George L. Strobel II co-founded Monarch Private Capital and serves as Managing Director of Credit Placements.
Many people have heard of environmental, social and governance (ESG) investing. To a much lesser degree, investors have heard of tax credits and tax equity or tax credit investing. And even fewer investors are familiar with how to utilize tax credits or tax equity investing to accomplish their ESG goals, satisfy sustainability initiatives and mitigate their tax liability.
More importantly, with tax equity investing, ESG criteria and ESG impact can be quantified. Yes, you can direct how your tax dollars are to be used and measure their environmental and social impact. You can give your money a mission.
Tax Credits Background
Tax credits were created by the government to incentivize investment in areas such as renewable energy, historic rehabilitation and affordable housing by offering investors in these activities a dollar-for-dollar reduction in their tax liability. Corporations, financial institutions and insurance companies have long used tax credits to mitigate their federal and state tax liability while providing much needed capital for projects promoting clean energy, conveniently located quality workforce housing and historic renovations in communities across the country. Investments in these types of activities, where the primary return to the investor is the tax attributes of the investment, is referred to as tax equity investing.
Tax equity investing offers a desirable tax mitigation and optimization strategy and can enhance the balance sheet of the taxpayer because it:
• Satisfies ESG policy objectives.
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• Converts dollars earmarked for tax payments into investments.
• Increases generally accepted accounting principles (GAAP) earnings/earnings per share (EPS).
• Reduces effective tax rate.
• Often generates predictable high rates of return — investments generate an immediate return of invested capital through tax benefits and additional cash returns.
• Does not require capital that the company needs or earmarks for other strategic or business operations.
• Can meet Community Reinvestment Act (CRA) needs for banks.
Three of the more commonly known federal tax programs are the Investment Tax Credit (ITC) Program, which promotes renewable energy, the Federal Historic Preservation Tax Incentives Program and the Low-Income Housing Tax Credit Program (LIHTC), which focuses on affordable housing. These programs offer a mechanism to mitigate your tax liability and make a positive impact environmentally and socially.
The ITC, created by Congress in 1962, is the primary reason for the rapid growth of solar energy in the U.S. Since 2006, it has helped the U.S. solar industry grow by more than 10,000%. The ITC:
• Produces significant permanent GAAP earnings benefits because of favorable basis write-down provisions in the Internal Revenue Code.
• Generates opportunities to satisfy sustainability initiatives and CRA requirements.
• Typically offsets up to 75% of current year tax liability, and excess credits may be applied to the prior year or carried forward 20 years.
The Historic Tax Credit (HTC) created through the Federal Historic Preservation Tax Incentives Program in 1976 has played a pivotal role in the preservation of this country’s historic buildings and community revitalization. From 1977-2019, the program spurred an estimated $102.6 billion in rehabilitation investment, and:
• Generates tax savings resulting in a lower effective tax rate and enhanced GAAP earnings.
• Typically offsets up to 75% of current year tax liability, and excess credits may be applied to the previous year or following 20 years.
The federal LIHTC program, created by the Tax Reform Act of 1986, is an essential source of affordable housing. Since it was implemented, the LIHTC has spurred development of over 48,500 projects and 3.2 million housing units, and its:
• Investments are used to meet CRA requirements for banks.
• Investors receive tax credits/losses due to depreciation and possibly cash distributions depending on the economics of specific projects.
Perhaps equally important is that the bulk of most tax equity investments can be made from funds already earmarked for tax payments.
Tax Credit Equity Plus ESG Investing
Tax credit investments can have a positive impact on individuals, communities and the world, but there has been concern about the lack of standardization or uniformity in ESG reporting. However, with the recent publication of The Global Risks Report 2020 by the World Economic Forum, there are efforts in motion to move to a more standardized reporting system. Although there may be a wide array of ESG frameworks or ESG criteria and presently companies can choose which items they want to report, tax credit equity investing is a direct investment, and its ESG impact can be quantified.
Tax credit equity ESG funds are direct investments in sector-specific projects that positively impact communities. These investments can provide societal benefits and predictable returns as a result of federal and state tax credit programs. Not only are universally accepted ESG criteria satisfied with these types of investments, but their impact can and is being measured by such organizations as the U.S. Environmental Protection Agency, the National Park Service, the National Association of Home Builders, etc.
In the renewable energy sector, impact metrics such as new renewable energy generation, homes powered for one year, greenhouse gas emissions avoided and jobs created can all be quantified. Simultaneously, ESG criteria associated with the specific project(s) generating renewable energy can be identified, tracked and reported in compliance with the standards set forth by the Sustainability Accounting Standards Board and Global Reporting Initiative. Lastly, United Nations Sustainable Development Goals, such as “Affordable and Clean Energy,” “Climate Action,” “No Poverty” and “Quality Education,” can be satisfied.
Likewise, in the low-income housing and historic rehabilitation sectors, impact metrics such as affordable homes created, individuals housed, jobs created, income generated, etc. can be quantified. Similarly, applicable ESG criteria and UN Sustainable Development Goals like “Sustainable Cities and Communities” and “No Poverty” can be identified and satisfied.
Tax equity investing allows investors to mitigate their tax liability while furthering ESG mandates, satisfying ESG initiatives and making a quantifiable impact in their community.