Article
Article
10.01.24
Enacted on August 16, 2022, the Inflation Reduction Act (IRA) adopts or extends valuable federal income tax credits for a wide range of clean energy technologies. Significantly, it provides the opportunity to monetize many of these tax credits by way of cash sale transactions or the receipt of direct payments from the U.S. Department of the Treasury (Treasury). The IRA represents a 10-year investment plan by Treasury, offering a measure of security in funding for clean energy industries. Treasury and the Internal Revenue Service (IRS) have issued significant guidance relating to the IRA tax credits, but taxpayer-specific rulings are not being considered at this time. Ahead, we address common questions about the IRA.
What Tax Credits Are Offered by the IRA?
The IRA typically offers one-time tax credits based on a percentage of a taxpayer’s investment in a qualifying clean energy investment (Investment Credits) and tax credits over a period of years, based on a percentage of a taxpayer’s clean energy production activity (Production Credits). Though the IRA extends the existing investment tax credit (ITC) and production tax credit (PTC) for wind, solar, geothermal and other renewable electricity sources through 2024 (and adds battery storage as an eligible investment for purposes of the ITC), in 2025, the ITC and PTC will be replaced with the “technology neutral” clean electricity investment credit (CEIC) and clean electricity production credit (CEPC). These credits will be available for technologies that generate electricity and have a greenhouse gas emissions rate not greater than zero.
The IRA extends and substantially modifies the tax credit for carbon capture and sequestration projects and adds new tax credits to produce clean hydrogen and biofuels, and incentivizes continued production from existing nuclear energy facilities. Manufacturing activities associated with clean energy, and projects designed to lower emission levels at manufacturing facilities, may also be entitled to tax credits under the IRA. In addition, the IRA makes tax credits available to consumers for purchases of electric vehicles (EVs) or investments in energy efficient home improvements.
A detailed list of the various tax credits under the IRA can be found here.
What Industries Benefit from the IRA?
Given the number of tax credits available under the IRA, the associated financial benefits will extend to many industries, including:
A summary of tax credit opportunities by industry can be found here.
What Are the Prevailing Wage and Apprenticeship Requirements?
Most of the tax credits available under the IRA include both a base rate and a “5 times multiplier,” with the latter conditioned on satisfaction of prevailing wage and apprenticeship (PW&A) requirements in connection with the construction, alteration or repair of a qualifying facility. For example, the base rate for the ITC and CEIC is 6 percent but is multiplied by five for a 30 percent rate if PW&A requirements are met. Under a legacy rule, however, projects that began construction prior to January 29, 2023, are not subject to PW&A compliance with respect to such construction.
A project satisfies the prevailing wage requirement if laborers and mechanics employed by contractors and subcontractors are paid “prevailing wages” during construction and for any alteration or repair made during a prescribed period following the original placed-in-service date. “Prevailing wage” means rates not less than the prevailing rates for construction, alteration or repair of a similar character in the locality in which such project is located as most recently determined by the Department of Labor (DOL), generally under the standards in effect for federal buildings. The DOL website provides prevailing wages for most geographic areas; otherwise, taxpayers can apply for a “supplemental wage determination” based on applicable Treasury regulations.
To satisfy the apprenticeship requirement, an amount equal to or greater than the “applicable percentage” of total labor hours for the project is performed by “qualified apprentices.” The “applicable percentage” is 10 percent for projects for projects begun in 2022, 12.5 percent for projects started in 2023, and 15 percent for projects for which construction begins during or after 2024. A “qualified apprentice” is an employee of the project’s contractor or subcontractor who is participating in a registered apprenticeship program.
In addition, under the apprenticeship requirement, journeyworker-to-apprentice ratios established by the DOL or the relevant registered apprenticeship program must be followed. Failure to do so will result in the labor hours of “excess” apprentices not being included in the applicable percentage calculation. Each contractor or subcontractor that employs four or more individuals to perform construction on the project must employ at least one qualified apprentice to perform the relevant work.
Our prior alert on the PW&A requirements and Treasury regulations can be found here.
What Are Bonus Credits?
Some renewable energy tax credits, specifically including the ITC, PTC, CEIC and CEPC, offer enhancements in the form of bonus credits (or “adders”) in certain circumstances. These bonus credits relate to the use of domestic content in the construction of a project or location of a project in an “energy community” and/or “low income community.” The bonus credits include a base rate and a five-times multiplier tied to PW&A compliance.
For the bonus credit related to domestic content, all steel and iron, and at least 40 percent of manufactured products used in the construction of a project, must be produced in the United States. Energy communities include communities that are located on brownfield sites, census tracts with closed coal mines or areas with historic employment related to the fossil fuel industry. Projects located in energy communities can obtain an increase of up to 10 percentage points for the ITC and CEIC, or a 10 percent increase in the applicable rate for the PTC and CEPC. The IRS provided additional guidance on the energy community bonus credit in Notice 2024-30.
