Inflation Reduction Act of 2022: The energy tax provisions you need to know about

Eversheds Sutherland (US) LLPThe Inflation Reduction Act of 2022 (the Act) runs 725 pages and includes numerous energy tax provisions aimed at enhancing US. energy security. The Act, if enacted, would extend and expand the renewable and alternative energy tax credits, shift to technology neutral credits in 2025, provide for US energy component manufacturing credits and modify the rules for electric vehicle tax credits. Buckle up as we breakdown the 300 plus pages of energy tax related provisions.

New concepts

The Act contains several new concepts that apply across numerous credits. When evaluating the applicability of many of the credits provided for in the Act, taxpayers will need to be aware of the following. We therefore begin with these new concepts.

Prevailing wage and apprenticeship requirements

Certain credit provisions provide that only 1/5th of the credit amount is available unless one of the following is satisfied:

  1. The facility’s maximum net output is less than 1 MWac;
  2. Construction of the facility began prior to (or within 60 days after) the release by Treasury or the IRS of guidance for the implementation of the prevailing wage and apprenticeship requirements; or
  3. The prevailing wage and apprenticeship requirements are satisfied.

Generally, to meet the prevailing wage requirement, laborers and mechanics employed by contractors and subcontractors in construction and alteration or repair of a facility must be paid wages not less than prevailing rates as determined by the Secretary of Labor. The apprenticeship requirement generally requires that (1) certain labor hour requirements for the construction, alteration or repair work with respect to the facility must be performed by apprentices and (2) for contractors with more than four employees, one in every four employees employed by contractors or subcontractors must be a qualified apprenticeship. Failure to satisfy the wage and apprenticeship requirements may be cured through additional payments to the affected workers and to the government. These requirements vary slightly for different credits and exceptions apply.

ES Observation: Since the prevailing wage and apprenticeship requirement is deemed satisfied if construction begins before (or within 60 days after) Treasury or the IRS releases guidance on these requirements, there remains an incentive to begin construction earlier than the extended deadlines for beginning construction (as discussed below). For taxpayers needing to comply with these requirements, practical guidance from Treasury and IRS implementing these rules will be critical. For example, it is unclear how a taxpayer can reasonably utilize the cure provisions without having direct access to employee information (including name, contact information and wages) of contractors and subcontractors. We expect this guidance to be the subject of substantial input from industry.

Energy community bonus credit

Certain bonus credits may be available for facilities constructed in an energy community, which includes brownfield sites, areas with significant employment (post-1999) related to extraction, processing, transport, or storage of coal, oil or natural gas, or any census tract (or adjoining tract) that had either a coal mine close after 1999 or coal-fired electric generating unit retired after 2009.

ES Observation:  The IRS will need to provide guidance regarding the relevant criteria for determining what constitutes “areas with significant employment.”  

Domestic content requirement

Bonus credits also may be available if domestic content requirements are satisfied. To satisfy this requirement, taxpayers must certify that any steel, iron or manufactured product that is a component of the facility (upon completion of construction) was produced in the US. Generally, manufactured products are deemed to have been produced in the US if 40% of costs of the manufactured products are attributed to components mined, produced or manufactured in the US (a lower 20% threshold applies for offshore wind facilities).

Further, if domestic content requirements are not satisfied, any direct payment made in lieu of a tax credit (discussed below) may be subject to a haircut.

ES Observation: The domestic content rules are coupled with new incentives (discussed below) for the manufacture of renewable energy components in the US. Until US manufacturing catches up with US renewable energy development, these rules may be difficult to satisfy. There are exceptions available to avoid the direct payment haircut if domestic content is unavailable or prohibitively expensive.

 Payments in lieu of credits

Direct payments: The Act provides for an election for direct payment in lieu of a tax credit. Any direct payment election must be made on a per facility/project/equipment basis. Direct pay is allowed for many of the credits mentioned in this alert.

Tax-exempt entities, state or local governments (or political subdivisions thereof), the TVA, an Indian tribal government, or any Alaska Native Corporation may make an election for direct pay. Other taxpayers are eligible for direct pay only for sections 45V (clean hydrogen), 45Q (carbon capture and sequestration), and section 45X (advanced manufacturing production credit), with certain limitations.

