The data center’s key role in digital commerce and connectivity has established the sector as one for governments to nurture. Towns and states across the U.S. are seeking data center opportunities on par with those in Silicon Valley and Virginia’s Data Center Alley. This is done via property tax abatements, sales tax exemptions on equipment, and income tax credits built around job creation and innovation. However, the landscape of national and state tax incentives for data centers is in some flux. Regulations regarding tax incentives for data center buildouts are always evolving, and the pace is accelerating.
Incentives for data centers lead to growth in tax coffers, and they can be beneficial for both operators and tenants. However, they require complex calculations that must be adjusted as new technologies arise and administrations change.
Data center planning has become more difficult recently as generative AI has spurred a radical overhaul of computing strategies. This computationally intensive form of an AI data center is driving new demands on municipal infrastructure for power and water, posing a new element for governments to factor in as tax benefits are allocated.
Keep reading to explore how tax incentives are evolving across the U.S., their impact on data center growth, and what this means for future developments.
Data Center Developments Hit Headlines
With AI in the mix, data centers have become national news. Perhaps most notable is Microsoft’s deal to purchase power from Constellation Energy, which plans to reboot the infamous Three Mile Island nuclear power plant to meet AI needs.
There is also news at the local and state levels. But negotiations on sales tax exemptions, property tax abatements, investment tax credits or bonus depreciations are a backdrop to power. Energy use raises the most controversy. AI’s pressing demand for energy can strain local power grids, threatening brownouts and blackouts.
Today, rapid U.S. expansion of data centers is the buzz in the corridors of Congress, state legislatures and U.S. town halls. Here are some snapshot views of relevant activity:
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The Inflation Reduction Act (IRA) – This national act promises investment tax credits and production tax credits for renewable energy generation and storage in data centers. Follow-through has been slow, and parts of the IRA’s fate are uncertain with the Trump administration in office.
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In Virginia, which has one of the most active clusters of data center buildouts, total capital investment of amounts to $203 billion. That’s per research by the Northern Virginia Technology Council (NVTC), which estimates data centers paid $640 million in taxes to the Commonwealth of Virginia and $1 billion to local governments in Virginia as of 2022.
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Michigan legislators worked on an economic development bill to build data center projects with tax credits, exemptions and grants, even as critics raised concerns. The state finds itself in competition with bordering Indiana and cross-lake Wisconsin to attract AI and other data center operations.
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In Georgia, the state legislature recently passed acts that would place a two-year moratorium on tax incentives allotted to the data center industry. This is due to fears of energy shortfalls because of data center needs. Governor Brian Kemp subsequently vetoed the bill, keeping the present pattern in place.
The race for data center development intensifies as communities weigh immediate tax revenue against long-term infrastructure investments and sustainability concerns. Image: Alamy
Tax Incentives in Data Center Development
While the above events are growing in effect, they are still overshadowed by long-standing efforts to stimulate data center construction. There are many examples of such incentivizing policies, as offered by the Sustainable Digital Infrastructure Alliance:
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In Alabama, data centers can gain eligibility for property tax and sales tax abatements for up to 30 years, based on various investment thresholds and job creation constraints.
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In Indiana, data centers investing at least $10 million in the state can qualify for a complete sales tax exemption on power infrastructure, computer equipment, and elements of the physical plant – but eligibility criteria can vary.
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In Washington state, a retail sales and use tax exemption is available for both businesses and tenants that operate data centers. The exemption includes purchases of qualified “server equipment and power infrastructure, and labor and services for installing such eligible power infrastructure.”
Governments offer a range of tax benefits to attract data center construction, which affects the costs of building and operating sites.
For towns and counties, the benefits can center on property tax reductions, where governments decrease property taxes on data center facilities for a set time.
Data Center Job Creation and Tax Benefits
Data centers promote job creation and reap tax benefits for states and localities. As such, they are sought by state and local officials who are intent on improving their treasuries. Virginia is often cited as a textbook example.
NVTC estimates that, in 2023, the data center industry in Virginia provided approximately 12,140 operational jobs and 14,240 construction jobs. For every job inside a Virginia data center, an additional 3.5 jobs are said to be supported in the rest of the Virginia economy, with 78,140 supported jobs counted for 2023.