The low-income community bonus is available to a facility claiming the ITC or CEIC (but not the PTC or CEPC) that generates electricity solely from wind or solar energy, has a maximum net output of less than 5 megawatts (as measured in alternating current), and falls within any of four categories of low-income communities. Eligibility for the low-income community bonus credit requires application for an allocation of a portion of the annual “environmental justice solar and wind capacity limitation” (which, for each of calendar year 2023 and 2024, is 1.8 gigawatts of direct current capacity).
Our prior alert on the bonus credits and related guidance can be found here.
What Is a Direct Payment Election?
Under the IRA, certain tax-exempt and governmental entities (defined as “applicable entities”) are eligible to make an irrevocable election to receive direct payments from Treasury with respect to most renewable energy tax credits. An “applicable entity” includes an organization exempt from federal income tax, a U.S. state (including the District of Columbia) or any political subdivision or agency thereof, the Tennessee Valley Authority, an Indian tribal government, an Alaska Native Corporation, or any corporation operating on a cooperative basis that is engaged in furnishing electric energy to rural areas. Because most applicable entities do not regularly pay federal income taxes, the direct payment election offers a direct monetary incentive to invest in clean energy projects. Treasury regulations provide a registration process that requires applicable entities and electing taxpayers to obtain a registration number for the relevant tax credits through an IRS portal in advance of filing a direct payment election.
Our prior alert relating to the direct payment election can be found here.
What Is a Cash Transfer Election?
Taxpayers other than applicable entities can sell most renewable energy tax credits to unrelated persons, solely for cash consideration, by making a cash transfer election. Amounts paid as consideration for the sale of tax credits generally are not taxable to the seller or deductible to the purchaser. A taxpayer may sell all or a portion of its available tax credits for each taxable year, but any sale of tax credits must include a proportionate amount of associated bonus credits.
Under applicable Treasury regulations, a cash transfer election must be made on an original federal income tax return filed no later than the applicable due date, including extensions, for the relevant taxable year (or a superseding tax return filed within such time period). A direct pay election may not be made for the first time on an amended return or by way of an administrative adjustment request (AAR), although corrections of numerical errors can be made on amended returns or AARs (except for items left blank or responses of “available upon request”). No late election relief is available under current administrative procedures.
Our prior alerts relating to the cash transfer election can be found here.
Are There Limitations on the Use of Renewable Energy Tax Credits?
There are various limitations under the Internal Revenue Code (IRC) that should be considered when claiming renewable energy tax credits. IRC section 38(c) generally limits the credit allowable for any taxable year so that a minimum amount of federal income tax is payable (very generally, 25 percent of the net regular tax liability of the taxpayer). Additionally, the passive activity limitations under IRC section 469 can affect the ability of individuals, estates, trusts and certain closely held corporations to take advantage of tax credits absent “material participation” in the credit-generating business. For projects financed using tax-exempt bonds, the amount of allowable tax credits can be subject to a reduction of up to 15 percent.
Note that the limitation under IRC section 38(c) does not preclude a taxpayer from transferring excess credits to an unrelated person pursuant to a cash transfer election, but a purchaser of tax credits will be subject to such limitation. The passive activity limitations under IRC section 469 can also apply to a purchaser of tax credits.
What Is Credit Recapture?
Investment Credits are generally subject to potential recapture if the qualifying assets cease to be used by the taxpayer in a trade or business, or otherwise fail to satisfy the credit eligibility requirements during a five-year recapture period. The amount subject to recapture would be reduced by 20 percent per year. In addition, certain tax credits dependent on emissions rates, such as the CEIC, CEPC and CHPC, are subject to potential recapture if the claimed emissions rates are determined not to have been achieved. Finally, the tax credit for carbon capture and sequestration is subject to recapture requirements based on leakage.
Notably, recapture can apply to renewable energy tax credits acquired pursuant to a cash transfer election. Any such recapture can result in imposition on the purchaser of the 120 percent tax on excessive transfers. Thus, risks associated with potential recapture should be addressed in the governing purchase and sale agreement or through tax insurance coverage (or both).
Is the Stacking of Renewable Energy Tax Credits Permitted?
The IRA adopted fairly broad “double dipping” limitations intended to prevent the claiming of multiple tax credits with respect to the same renewable energy project. For example, only one of the ITC, PTC, CEIC or CEPC may be claimed for a single clean electricity project, and both the CHPC and the tax credit for carbon capture and sequestration cannot be claimed for a clean hydrogen facility. That said, opportunities remain to stack tax credits in certain circumstances, such as a facility that produces clean hydrogen that is eligible for the CHPC and uses the hydrogen in the production of biofuels eligible for the CFPC. Careful consideration of the rules and relevant facts are required in evaluating stacking possibilities.
