The tax framework of the energy tax provisions is structured as a hybrid approach to the previous House of Representatives proposal, and the approach advocated by the Senate. The IRA would initially extend existing tax credits (and create certain new credits) before transitioning to a technology-neutral approach that is intended to allow power producers to qualify for either a production tax credit or an investment tax credit for any facility with zero or net-negative carbon emissions. (For a detailed comparison of the previous legislative proposals, please see Pillsbury’s prior analysis here.)

The IRA provides a broad-based network of incentives to help fund the energy transition, including incentives for clean electricity, clean transportation and advanced manufacturing. Like prior proposals, the legislation would require projects that receive these tax benefits to comply with federal labor requirements, including payment of prevailing wages.

The IRA provides for far more limited direct payment provisions than prior proposals. Except in the case of three specific tax credits for clean hydrogen, carbon capture and advanced manufacturing, direct payment in limited only to certain tax-exempt entities that would be ineligible to claim tax credits. The IRA, however, would significantly depart from the current tax credit regime and other recent legislative proposals by allowing taxpayers to sell their tax credits to unrelated third parties for cash payments.

Summary of IRA Tax Credit Provisions

Incentives for Clean Electricity:

• Extends and expands existing tax credits through 2024 and adds various new tax credit benefits for clean hydrogen, nuclear and stand-alone energy storage.
• Post 2024, it converts energy tax credits into emissions-based, technology-neutral tax credits available to all types of facilities with zero or net-negative carbon emissions, which allows any eligible facility to elect either a production tax credit or an investment tax credit.
• Extends and modifies the Internal Revenue Code (IRC) Section 45Q carbon sequestration tax credit.
• Contains new provisions allowing for certain direct sales of tax credits to unrelated taxpayers.

ITC and PTC
The IRA would first extend and expand existing energy tax credits, such as the production tax credit under IRC Section 45 (PTC) and the investment tax credit under IRC Section 48 (ITC) through 2024 and would restore the tax credit amounts to the previous levels before currently implemented phase downs. Property eligible for the ITC would generally qualify for a tax credit equal to the full 30% of eligible tax basis starting in 2022, while wind and geothermal would be eligible for the full inflation-adjusted PTC equal to the full inflation-adjusted $26 a MWh for 2022, and in each case is subject to the wage and hour requirements discussed further below. The ITC would also be expanded to include stand-alone energy storage (previously only eligible if charged with solar energy), qualified biogas property and microgrid controllers. Additionally, owners of solar project would gain the option of claiming PTCs instead of ITCs on projects placed in service in 2022 or later. A corollary 30% tax credit would be available for residential homeowners through 2034 and, like the ITC, would include eligibility for stand-alone energy storage for the first time.

The proposal would also provide bonus amounts of ITC or PTC for meeting additional requirements. Eligible facilities can qualify for an additional 10% ITC (or a 10% increase in PTC amount) by using a required percentage of steel, iron and manufactured products that are produced in the United States. Facilities can also qualify for as much as another 10% ITC (or another 10% increase in PTC amount) if located in any “area” that at any time after 1999 had “significant employment related to the extraction, processing, transport, or storage of coal, oil, or natural gas” or in census tracts (or adjoining tracts) where a coal mine closed after 1999 or a coal-fired generating “unit” was retired after 2009. Additionally, based on an application process and applicable cap, a bonus ITC of up to 20% is available for small wind and solar projects placed in service in certain low-income communities. The bonus credits can be stacked, so a project that meets several of the additional requirements could qualify for upwards of a 50% ITC or more.

To receive the full tax credit amount, taxpayers must meet prevailing wage rates requirements and utilize registered apprenticeship programs in order to be eligible for tax credits on facilities that are 1 MW or greater. The prevailing wage requirement would also apply to alterations and repairs made during the applicable 10-year PTC period or five-year ITC recapture period. If a facility does not meet the wage and hour and apprenticeship requirements, it is only eligible for a credit equal to the “base rate” of 20% of the full credit amount. The additional wage and hour requirements are structured as a bonus credit amount by reducing the base rate of the tax credit to 20% of their previous amount (e.g., from a 30% to a 6% ITC) and allowing an additional 80% as a “bonus” for meeting the wage and hour requirements. It is structured as a bonus amount to avoid potential issues related to the Senate’s complex reconciliation rules, but it is ultimately intended to be a significant penalty for failing to meet the new labor requirements.

Starting in 2025, the IRA would convert the existing PTC and ITC into technology-neutral incentives. Any power facility using any technology can qualify for the credits and choose between an ITC or PTC, as long as the facility’s carbon emissions are at or below zero. The technology-neutral credits would remain at the full 30% ITC and inflation-adjusted PTC rate until 2032 or when annual greenhouse gas emissions from U.S. electricity generation falls by at least 75% from 2022 levels, at which point the tax credits would phase down over several years. Projects starting construction two years after the phase down starts would qualify for tax credits at 75% of the full rate. Projects starting construction three years after would qualify for tax credits at 50% of the full rate.

