Key Takeaways

• The Inflation Reduction Act (IRA) was signed into law on Aug. 16, 2022. The IRA extends and modifies already existing renewable energy credits, and it adopts several new renewable energy credits.
• In addition, the IRA provides bonus credits if certain prevailing wage and registered apprenticeship requirements are met, and there are additional incremental credits if domestic content requirements are met or if the project is built in an energy community.
• The IRA also enacted two novel alternatives for monetizing renewable energy credits. The first allows certain entities to receive a “direct pay” cash payment in the form of a tax refund from the federal government. The second allows entities to sell or transfer credits to third parties.
• The U.S. Treasury Department issued Notice 2022-61 on the prevailing wage and apprenticeship standards. The Treasury Department is expected to issue a notice of proposed rulemaking in 2023 addressing the modifications to already existing credits and the newly adopted credits.
• With the Treasury Department working expeditiously to write rules, we intend to publish a series of additional client alerts related to the development of these renewable energy tax credits.

Overview

In the United States, federal tax policy, through federal income tax credits, is one of the primary methods used to effectuate government subsidies for the development of renewable energy technology in the private sector. These renewable energy credits were modified and expanded under the IRA. What follows is an overview of these modifications and new credits.[1]

Bonus Credits – Structural Changes

The IRA amended several existing tax credits and included in certain new tax credits a mechanism for the tax credits to increase by a multiple of five if the taxpayer or energy project satisfies the prevailing wage and registered apprenticeship requirements. The IRA also included incremental increases equal to 10 percent if the taxpayer or project satisfies the domestic content requirements for steel, iron and manufactured products. There is also a second incremental increase equal to 10 percent if the energy project is located in an “energy community.” There are further incremental increases for certain wind and solar projects of 5 megawatts or less where the project (a) receives an allocation of available capacity limitation of 1.8 gigawatts for each of calendar years 2023 and 2024; (b) qualifies for the investment tax credit (“ITC”); and (c) is either (i) located in a “low-income community” or on American Indian land or (ii) is part of a qualified low-income residential building. The incremental increase for item (i) is 10 percent, while the incremental increase for item (ii) is 20 percent.

i.) Prevailing Wage and Apprenticeship Requirements

Taxpayers that pay prevailing wages and meet certain apprenticeship requirements qualify for a “bonus” credit amount that increases a base credit by a multiple of five. The prevailing wage requirement is satisfied if laborers and mechanics employed by the taxpayer or any contractor or subcontractor working on the construction of such facility or on repairs or alterations to the facility are paid wages at rates not less than the prevailing rates for construction, alteration or repair of a similar character in the locality in which such work is performed. What constitutes a prevailing wage is based on statutorily prescribed wage rate requirements and rates published by the Department of Labor for the geographic areas and type of job or labor classification. Taxpayers that fail to satisfy the prevailing wage requirement can correct their failure if they pay each worker the difference between actual wages paid and the prevailing wage (increased to three times the difference if the taxpayer intentionally disregarded the rules) plus interest and if they pay a $5,000 penalty for each worker paid below the prevailing wage (increased to $10,000 if the taxpayer intentionally disregarded the rules).

The apprenticeship requirement is satisfied by ensuring that an applicable percentage of total labor hours with respect to the construction, alteration or repair work is performed by qualified apprentices and that each contractor or subcontractor that employs four or more individuals employs one or more qualified apprentices to perform such work. A qualified apprentice is defined as an individual who is employed by the taxpayer or any contractor or subcontractor and who is participating in a registered apprenticeship program. Taxpayers that make a good-faith attempt to request apprentices from registered apprenticeship programs and receive denials from the program or the registered apprenticeship program fails to respond to such request within five business days after receiving the request are deemed to have satisfied the apprenticeship requirement. The applicable percentage for a qualified facility (i) the construction of which begins before Jan. 1, 2023, is 10 percent; (ii) the construction of which begins after Dec. 31, 2022, and before Jan. 1, 2024, is 12.5 percent; and (iii) the construction of which begins after Dec. 31, 2023, is 15 percent. Taxpayers that fail to satisfy the apprenticeship requirement can be deemed to satisfy it if they pay a penalty to the IRS equal to $50 (increased to $500 if the taxpayer intentionally disregarded the rules) multiplied by the total number of labor hours that did not satisfy the apprenticeship requirement.

Taxpayers must maintain sufficient books and records in accordance with establishing satisfaction of the prevailing wage requirements and the taxpayers’ request for qualified apprentices from a registered apprenticeship program and/or the program’s denial or lack of a response to their request.

