As a financial analyst by education, I’m surprised at how few posts I’ve made on the investment returns of solar energy products. Residential solar energy systems provide a return on investment that rival investments of similar risk. One factor that is often left out of financial analyses is the impact of personal income taxes, not from the perspective of tax credits, but from the perspective of electricity costs. Let me explain…
When you pay for your utility bill each month, you are probably paying with money from your checking account. This is money upon which you have presumably paid taxes, or will pay taxes. Let’s say your utility bill is $160 this month. Let’s also assume that your marginal tax rate (the rate you pay on your next dollar of earnings) is 20%. How much did you have to earn to pay the $160 utility bill?
$160 / (1-20%) = $200
Let’s assume that you install solar panels that produces enough energy to reduce your electricity bill by $160 this month. You will have “earned” $160, and no taxes are due! Why is this important?
We often compare the investment in solar energy systems with other investments with similar risk profiles. For example, a stock may provide a dividend yield, but that investment income is taxable. We should be looking at pre-tax rather than after-tax cash flows. You would have to earn a $200 dividend to equal a $160 cash savings on your utility bill!
This fact is usually left out of the financial analysis performed when evaluating a solar energy system’s investment performance. Most financial models are too simplistic, understandably so, because there are already a multitude of factors that go into the analysis making it quite complex and sensitive to a few key variables. Moreover, changing and unpredictable tax rates and structures over the 25+ year lifetime of a solar energy system make taxation a difficult and risky factor to include in the analysis. However, savvy investors know that taxation plays a large part in investment planning, and can be an important decision-making factor.
If you are in a higher tax bracket, expect to be in a higher bracket in the future, or expect tax rates to increase, the savings are amplified and the decision to invest in a solar energy system is that much easier!