Tax Credits for CCS/Clean Hydrogen/Nuclear
The IRA would also extend eligibility for the carbon capture tax credit under IRC Section 45Q for an additional seven years to 2033 and would substantially lower the minimum capture thresholds required for carbon capture projects placed in service after December 31, 2022. Electricity generating facilities would only qualify if the carbon capture equipment is designed to capture at least 75% of the facility’s carbon output. Carbon capture projects are also subject to the wage and hour requirements to receive the full available tax credit.

In addition to the previously existing tax credits, the IRA would also provide certain new production tax credits for clean hydrogen facilities and certain existing nuclear facilities. Both the clean hydrogen and nuclear proposals are generally consistent with the previous proposals related to BBB. The hydrogen PTC would provide a tax credit of up to $3/kg based on the life cycle greenhouse gas emissions rate of CO2 for the first 10 years of operation for qualifying facilities that commence construction before 2033, which can be converted into ITC, as well. A taxpayer may retrofit an existing facility to produce qualified clean hydrogen. Importantly, clean hydrogen projects that source power from renewable energy generation may claim tax credits on the renewable projects even if the same owner directly uses the power to produce clean hydrogen, however, clean hydrogen credits cannot be claimed in conjunction with carbon capture credits under IRC Section 45Q. The nuclear production tax credit is intended to primarily benefit struggling facilities, with a base rate equal to the PTC but with a proportional reduction for revenue over certain thresholds in excess of 2.5 cents per kWh (credit completely zeroes out at 4.375 cents per kWh). The nuclear PTC would be available beginning in 2024 to facilities that are already in service at the time. Both of these new tax credits would also be subject to the wage and hour requirements.

Direct Pay/Tax Credit Transfers/Carryforward
In a departure for prior BBB proposals, the IRA provides for a far more limited direct payment provision (i.e., a taxpayer option of receiving the credits as direct cash refunds). Except in the case of three specific tax credits for hydrogen, carbon capture and advanced manufacturing, direct payment is limited only to certain tax-exempt entities that would otherwise be ineligible to claim tax credits.

Starting in 2023, as an alternative to direct payment, the IRA would, for the first time, allow taxpayers to directly sell some or all of their tax credits to unrelated third parties without having to resort to complicated tax equity structures. The payment must be made in cash, would be excluded from the seller’s taxable income, and cannot be deducted by the buyer. The transferred tax credit is then taken into account by the buyer in its first taxable year that ends within or after the taxable year of the seller. The buyer must reduce its basis in property with respect to transferred ITCs. The statute is silent on the treatment of recapture of ITCs, but presumably there would be no recapture, since the concept was based on retaining ownership to qualify for the credit, which should no longer be relevant in this context. In our analysis section below, we delve a bit deeper into what this significant shift might mean going forward.

The bill also allows most energy-related tax credits to be carried back three years and to carry any remaining tax credits forward for up to 22 years (rather than the current one-year carryback and 20-year carryforward). Tax credits that are carried backward or forward by a taxpayer cannot be subsequently sold.

Incentives for Clean Transportation:

• Expands tax incentives for battery and fuel-cell electric vehicles and electric vehicle charging.
• Provides a technology-neutral tax credit for production of clean fuels.

The IRA modifies the existing $7,500 electric vehicle tax credit by eliminating the per-manufacturer cap, increasing the minimum battery size to 7 kWh and extending the credit through December 31, 2032. The IRA would also add new domestic content requirements. The $7,500 credit amount would be available in two $3,750 tranches. The first requires that a percentage of the critical minerals in the battery are extracted or processed in a country with a United States free trade agreement. The second requires a certain percentage of the battery to be manufactured or assembled in North America. The proposal would also allow dealerships to claim the credit on behalf of the customer and pass it through as a discount. The legislation introduces new upper income limits, excludes more affluent purchasers and introduces vehicle price caps based on vehicle type. Also, for the first time, certain used vehicles may also qualify for a tax credit of up to $4,000. Commercial operators will be eligible for a non-refundable tax credit worth 30% of the purchase of an electric vehicle (capped at $7,500 for vehicles less than 14,000 pounds and $40,000 for larger vehicles) through December 31, 2032.

The IRA would also significantly expand and extend the alternative refueling property tax credit. For the first time, this tax credit would be provided a longer eligibility period as opposed to a series of often unpredictable one-year extensions. The available cap would also increase up to $100,000 per charger, and the legislation would clarify that bidirectional chargers qualify for the credit. One significant new limitation, however, is that credit would only be available for charging equipment in low-income communities and non-urban area. This credit would also become subject to the new wage and hour requirements.

The proposal would extend a variety of fuels incentives through December 31, 2024, and create a technology-neutral incentive for the domestic production of clean fuels commencing in 2025. The level of the incentive depends on the life cycle carbon emissions of a given fuel. Zero and net-negative emission fuels qualify for the maximum incentive of $1.00 per gallon. To be eligible for the tax credits, taxpayers must satisfy prevailing wage requirements and utilize registered apprenticeship programs.

Incentives for Advanced Manufacturing:

• Creates new tax credits for manufacturing clean energy components.