(i) Domestic Content Bonus Credit

Energy projects under § 45, § 48, § 45Y and § 48E that meet the domestic content requirements and certify that certain steel, iron and manufactured products used in the project were domestically produced are eligible for additional bonus credits equal to 10 percent. The increase applies to the base and bonus credits.

The domestic content requirement is satisfied if a qualified project certifies to the Treasury Department that any steel, iron or manufactured product that is a component of a qualified project or facility was produced in the United States. Neither the definition of manufactured product nor whether steel, iron or manufactured products are produced in the United States are defined by statute. Instead, the statute provides that the Buy America Act and the regulations thereunder are determinative of whether steel and iron are produced in the United States. Under these rules, a manufactured product will be considered manufactured in the U.S. if certain percentages of the total components are mined, produced or manufactured in the United States.

(ii) Energy Community Bonus Credit

Energy projects located in energy communities also qualify for a 10 percent increase to the base and additional bonus credits. An energy community includes a brownfield site; an area that has or had certain amounts of direct employment or local tax revenue related to oil, gas or coal activities and has an unemployment rate at or above the national average; or a census tract or any adjoining tract in which a coal mine closed after Dec. 31, 1999, or in which a coal-fired electric power plant was retired after Dec. 31, 2009.

The following table summarizes the credits discussed herein that qualify for these bonus and incremental increases.

Changes to How Credits Are Monetized

Historically, renewable energy credits were monetized through “tax equity” financing structures or complicated sale-leaseback provisions. While these still exist, the IRA adds two new novel elections that provide additional ways for taxpayers to monetize credits. The first allows certain entities to receive a “direct pay” cash payment in the form of a tax refund from the federal government. The second allows entities to sell or transfer credits to third parties.

(i) Direct Pay

For tax years beginning after Dec. 31, 2022, and before Jan. 1, 2033, tax-exempt entities, state and local governments, and Indian tribal governments may elect to treat certain tax credits as refundable payments of tax. Such entities are eligible to receive a direct payment for any amount paid in excess of their tax liability for credits under § 30C (alternative fuel refueling property), § 45 (PTC), § 45Q (carbon oxide sequestration credit), § 45U (zero-emission nuclear power production credit), § 45V (clean hydrogen production credit), § 45X (advanced manufacturing production credit), § 45Y (clean electricity PTC), § 45Z (clean fuel production credit), § 48 (ITC), § 48C (qualifying advanced energy project credit) and § 48E (clean electricity ITC). In addition, certain tax-exempt entities may elect to receive a direct payment of tax credits under § 45W (qualified commercial vehicles).

All entities other than tax-exempt entities, state and local governments, and Indian tribal governments are eligible for this direct payment only for credits under § 45Q (carbon capture credit), § 45V (clean hydrogen production credit) and § 45X (advanced manufacturing production credit). This refund election expires on Dec. 31, 2032.

(ii) One-Time Transfer

For tax years beginning after Dec. 31, 2022, taxpayers that are not tax-exempt entities are also allowed to transfer certain tax credits to taxpayers that are not related to the transferor taxpayer. Tax credits eligible for this transfer include those under § 30C (alternative fuel refueling property), § 45 (PTC), § 45Q (carbon oxide sequestration credit), § 45U (zero-emission nuclear power production credit), § 45V (clean hydrogen production credit), § 45X (advanced manufacturing production credit), § 45Y (clean electricity PTC), § 45Z (clean fuel production credit), § 48 (ITC), § 48C (qualifying advanced energy project credit) and §48E (clean electricity ITC). Any payments received in exchange for the transfer of credits are excluded from income, and any amounts paid to obtain a transferred credit cannot be deducted from income.

Production Tax Credit

The PTC under § 45 was modified and expanded by the IRA. The PTC provides tax credits for the production of electricity from renewable sources. The base credit amount equals 0.3 cents per kilowatt hour (kWh) (adjusted for inflation) and is available for energy facilities the construction of which begins before Jan. 1, 2025 (thereafter, it is replaced by the § 45Y clean electricity PTC). An energy facility is any facility that generates electricity or places electricity on the grid from wind, biomass, geothermal, solar, small irrigation, landfills and trash, hydropower, and marine and hydrokinetic renewable energy.

As noted previously, a taxpayer can qualify for bonus credits under the PTC if it meets the prevailing wage and apprenticeship requirements, and it can qualify for incremental increases to this amount if it meets the domestic content bonus credit and/or the project is built in an energy community.