Information regarding stacking limitations and opportunities for various tax credits can be found here.
Is There an Application Process Involved in the Claiming of Renewable Energy Tax Credits?
Generally, tax credits are claimed on a self-certification basis by filing the requisite forms and documents with a taxpayer’s federal income tax return, with any review process occurring upon an IRS examination of such return on audit. The qualifying advanced energy project credit under IRC section 48C involves a competitive application process, as the IRA allotted a total of $10 billion to be awarded to eligible projects (with at least $4 billion of the total dedicated to projects located in certain energy communities). Applications are processed and reviewed by the IRS in close consultation with the Department of Energy (DOE). Similarly, the low-income community bonus credit requires application for an allocation of a portion of the annual capacity limitation discussed above. Both the direct payment election and cash transfer election have a pre-filing registration process under which registration numbers must be obtained from the IRS as a condition to making an election.
Are There Foreign Entity of Concern (FEOC) Restrictions on Renewable Energy Tax Credits?
Under IRC 30D, the purchase of an EV will not qualify for the clean vehicle credit of up to $7,500 if (i) for any EV placed in service after December 31, 2024, any applicable critical minerals included in the battery were extracted, processed or recycled by an FEOC, or (ii) for any EV placed in service after December 31, 2023, any battery components are manufactured or assembled by an FEOC. For this purpose, an FECO is defined by reference to section 40207(a)(5) of the Infrastructure Investment and Jobs Act (42 U.S.C. 18741(a)(5)) and guidance promulgated thereunder by the DOE thereunder. Pursuant to DOE guidance, an entity is considered an FEOC if it is headquartered, incorporated or performing relevant activities in a “covered nation” (i.e., China, Iran, Russia and North Korea), if 25% or more of its voting rights, board seats, or equity interest are held by the government of a covered nation, or if the entity is effectively controlled by an FEOC through a license or contract with that FEOC. IRC section 48D, relating to the advanced manufacturing investment credit, also includes restrictions relating to FEOCs.
Our prior alert relating to the clean vehicle credit can be found here.
What Impact Do the Three Pillars Have on Renewable Energy Tax Credits?
Proposed regulations relating to the CHPC under IRC section 45V adopted the use of “energy attribute certificates” (EACs) as an approach to implement the three pillar requirements for clean hydrogen advocated by environmental groups: incrementality, temporal matching and deliverability. EACs, defined as tradeable contractual instruments issued through a qualified registry or accounting system, would need to be acquired and retired to claim that electricity used for hydrogen production was generated with the specific attributes associated with the EACs. For incrementality, the EAC would have to represent that electricity from an incremental source has a commercial operations date within 36 months of when the hydrogen production facility was placed in service. For temporal matching, the EAC would have to represent that electricity is generated in the same hour that the taxpayer's hydrogen production facility uses electricity to produce the hydrogen (subject to a transition rule, until 2028, under which an EAC can represent that electricity is generated in the same calendar year that the taxpayer's facility uses electricity to produce hydrogen). For deliverability, the EAC would have to represent that electricity was produced by an electricity-generating facility in the same region as the relevant hydrogen production facility.
The introduction of the three pillar requirements under IRC 45V has been criticized by the industry, so there is uncertainty as to whether Treasury and the IRS might revise the requirements when final Treasury regulations are issued.
Our prior alert on the CHPC and the three pillar requirements can be found here.
What Are “Technology Neutral” Renewable Energy Tax Credits?
The CEIC and CEPC, which go into effect in 2025, are considered technology neutral because the primary requirements under IRC sections 48D and 45Y, respectively, are that a facility (i) is used for the generation of electricity, and (ii) has a GHG emissions rate not greater than zero. Unlike the current ITC and PTC, there is no identification of specific technologies, such as solar, wind or geothermal, that may qualify for the CEIC or CEPC. Thus, IRC sections 48D and 45Y are accommodating to the potential for technological advances in coming years. In similar fashion, proposed regulation issued under IRC section 48 with respect to the ITC gave broad interpretations to the various types of energy property that can qualify for the ITC, with the same objective of affording flexibility for technological advances.
Our prior alerts regarding proposed regulations for the ITC, CEIC and CEPC can be found here and here.
Can Renewable Energy Tax Credits Be Combined with Other Federal Incentives?
In general, the IRC does not restrict the ability to combine most renewable energy tax credits with other federal incentives, such as DOE grants or loans, but the specific requirements of the relevant incentive program should be reviewed for possible limitations. State tax and other incentives may also be available for renewable energy projects, in addition to the tax credits provided by the IRA. In addition, projects claiming renewable energy tax credits may be eligible for accelerated depreciation deductions under IRC section 168 and/or the “efficient energy commercial buildings deduction” under IRC section 179D. In some cases, however, the depreciable basis of project assets may need to be reduced by all or a part of the tax credit amount claimed.