Transferability: Additionally, taxpayers may make a yearly election to transfer all (or any portion) of an eligible credit to an unrelated taxpayer, provided that consideration for such transfer is paid in cash. Such consideration is not includible in the transferor’s gross income, and is not deductible by the transferee. Any taxpayer other than persons that are entitled to direct payments are entitled to transfer the credits. The credit is taken into account in first taxable year of the transferee taxpayer ending with, or after, the taxable year of the eligible taxpayer with respect to which the credit was determined. Many of the credits mentioned herein are eligible for the transfer provision.

ES Observation: The Act notes that IRS may request further information before providing any direct payments, which could delay the receipt of payments and increase the likelihood of IRS audit. Further, note that although these monetization opportunities address credit monetization, they do not address monetization of the depreciation benefits.

Renewable power credits

Current credits for renewable power would be extended under the Act until 2025, whereupon the credits would switch to a technology-neutral approach that would provide credits based on the applicable emissions rate.

Section 45 PTC

Under the Act, the beginning of construction deadline would be extended to December 31, 2024 for wind facilities, solar energy, closed-loop biomass, open-loop biomass, landfill gas, trash, qualified hydropower, marine and hydrokinetic renewable energy, and geothermal energy. The existing phase down for wind facilities would apply only to facilities placed in service before January 1, 2022.

The Act would reinstate the full value of the PTC; however, the Act provides for a credit amount equal to 1/5th of the otherwise available amount if the prevailing wage and apprenticeship requirements are not satisfied. 

The amendments to the section 45 PTC apply to facilities placed in service after December 31, 2021, except for domestic content and energy credit bonus credits, and the domestic content direct pay reduction, which all apply to facilities placed in service after December 31, 2022.

ES Observation: A welcome change for many, solar facilities would now be eligible for the PTC. For regulated public utilities, the ability to claim PTCs for solar facilities also will avoid the normalization requirements applicable to the ITC.

Section 45Y clean electricity PTC

Under the Act, facilities placed in service after December 31, 2024 would be eligible for a 10-year technology neutral PTC. Taxpayers are not eligible for section 45Y if a credit was allowed under sections 45, 45J, 45Q, 45U, 48, 48A, or 48D. The credit begins to phase out over three years after the earlier of (1) the year the Secretary determines the annual GHG emissions from production of electricity is equal or less than 25% of GHG in 2022, or (2) 2032.

ES Observation: Some facilities may be able to choose between the section 45 PTC and the Section 45Y PTC, if construction began before January 1, 2025 and the project is placed in service on or after January 1, 2025

Facilities must be (1) owned by the taxpayer, (2) used for generation of electricity, (3) placed in service after December 31, 2024, and have a GHG emissions rate that is not greater than zero to be eligible for the credit. The credit amount is equal to 0.3 cents (or 1.5 cents if prevailing wage and apprenticeship requirements satisfied) per KWh of electricity produced in US or US possession by taxpayer at a qualified facility and either (a) sold to a unrelated person, or (b) if equipped with a metering device owned and operated by an unrelated person, sold, consumed or stored by taxpayer.

Section 48 ITC

The Act would generally extend the beginning construction deadline for current energy property to December 31, 2024. New energy property eligible for the property includes energy storage technology, qualified biogas property, and microgrid controllers. Certain interconnection property is also now eligible. Similar to the PTC, the existing credit percentages are reduced to 1/5th of the otherwise available amount if the prevailing wage and apprenticeship requirements are not satisfied.

The amendments to the section 48 ITC apply to facilities placed in service after December 31, 2021, except for domestic content and energy credit bonus credits, and the domestic content direct pay reduction, which all apply to facilities placed in service after December 31, 2022.

ES Observation: The continued expansion of the ITC to additional technologies, including the long-awaited addition of energy storage technology (as a stand-alone credit) acknowledges the need to continue to incentivize additional technologies as we move toward a technology neutral tax credit regime. The energy storage ITC also includes an opt-out from the normalization rules. 

Section 48D clean electricity ITC

Under the Act, facilities placed in service after December 31, 2024 would be eligible for a 10-year technology neutral ITC. Projects for which a credit was allowed under sections 45, 45J, 45Q, 45U, 48, 48A, or 48Y are not eligible. The credit phases down in the same manner as Section 45Y.