Clean Electricity PTC

The tax credit under § 45Y is intended to provide a technology-neutral tax credit for the production of clean electricity and will replace the clean electricity PTC starting in 2025. The clean electricity PTC applies to electricity generated from renewable sources with a greenhouse gas emissions rate not greater than zero. A qualified facility can use carbon capture sequestration equipment to achieve a zero-emission rate. The base credit amount is equal to 0.3 cents per kWh (adjusted for inflation), but the bonus credits for meeting the prevailing wage and apprenticeship requirements and the incremental increases under the domestic content and/or the energy community increases also apply.

Investment Tax Credit for Energy Property

The ITC under § 48 was modified and expanded under the IRA. The ITC provides tax credits equal to 6 percent of the basis of each energy property placed in service during the taxable year. The term energy property is broadly defined to include fuel cell, solar, geothermal, small wind energy, energy storage, biogas, microgrid controllers, waste energy recovery property, and combined heat and power properties with respect to which depreciation or amortization is allowable. A taxpayer must either construct, reconstruct or erect the property or be the original acquirer of the property. A taxpayer may elect in lieu of the PTC to treat as an energy property a qualified facility that also qualifies as an energy project under the ITC. The ITC additionally extends to qualified intercompany property that is party to an addition, modification or upgrade to a transmission or distribution system.

Similar to the PTC, the ITC is increased by a multiple of five if the energy facility meets certain prevailing wage and registered apprenticeship requirements, and there are incremental increases to this amount if it meets the domestic content bonus credit and/or the project is built in an energy community.

Clean Electricity ITC

The clean electricity ITC under § 48E provides a technology-neutral tax credit for investment in qualifying zero-emissions facilities that generate clean electricity from renewable sources and energy storage technology. The clean electricity ITC will replace the ITC starting in 2025. The base credit amount is 6 percent of the basis of each energy property placed in service during the taxable year. The qualified investment of a qualified facility is equal to the basis of any qualified property placed in service by the taxpayer during the taxable year plus certain expenditures for qualified interconnection property. Qualified property is tangible personal property with respect to which depreciation or amortization is allowable. A taxpayer must either construct, reconstruct or erect the property or be the original acquirer of the property. A qualified facility does not include any facility for which the PTC under § 45, the advanced nuclear power facility production credit under § 45J, the carbon oxide sequestration credit under § 45Q, the zero-emission nuclear power production credit under § 45U, the clean electricity PTC under § 45Y, the ITC under § 48 or a qualifying advanced coal project credit under § 48A is claimed.

Similar to the ITC, the clean electricity ITC is increased by a multiple of five to the extent that the prevailing wage and apprenticeship requirements are met, and there are incremental increases to this amount if it meets the domestic content bonus credit and/or the project is built in an energy community.

Qualifying Advanced Energy Project Credit

The credit under § 48C provides a tax credit for investments in advanced energy projects that either reequip, expand or establish an energy manufacturing facility. The IRA provided a $10 billion allocation for the § 48C credit. The credit is administered through an application process that entails the submission of an application and a concept paper that will be evaluated by the IRS and the Department of Energy. The first round of the program begins on May 31, 2023, with applications and concept papers due by July 31, 2023.

The base credit amount is 6 percent of a taxpayer’s qualifying investment for a project that (1) reequips, expands or establishes an industrial or manufacturing facility for the production or recycling of specified advanced energy property; (2) reequips an industrial or manufacturing facility with equipment designed to reduce greenhouse gas emissions by at least 20 percent; or (3) reequips, expands or establishes an industrial facility for the processing, refining or recycling of critical materials. A manufacturing facility is defined as any facility that makes or processes raw materials into finished products or accomplishes any intermediate stage in that process.

Specified advanced energy property includes (a) property designed for use in the production of energy from the sun, water, wind, geothermal deposits or other renewable resources; (b) fuel cells, microturbines or energy storage systems and components; (c) electric grid modernization equipment or components; (d) property designed to capture, remove, use or sequester carbon oxide emissions; (e) equipment designed to refine, electrolyze or blend any fuel, chemical or product that is renewable; (f) property designed to produce energy conservation technologies; (g) light-, medium- or heavy-duty electric or fuel cell vehicles as well as technologies, components or materials for such vehicles and associated charging or refueling infrastructure; (h) hybrid vehicles with a gross vehicle weight rating of not less than 14,000 pounds as well as technologies, components or materials for such vehicles; or (i) other advanced energy property designed to reduce greenhouse gas emissions. The property must be tangible personal property for which depreciation or amortization is allowable.