Job creation is paramount for many municipalities considering data center proposals. These are eyed with increasing scrutiny, as automation in data centers grows. The particulars in tax benefits vary widely, so tax and economic development experts are often called on to help navigate the process.
For data center operators, the challenge can include negotiating a time frame that aligns with a data center’s ‘go-live’ date. Moreover, the servers, storage systems, and networking gear must be explicitly specified to be exempt from sales tax. As power and cooling rise in the project equation, a host of other equipment is being considered for coverage.
Data centers drive local economic growth, and state officials are competing to attract the industry through strategic tax incentives. Image: Alamy
Define Projects Before Incentives
Tax incentives impact total cost of ownership, so they are especially important to enterprise decision makers, as according to Gordon Bell, principal for strategy and execution at EY-Parthenon. However, the overall contours of a development project must be defined before those tax incentives can be effectively negotiated.
“The availability of tax incentives will vary based on the specific location of the potential development site and the overall structure of the project, as incentives are often tied to metrics such as job creation,” Bell said. “The devil is in the details.”
For these reasons, he emphasized that it is important for users and operators to “proactively build incentive strategies early on in the process.”
Weighing Tax Incentives vs. Latency
Data center tax incentives primarily benefit operators, not tenants. But that varies. In any case, tenants may see cost savings due to operators qualifying for incentives, according to Stefanie Williams, senior research analyst at S&P Global Market Intelligence.
Data center operators often provide guidance and support to tenants in claiming tax incentives in locations where both the operator and the tenant are eligible.
Still, she said, these incentives are now usually secondary to factors like land, power, and staffing costs.
“For example, states such as Virginia and Georgia may have similar incentives, but the overall expenses in Virginia are significantly higher, leading to Georgia being a more economically viable choice,” Williams said.
For the leased data center company itself, legislated tax incentives serve as a tie-breaker between two suitable geographies rather than a must-have. For tenants, location is still largely determined by the latency requirements of the workloads they are running.
Some geographic areas may be unsuitable for specific workloads irrespective of available incentives. Best practices involve prioritizing workload suitability when evaluating potential sites and using tax incentives as a final decision-making factor instead of a primary requirement.
Williams said that some geographies may not be suitable for a particular workload, regardless of the incentives available.
Meeting Incentive Requirements
CBRE’s Patrick Lynch agrees that the tax incentives’ role as cost-savers is eclipsed today by other aspects of data center site location.
“When considering data center site selection, the most crucial factor for the next 36 to 48 months will be locating developable land with access to a reliable and timely power supply,” said Lynch, who is executive managing director for data center solutions at the real estate services and investment firm. “Tax incentives, while potentially beneficial, take a backseat to power availability.”
Still, once suitable land and power are secured, tax incentives can significantly influence the final site selection. Again, the details can be challenging. Ultra-specific job creation requirements come with set average salary levels, capital investment conditions and so on, and these must be carefully administered by data center operators and, sometimes, tenants.
“Those goals can only be met if data center operators and tenants work together closely to meet targets and qualify for incentives,” Lynch said.
Tax Incentives Are Not Forever
Texas is among the locales that aggressively created temporary state sales and use tax exemptions for numerous qualified data centers. The state’s friendly attitude led Lancium, a company that provides energy to power-intensive industries, to focus efforts there, according to company president Ali Fenn.
The company, which has served the bitcoin mining industry, is refocusing its efforts on AI data centers.
“With the highly intensive capital nature of developing a data center, the sales taxes associated with the development and operations of the data center can be significant,” Fenn said. “The application and approval process is complex, and once certain requirements have been met, they must be conscientiously maintained over time.”
The incentives are not permanent, she underlined, “so there should be considerable thought as to the timing of the exemption for the best utilization of development and operational costs.” At the county level, she continued, there can be reductions on some property taxes in the form of an abatement.
“The structure of each abatement will be as unique as the data center itself, so the developer must establish a collaborative relationship with county or city officials and local economic development representatives,” Fenn said.
Embracing Next-Gen Data Centers
Brian Anderson, director for credits and incentives, renewable energy and utilities, at DuCharme, McMillen & Associates, describes an ever-more complex selection process. Data center site selection now calls for an intricate interplay of factors, particularly considering the growing influence of AI.
“The adage in the industry is, ‘It’s not site selection, it’s site elimination,’” he said. That involves engaging with multiple locations and stakeholders at the same time, as well as narrowing down options.
