What Is Tax Equity?

Federal governments have extended tax credits to promote the proliferation of renewable energy, including solar, geothermal, which harnesses heat from the earth, and wind power. The U.S. is no exception, and this government has provided financial incentives for investors and renewable energy developers to further the industry, especially as traditional oil and gas prices become prohibitive. Tax equity is a strategy that investors can use to provide capital to alternative energy projects. This type of incentive program has its challenges, however, and any roadblocks to this financing threaten to slow the pace of alternative energy further.

Investment banks have fueled much of the growth of solar and wind power. Part of the incentive for investing is the growth potential for the nascent industry, but government tax credits also play a role in this business. The U.S. government has earmarked funds for renewable energy market participants, but those benefits are not always cut and dried.

In order to qualify for some of the financial benefits tied to investing in wind and solar power generation, investors need to generate profits that exceed a certain threshold. This is because, instead of a direct break, the tax credit is offered as a means to counter the investor's anticipated tax liability, a process known as tax equity. Given that renewable energy distribution in the U.S. remains in its early stages, developers do not typically earn enough profits to qualify for the tax equity.

Wind power and solar energy projects are extremely costly endeavors. Typically, developers do not have enough capital to complete these large-scale projects without the help of tax equity. Subsequently, the renewable energy industry is largely dependent on the policies set forth by the federal government and also the profitability at investment banks. In the event that investors do not remain eligible for tax equity benefits, whether profits falter or for some other reason, there is less incentive for these institutions to finance renewable energy projects. When the state of the tax equity market is in question, so too is the future of alternative energy production.

Federal policies surrounding tax equity continue to take shape through changing economic cycles. Renewable energy developers have pushed for allowances tied to tax credits that would keep the flow of financing from stalling. For instance, market participants have been known to request reimbursements for tax credits that were not used and permission to trade credits among parties.