On Aug. 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022 (IRA), which includes various amendments and additions to the Internal Revenue Code of 1986 (the Code). This is the second of two alerts from our Tax Group (the first can be found here). This alert describes several new and revised tax incentives for clean energy projects.
Among other changes, the IRA made material changes to the Production Tax Credit (PTC) and the Investment Tax Credit (ITC).
Production Tax Credit
The PTC is a 2.6 cents per kWh credit (to be adjusted for inflation) available for electricity produced at qualified facilities, including wind, biomass, geothermal, landfill gas, and hydropower. The IRA also reinstates the PTC for solar facilities that have been able to use only the ITCs since 2006.
Under the IRA, the PTC will be broken into a base credit (20 percent of the credit amount) and an increased credit (80 percent of the credit amount), with the increased credit being available for projects that satisfy prevailing wage and apprenticeship requirements. Therefore, to qualify for the full 2.6 cents per kWh credit, taxpayers will be required to satisfy the yet-to-be-published prevailing wage and apprenticeship guidelines. Note, however, that the wage and apprenticeship requirements will not apply to projects if construction begins prior to the date that is 60 days after the IRS publishes guidance establishing the new guidelines.
The new PTC regime will apply to any projects for which construction begins before January 1, 2024.
Investment Tax Credit
The ITC is a credit equal to 30 percent of the qualified costs of eligible projects. The IRA expands the technologies that can benefit from the ITC to include, among others, standalone energy storage, and biogas projects. To be eligible for the enhanced ITC, a taxpayer must place the qualified project in service after December 31, 2022. Taxpayers with projects that are eligible for both the ITC and PTC may still elect to claim the ITC in lieu of the PTC.
Like the PTC, the ITC now will have a base credit (6 percent) and increased credit (24 percent) component. Projects for which construction begins after the date that is 60 days after published guidance on the wage and apprenticeship guidelines will be eligible for the full 30 percent credit only if the guidelines are met.
The new ITC regime will apply to any projects for which construction begins before January 1, 2024.
PTC and ITC—Additional Bonus Credits
Both the ITC and PTC can be increased by an additional 10 percent (i.e., up to 40 percent in the case of the ITC) if projects meet “domestic content” requirements. The domestic content requirements will be satisfied if (i) 100 percent of the steel or iron used in a qualifying project is produced in the United States, and (ii) 40 percent of the manufactured products that are used in constructing the project are produced in the United States. The 40 percent test will be satisfied if at least 40 percent of the total costs of all components are attributable to products that are produced or manufactured in the United States.
A taxpayer also can earn an additional 10 percent PTC or ITC (i.e., up to 40 percent in the case of the ITC) if a project is located in an “energy community,” which includes: (i) a brownfield site, (ii) areas with substantial coal, oil, or natural gas production, which have an unemployment rate above the national average, or (iii) census tracts which encompass closed coal mines or closed coal-fired electric generating units.
Reduction of Certain Tax Credits where Tax-Exempt Financing is Used
In the case of the PTC, ITC, and the credits described in Code Sections 45Q, 45V, and 48E, all as described below, the available credit is reduced, up to a maximum of 15 percent, by the amount of tax-exempt financing used to finance the credit generating facility.
Direct Pay and Credit Transfer
For the first time, the IRA will allow PTC and ITC recipients (along with recipients of several of the newly enacted credits described below) to monetize credits through a “direct pay” option or by selling all or a portion of the credits.
The direct pay option allows many entities that are not subject to federal income tax to make an election (by the due date of their tax return for the year in which the election is made, or by a to-be-determined date in the case of entities not required to file a return) to receive a cash payment equal to the amount of otherwise allowable credits. The direct pay option also is available to taxpayers (other than entities that are not subject to tax) claiming the production of clean hydrogen and carbon oxide sequestration credit or the advanced manufacturing production credit (but for the first five years of the credit period only).
Note that, although tax-exempt entities will be able to monetize credits in a way that was not previously available, there remains no mechanism for tax-exempt entities to take advantage of accelerated depreciation.
The transferability provisions allow taxpayers that have earned the credits to sell the credits—for cash—to another unrelated taxpayer by making an irrevocable election by the due date of the return for the year in which the credit is claimed. The buyer of a credit may not deduct the cost paid for the credit and the payment will not be included in the income of the taxpayer that sells the credit. In addition, the buyer of the credit may not sell any part of the purchased credit. Taxpayers that sell credits in excess of what they properly could claim directly are subject to penalties.
Both the monetization and transferability options are subject to basis reduction and recapture rules. In addition, under both options, the election with respect to credits earned by entities that are treated as partnerships or S corporations for federal income tax purposes must be made at the entity level.
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In addition to materially changing the rules applicable to the PTC and ITC, the IRA added several new tax credit provisions and extended others, many of which are governed by rules similar to those that apply to the PTC and ITC, as amended.
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