“We’re usually having conversations with several communities simultaneously, trying to find the best fit,” Anderson said.
The topics involved in such data center site selection are numerous, encompassing power, water, environmental risks, and the overall tax structure of a location.
Anderson said a trend is emerging that sees a more comprehensive definition of personal property in the context of data center design. Tax overseers are realizing this includes not just servers but also the associated power and cooling infrastructure.
“What I’ve seen in the Southeastern U.S., particularly, is that it’s not just the computer equipment that gets the abatement, but it’s all the associated equipment – and by definition, that includes power delivery, power backup, and generators. It’s the water, it’s the cooling systems, it’s the HVAC – all that’s keeping things running.”
He suggests that this shift to careful definition is beneficial, taking much of the guesswork out of the process for companies and providing greater certainty regarding the tax implications of their investments.
Finally, a favorable aspect of the AI trend is that an AI data center seems to place a community on the cusp of future commerce.
“There’s a strong value to being able to say, ‘Hey, this isn’t your grandfather’s data center. This is brand new – cutting edge.’”
The Generative AI Power Imperative
As IT veterans are discovering, the introduction of GenAI brings more complexity to the data center. Much of this has to do with electricity. That is because generative AI is based on GPUs as the technology’s underlying workhorses. Generative AI-based language models require large-scale processor farms that consume dramatically large power loads. For example, the DGX H100 server from Nvidia consumes around 10.2 kW of power. That dwarves average servers, which may typically consume around 0.5 kW.
“The need to train large frontier AI models has driven significant increases in aggregate data center demand,” said EY-Parthenon’s Bell, “It also drives the size of individual hyperscale data center campuses. In just a few years, we have seen ‘large leases’ go from around 30 MW to around300 MW and more.”
As power needs are paramount, a rebirth of interest in nuclear power now rides along with interest in dedicated genAI data centers. The trend has seen some regulators looking to require that data center providers bring their own power source to new locations.
Bell said that has meant a shift in the tenor of local development conversations, which previously focused on linking tax incentives to jobs.
“Now, data centers often require the construction of new power infrastructure that can impact the surrounding rate base. Recent developments have faced increased push-back from local constituents,” Bell said. “Additionally, the fact that data centers can use significant amounts of water also raises concerns from the local community. These dynamics can potentially impact incentive availability in the future.”
Tax incentives for data centers are still in the offing, but the path can be more circuitous. Evidence shows that power and cooling water concerns have raised some resistance to progressive data center tax policy.
For example, a tussle over water for the buildout of a Microsoft AI data center site has impacted a Mt. Pleasant, Wisconsin, location. There, former farmland became a political football of sorts over more than two presidential terms, with presidents Trump and Biden both visiting the area for ground-turning events. The site was originally pegged as a high-tech Foxconn Technology Group manufacturing plant, but Microsoft took over most of the land in question after the Taiwanese display manufacturer failed to meet job creation criteria. The new Microsoft plan included sales tax incentives, but water resources remained an issue for the adjoining town of Racine, on the shores of Lake Michigan, where officials were initially reluctant to approve water service extensions for the development.
In another case, the Georgia legislature voted to suspend tax incentives related to data centers. That bill was subsequently vetoed by the governor.
In Kuna, Idaho, a Meta data center project originally aimed at hosting virtual metaverse applications was recast as an AI undertaking. In ongoing activity, power and other concerns led some Idaho lawmakers to propose the decoupling of sales tax exemptions and urban renewal benefits. For its part, Facebook parent Meta has pledged to develop a water treatment facility to allay some concerns.
Even in data-center-friendly Texas, a chairman of the Public Utility Commission suggested new conditions for some AI data center builders: That they must contribute to the power supply themselves.
Looking Ahead After U.S. Election
With pressing power requirements, tax incentives for data centers are likely to be a moving target in the months ahead. The 2022 IRA legislation, a lynchpin in national tax policy affecting data center construction, includes billions of dollars in support for renewable energy. This came under review after Donald Trump’s presidential election victory.
Observers suggest any cutbacks at the national level could spur greater attention on state and local tax incentives for data centers. Looking forward, the critical role of power availability could well join existing intricacies of taxation and incentives when enterprises choose locations.