The IRA includes most of the operative provisions of the proposed Solar Energy Manufacturing for America Act—in particular, tax credits for the domestic production of solar cells, modules and components thereof. The IRA would create a new advanced manufacturing production credit, intended to spur U.S. manufacturing of certain clean energy components. The amount of the credit would vary significantly depending on the component or material being produced; for example, certain components would be eligible for credit based on the component’s weight or capacity, while certain others would have their credit based on the manufacturer’s cost of production. The credit, which would be available for components produced and sold after 2022, would be reduced beginning in 2030 and eliminated for components sold after 2032.

The proposal also contains an additional $500 million appropriation to fund the Defense Procurement Act. However, the IRA does not specify how the administration must appropriate these funds.

Analysis of Certain Key Items in IRA Proposal

The Ability to Sell Tax Credits
Historically, with few exceptions, to claim energy tax credits, taxpayers have been required to at least be an owner of the facility, if not both an owner and operator. Ultimately, the entire construct of tax equity is based on the need for a tax investor to hold an ownership interest in the facility. So, the ability for project owners to sell tax credits to unrelated third parties for a cash payment is a significant departure from the current tax credit regime and opens some new and interesting possibilities for developers to monetize tax credits. The scarcity of tax equity is an ongoing issue for many developers, so the ability to sell credits in a frictionless fashion could help expand the pool of available counterparties and limit the need to deploy more complex tax equity structures.

Before you take your tax equity provider off speed dial, however, there are some drawbacks that should be considered. It is best to see this provision as essentially a privately functioning direct payment option, with similar benefits and drawbacks to direct payment. Like in a direct payment situation, if tax credits are sold to a third party, developers need to consider the applicable drawback (e.g., no depreciation monetization by tax equity, no step up to fair market value on the ITC, potential need for bridge loan financing until tax credit proceeds are received, etc.). One obvious difference from direct payment is that no private party is going to pay one hundred cents on the dollar for tax credits, so there will be an applicable discount rate determined by the market that will reduce the net proceeds to the developer.

It is also important to note that tax credits that are sold to third parties will be subject to Treasury review in the same fashion as direct payments and could potentially be subject to haircuts. Like with direct payment, any haircut amount deemed to be an excess payment would also be subject to a 20% penalty on the excess amount. Particularly in the context of the ITC, it will be interesting to see the scope of information that Treasury ultimately requires along with the sale election form and how actively Treasury reviews these transactions.

Labor/Prevailing Wage Requirements
The prevailing wage requirement could impact the development and financing of projects in various ways. First, mandating prevailing wage would increase developments costs, which may hurt the financial viability of certain projects. Additionally, recapture risk for failure to meet prevailing wage requirements would likely be a concern for tax equity investors, especially considering the ongoing nature of the requirement/recapture risk that extends well into the operating period of the facility. That said, the prevailing wage requirements have been softened through various iterations since they were initially proposed under the BBB to allow for retroactive corrections for inadvertent breaches, which helps alleviate the risk of recapture.

PTC/ITC Sunset Dates Arbitrage
The initial extension of the ITC and PTC through 2024 uses the current approach retained in the House legislation of setting a deadline for when projects must commence construction to qualify for tax credits. The post-2024 provisions modeled after the Senate legislation are based on the project being placed into service. The IRS currently requires completion within four to six years after construction commencement. Accordingly, without a technical correction, any projects that cannot meet its completion deadline would have to wait until 2025 or later, when the technology-neutral credits allow a full tax credit based solely on the project’s placed-in-service date.

What about Transmission Property?
One major item that was previously included in the BBB proposals but left on the cutting room floor by the IRA is an ITC for transmission property.

Final Analysis
The IRA would provide a holistic update to the existing energy tax credit framework that was designed decades ago. A revamp and redesign of these incentives to fit the needs of the forthcoming energy transition is well overdue. In fact, considering that just recently the climate provisions were considered dead in the water, it was encouraging that the bulk of the energy tax items for the highly ambitious BBB proposals mostly make it into the IRA compromise legislation without many significant adjustments, including a retention of the full 10-year extension of the PTC and ITC.

With the largest legislative climate investment in U.S. history hanging in the balance, all eyes now will now turn to the remaining steps in the legislative process. While it seems unfathomable that after this arduous drawn-out process over the BBB that Democrats would somehow fail to pass some version of the IRA, it is not quite a done deal yet. The IRA will require unanimous support of all 50 Senate Democrats to pass under strict budget reconciliation rules and can only afford limited defections in the House in the face of nearly unanimous Republican opposition. Particular focus is likely to be on Senator Kristen Sinema (D-AZ), especially considering her prior stance against closing the carried interest loophole included in the current IRA, and to a lesser extent certain members of the House that have previously threatened to hold out over their request to eliminate the state tax deduction cap. While obstacles may exist, one would have to assume that, particularly with midterm elections looming, eventually Democrats will unite on this proposal. Until that happens, we’ll continue to monitor the process and provide updates on this potentially historic legislation.