The base credit is increased by a multiple of five to the extent that the prevailing wage and apprenticeship requirements are met. A taxpayer that claims the § 48C credit cannot also claim the ITC under § 48, the advanced manufacturing credit under § 45X, the clean electricity ITC under § 48E, the credit for carbon oxide sequestration under § 45Q or the clean hydrogen production credit under § 45V.

Advanced Manufacturing Production Credit

The credit under § 45X provides a tax credit for each eligible component produced in the United States and sold by a manufacturer to an unrelated person. The eligible component must be produced in the ordinary course of the manufacturer’s trade or business. An eligible component is broadly defined to include solar and wind energy components, inverters, qualified battery components, and certain critical minerals. The amount of the credit varies between the eligible components (for example, the credit for a thin film photovoltaic cell equals $0.04 multiplied by its capacity, while a photovoltaic wafer is $12 per square meter). The advanced manufacturing credit begins to phase out for eligible components sold after Dec. 31, 2029.

Alternative Fuel Refueling Property Credit

The credit under § 30C provides a tax credit for qualified alternative fuel vehicle refueling property that is placed in service by a taxpayer. This credit originally expired in 2021, but it was reinstated by the IRA for tax years beginning after Dec. 31, 2022. It applies to refueling property that is used for any fuel (i) at least 85 percent of the volume of which consists of ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas or hydrogen; (ii) any mixture of biodiesel, diesel fuel or kerosene where at least 20 percent of the volume consists of biodiesel; and (iii) electricity.

The amount of the credit is equal to 6 percent of the cost of qualified property, with a limit of $100,000 per item of property. The base credit is increased by a multiple of five to the extent that the prevailing wage and apprenticeship requirements are met. In addition, there are certain geographic limitations related to the credit, including that the equipment must be located in an eligible census tract. An eligible census tract includes a low-income community as defined under § 45D(e) or a census tract that is not in an urban area.

Credit for Carbon Oxide Sequestration

The credit under § 45Q for carbon sequestration was modified and expanded under the IRA. The credit was first introduced in 2008, and it has since been amended several times. In general, taxpayers that (1) own carbon capture equipment that captures qualified carbon oxide from an industrial facility and (2) sequester or use carbon for certain purposes are entitled to a credit for each metric ton of qualified carbon oxide captured and sequestered.

The base credit amounts are $17 per metric ton of qualified carbon oxide captured and disposed of in a secure geological storage facility and $10 per metric ton of qualified carbon oxide captured and stored in oil and gas fields. The base credit is increased by a multiple of five to the extent that the prevailing wage and apprenticeship requirements are met.

Zero-Emission Nuclear Power Production Credit

The credit under § 45U provides a tax credit for zero-emission nuclear power production. The amount of the credit is equal to 0.3 cents per kWh (adjusted for inflation) of electricity produced by the taxpayer at a qualified nuclear power facility that is sold to an unrelated person. The base credit is increased by a multiple of five to the extent that the prevailing wage and apprenticeship requirements are met.

Clean Hydrogen Production Credit

The credit under § 45V provides a tax credit for clean hydrogen power production. The amount of the credit ranges from $0.12 to $0.60 per kilogram of qualified clean hydrogen produced by a clean hydrogen facility. The base credit is increased by a multiple of five to the extent that the prevailing wage and apprenticeship requirements are met.

Sustainable Aviation Fuel and Clean Transportation Fuel Credits

The credit under § 40B provides a tax credit for the sale or use of sustainable aviation fuel that achieves a life cycle greenhouse gas emissions reduction of at least 50 percent as compared with petroleum-based jet fuel. The § 40B tax credit is available for the period from Jan. 1, 2023, to Dec. 31, 2024. The base credit amount is $1.25 per gallon.

The credit under § 45Z effectively replaces the § 40B tax credit. It provides a tax credit for the domestic production of clean transportation fuels, including sustainable aviation fuels. The § 45Z tax credit applies to fuels produced after Dec. 31, 2024, and sold before Dec. 31, 2027. The amount of the credit ranges from $0.20 a gallon for nonaviation fuels to $0.35 per gallon for aviation fuels, multiplied by an emissions factor. The base credit is increased by a multiple of five to the extent that the prevailing wage and apprenticeship requirements are met.

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