Facilities must be (1) placed in service by the taxpayer; (2) used for generation of electricity; (3) placed in service after December 31, 2024, (4) have an anticipated GHG rate not greater than zero, (4) include tangible personal property or other tangible property (not including building or structural components) used as an integral part of the qualified facility, and (5) depreciable or amortizable.

The credit amount is equal to 30% of qualified investment in qualified facility if prevailing wage and apprenticeship requirements are satisfied (otherwise 6%). The credit is subject to recapture if Secretary determines GHG emissions rate is greater than 10 grams of CO2e per KWh.

Section 45U zero-emission nuclear PTC

Nuclear facilities already in service and not receiving a credit under section 45J, are eligible for the new Section 45U credit, which provides for a credit equal to 0.3 × KWh of electricity produced by taxpayer and sold to an unrelated person less the reduction amount (equal to 80% of the gross receipts less the product of 2.5 cents and the energy produced and sold). That credit amount is multiplied by 5 if the prevailing wage and apprenticeship requirements are satisfied.  As with the section 45J credit, if a facility has more than one owner, the production is allocated pro rata to interests in gross sales.

The credit is available for electricity produced and sold for taxable years beginning after December 31, 2023 and before December 31, 2032.

ES Observation: This bill makes an unfavorable, and potentially unintended, change to the formula provided above by substituting 80% for 16% (which was in the Build Back Better Act). This potentially may be corrected in any final legislation.

Section 45V clean hydrogen PTC

The Act provides for a new 10-year clean hydrogen PTC under section 45V for facilities that begin construction before January 1, 2033 and for clean hydrogen produced after December 31, 2022. A qualified facility must produce hydrogen that results in a lifecycle greenhouse gas emission of not greater than 4 kilograms of CO2e per kilogram of hydrogen. Hydrogen must be produced in the US, in the ordinary course is a trade or business of the taxpayer, and in compliance with other requirements as determined by the Secretary.

The amount of credit is based on the kilograms of qualified clean hydrogen produced by the taxpayer; the credit amount equals $0.60 (increased by 5x if the wage and apprenticeship requirements are satisfied) if the facility produces qualified clean hydrogen that results in lifecycle greenhouse gas emission of less than 0.45 kilograms of CO2e per kilogram of hydrogen; if the CO2e level is between 0.45 kilograms and 4 kilograms, the credit is available albeit at a lower credit rate.  Taxpayers can make an election to claim the ITC in lieu of the PTC. A taxpayer cannot receive the section 45V credit if facility includes carbon capture equipment and the taxpayer receives 45Q credit.

ES Observation: This is another long-awaited tax credit incentive that, if the Act becomes law, finally will be available. Taxpayers engaged in hydrogen production will need to assess the lifecycle greenhouse gas emissions of such production to determine the credit amount for any hydrogen produced and sold.

Carbon capture

The Act provides support for carbon capture and sequestration by increasing the credit amounts and reducing minimum threshold requirements.

Section 45Q CCUS credit

Section 45Q would be extended to facilities the construction of which begins before 2033. Notably, the Act reduces minimum capture thresholds, and increases the tax credit rate. The credit amount increases to $85 for disposal, $60 for injection or utilization, and $180 for direct air capture, subject to a 1/5th reduction if the prevailing wages and apprenticeship requirements are not satisfied. 

The amended provisions generally apply to facilities or equipment placed in service after December 31, 2022.

ES Observation: These are positive changes for the industry, allowing smaller and capital intensive carbon capture projects to be constructed.   Congress should continue to expand this credit to allow for additional facilities that similarly are used to capture and store CO2 to benefit from this credit. 

Fuels

Importantly, the Act would revive expired alternative fuel credits, and provide credits for sustainable aviation fuel and clean fuel.

Existing fuels tax credits

The Act extends existing biodiesel, renewable diesel, alternative fuels and second generation biofuels tax credits extended to end of 2024 (with expired credits retroactively extended to January 1, 2022). Hydrogen is no longer eligible for the alternative fuels tax credits for fuel sold or used after December 31, 2022 (as it would be entitled to a separate credit, as discussed above).

