subsidy. This taxpayer would thus benefit both from the lack of tax on the state incentive and from basing the federal tax credit on the gross purchase price of the system, which is explicitly prohibited by Section 136.
Doesn’t the System Have to Be Profitable for the Incentive to Be Taxable?
If you Google enough, you’ll find some people who claim that REC payments to consumers are not taxable unless and until their solar system becomes ‘profitable’. Bluntly, this is incorrect. The Code imposes tax on taxable income, not profit. Section 63 says taxable income is simply gross income minus allowable deductions.
Section 167 allows for depreciation deductions, but only for property used (1) in a trade or business, or (2) held for the production of income. Treasury Regulation 1.167(a)-2 further clarifies that no depreciation is allowed for a personal residence or on its furniture or furnishings. It would seem aggressive to assert that a solar system on a personal residence is either (1) a trade or business, or (2) somehow not subject to the limit on deprecation in the regulations.
What Should You Do?
It is frustrating that the IRS doesn’t provide specific rules or guidance on the whether the Illinois solar incentive is taxable. We know that customers would understandably prefer a ‘no tax’ answer, but we’ve described here what Certasun believes the law requires.
Having said this, every taxpayer is responsible for his or her own return. Your situation may be unique, and you are free to take whatever position you believe is correct on your return irrespective of the company that installs your system.