Section 40B sustainable aviation fuel credit (section 40B, 6426(k) and section 6427)

The Act provides for a new credit available with respect to sustainable aviation fuel (SAF) mixtures sold or used after December 31, 2022 through December 31, 2024. A qualified mixture must be a mixture of SAF (as defined in the Act) and kerosene, produced by the taxpayer in the US, used  by the taxpayer or sold for use in an aircraft in the ordinary course of business, and the fueling must occur in the US.

The amount of the credit is equal to the number of gallons of SAF in the qualified mixture multiplied by the sum of $1.25 plus a supplementary amount for each percentage point over 50% reduction of lifecycle greenhouse gas emissions, capped at a total credit amount of $1.75. Certain substantiation requirements also apply.

Section 45Z clean fuel production credit

The credit applies to transportation fuel produced after December 31, 2024, and is only applicable to transportation fuel sold before December 31, 2027. Transportation fuel must be produced by the taxpayer at a qualified facility and used by an unrelated person in the production of a fuel mixture, in a trade or business, or for sale at retail.

The amount of the credit is equal to the product of (1) $1.00 (or $1.75 for SAF) per gallon or (gasoline gallon equivalent) of transportation fuel and (2) the emissions factor for such fuel. The credit is reduced by 1/5 if prevailing wage and apprenticeship requirements are not met.

ES Observation: Taxpayers should analyze 2022 fuel activities to see if they are eligible for one of the reinstated and retroactive fuels credits.

Clean Vehicle Credits

Existing clean vehicle and refueling property credits

Section 30D for clean vehicles would not be allowed for taxpayers with AGI exceeding $300,000 for joint returns, $225,000 for head of household, and $150,000 for all other taxpayers. Section 25E for previously-owned clean vehicles would not be allowed for taxpayer with AGI exceeding $150,000 for joint returns, $112,500 for head of household, and $75,000 for all other taxpayers.

Section 30C(g) for alternative fuel refueling property would be extended through 2032, and reduced to 1/5 of the amount for failing to meet wage and apprenticeship requirements. The credit would be revised to limit $30,000 for any property, and $100,000 for any such item of property.

Section 45W credit for qualified commercial clean vehicles

Section 45W would be available for qualified commercial vehicles acquired after 2022 and before 2033. A qualified commercial vehicle must be made be a manufacturer and acquired for use or lease by the taxpayer, be depreciable, be either a motor vehicle or machinery, and have an electric of fuel cell motor.

The amount of the credit is generally the lesser of 15% of the vehicle’s basis (or 30% for vehicles not powered by a gasoline or diesel internal combustion engine); or the incremental cost of the vehicle (the amount the purchase price of the commercial clean vehicle exceeds that of a vehicle comparable in size and use powered solely by a gasoline or diesel internal combustion engine). The credit is capped at $7,500 for vehicles with a gross vehicle weight rating of less than 14,000 pounds, and $40,000 for all other vehicles.

ES Observation: The above clean vehicle credits must generally be used in the US, and a vehicle can only receive either the 30D or 45W credit.

Superfund

Section 4611 hazardous substance superfund financing rate reset

The Superfund financing rate is increased from 9.7 cents to 16.4 cents (the rate has effectively been $0 since 1996). This new rate is effective January 1, 2023.

ES Observation: The Superfund tax is back as of July 1, 2021. To learn more about the effects of the tax, read our alert.

Manufacturing credits

Section 48C advanced energy project credit extension

Section 48C would be extended to provide an additional $10B in credits allocable to qualified investments with maximum $6B allocated to investments not in energy communities, effective January 1, 2023. The base credit of 6% is increased to 30% if the wage and apprenticeship requirements are met. Taxpayers are not eligible for section 48C if they received prior credits under sections 48B, 48D, 45Q or 45V. Existing and modified industrial or manufacturing facilities may be eligible for the credit.

Section 45X advanced manufacturing PTC

New Section 45X would provide a credit for each eligible component produced in the US or a possession and sold by taxpayer to unrelated person in the taxpayer’s trade or business. Eligible components include specified solar, wind, inverter, and battery components and critical materials, with the exact amount of credit dependent upon the component. The credit applies to components produced and sold after December 31, 2022.

ES Observation: With many of the energy tax credits in the Act requiring the use of domestic content for bonus credit amounts and for full amounts upon a direct pay election, the credit for additional manufacturing of components in the US is welcome.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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