The CEAA Proposes Alternative Structuring of Energy Tax Credits

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Far-reaching proposal would replace existing energy and fuel tax credits with technology-neutral incentives.

TAKEAWAYS

  • Legislation would increase available incentives and expand availability to all types of power generation facilities with zero or net-negative carbon emissions.
  • Tax credits would expire when emission goals are achieved as opposed to specific end dates.
  • Contains significant incentives for clean transportation and energy efficiency.

On April 21, 2021, Senator Ron Wyden (D-OR) introduced the Clean Energy for America Act (CEAA), a bill that would create emissions-based incentives to spur growth in clean power, clean transportation and energy efficiency. The tax framework would be technology-neutral and is intended to allow power producers to qualify for either a production tax credit or an investment tax credit for facilities with zero or net-negative carbon emissions.

The CEAA provides a broad-based network of incentives to help fund the energy transition including incentives for clean electricity, clean transportation, and energy conversation. The legislation would require projects that receives these tax benefits comply with federal labor requirements, including payment of prevailing wages. The legislation would also end tax incentives for fossil fuels and would create a tax credit for holders of bonds used to finance facilities producing clean electricity or clean transportation fuels. To provide transition relief and time for administrative coordination, the CEAA also provides extensions of certain current expired and expiring clean energy provisions.

The CEAA would present a departure for the current tax credit regime and other recent more conventional legislative proposals, such as the Growing Renewable Energy and Efficiency Now Act (GREEN Act) reintroduced in February 2021 by Representative Mike Thompson, (D-CA), a member of the Committee on Ways and Means of the U.S. House of Representatives. Our comparison of the two proposals can be found here.

Summary of CEAA Tax Credit Provisions

Incentives for Clean Electricity:

  • Provides an emissions-based, technology-neutral tax credit for the production of clean electricity that is available to all types of facilities with zero or net negative carbon emissions.
  • Allows any eligible facility to elect either a production tax credit (up to 2.5 cents per kilowatt hour (KWh)) or an investment tax credit (of up to 30 percent of qualifying investments).
  • Encourages investments in stand-alone energy storage and high-capacity transmission lines through an investment tax credit.
  • Extends and modifies the Internal Revenue Code Section 45Q carbon sequestration tax credit, which would be tied to certain emissions goals and eliminates prospective benefit for enhanced oil recovery projects.

The CEAA creates emissions-based incentives that would be neutral as to the energy producing technologies. Taxpayers can choose between a production tax credit (PTC) or an investment tax credit (ITC). The availability of each of the credits is based on the carbon emissions of the electricity generated—measured as grams of carbon dioxide equivalents (CO2e) emitted per KWh generated. Any power facility of any technology can qualify for the credits, so long as the facility’s carbon emissions are at or below zero. The increased tax credits would be available for projects placed in service after 2022.

Taxpayers electing the PTC will receive a credit equal to 2.5 cents per kilowatt hour (KWh) of electricity produced and sold in the 10-year period after a qualifying facility is placed in service. Taxpayers electing the ITC will receive a credit worth 30 percent of the investment in the year the facility is placed in service, or 40 percent if the project is in a qualifying low-income area. Taxpayers are provided the option of receiving the credits as direct refunds, however, those wishing to avail themselves of this election must inform the Treasury Department before the facility to which the election relates starts construction. A corollary 30 percent tax credit would be available for residential homeowners with the same applicable phase out period but would not be eligible for direct payment (instead residential homeowners would receive a three-year carry-forward for any unused tax credits).

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 on alterations and repairs during the applicable 10-year PTC period or five-year ITC recapture period.

The credits are set to phase out when emission targets are achieved and would occur on an industry-wide basis when EPA and the Department of Energy (DOE) certify that the electric power sector emits 75 percent less carbon than 2021 levels. The incentives will be phased out over five years. Facilities will be able to claim a credit at 100 percent value in the first year, then 75 percent, then 50 percent, and then zero percent. The credit amounts would fall to 75 percent of the full rate for projects on which construction starts two years after the year in which annual greenhouse gas emissions for the U.S. power sector have declined by at least 75 percent from 2021 levels to 50 percent for projects starting construction the next year and to zero percent in years after.

To provide transition relief and time for administrative coordination between the Treasury Department, EPA, and DOE, the bill extends, through December 31, 2022, current expiring clean energy provisions.

Qualifying grid improvements, which can enable the deployment of additional zero emission power and improve grid stability, are also eligible for the full 30 percent ITC and are also cash refundable. Qualifying grid improvements includes transmission property (including transmission lines of 275 kilovolts (kv) or higher, along with any necessary ancillary equipment) and stand-alone energy storage property. However, energy storage property only qualifies if electricity is “sold” to third parties, which could eliminate use of tolling agreements. The emissions requirements do not apply to ITCs on standalone storage or transmission equipment.

The Section 45Q tax credit is extended until the power and industrial sectors meet emissions goals. The qualifying capture thresholds are modified to require a minimum percentage of emissions be captured; each year at least 75 percent of carbon emissions at a power plant or at least 50 percent at other industrial facilities that would otherwise be released into the atmosphere must be captured. Additionally, the credits for enhanced oil recovery would be terminated on a prospective basis, and the tax credits for direct air capture would increase to $175 a ton for secure burial and $150 a ton for permitted commercial uses. The bill would also repeal an existing election allowing owners of carbon capture equipment placed in service before February 2018 to elect the current section 45Q tax credit. The prevailing wage requirements and direct payment options apply in a similar fashion as the PTC and ITC requirements.

Also similar to the PTC and ITC, the phase out of Section 45Q tax credits would start for carbon capture at any power plant or other industrial facility on which construction commences for tax purposes two or more years after greenhouse gas emissions in the U.S. power or industrial sector drop by at least 75 percent from 2021 levels. Tax credits would drop to 75 percent of the full rate for any industrial facility on which construction starts two years after the year emissions fall to that level. It would drop to 50 percent where construction starts three years after and then to zero percent. The phase out would not be applicable to direct air capture technology.

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 CEAA modifies the existing electric vehicle tax credit by eliminating the per-manufacturer cap and making the credit refundable for individuals. Commercial operators will be eligible for a non-refundable tax credit worth 30 percent of the purchase of an electric vehicle. The credits will be available until electric vehicles represent more than 50 percent of annual vehicle sales, at which point the credits will phase out.

The proposal would also create a technology-neutral incentive for the domestic production of clean fuels. The level of the incentive depends on the lifecycle carbon emissions of a given fuel. Fuels may qualify for the credit if the fuel’s lifecycle emissions are at least 25 percent less than the current U.S. nationwide average. Zero and net-negative emission fuels qualify for the maximum incentive of $1.00 per gallon.

Fuels must be at least transportation grade, but may be used for any business purpose, including as industrial fuel, or for residential or commercial heat. To be eligible for the tax credits, taxpayers must satisfy prevailing wage requirements utilize registered apprenticeship programs. The credits are set to phase out when EPA and DOE certify that the transportation sector emits 75 percent less carbon than 2019 levels, the incentives will be phased out over five years. Facilities will be able to claim a credit at 100 percent value in the first year, then 75 percent, then 50 percent, and then zero percent.

Incentives for Energy Conservation:

  • Creates performance-based tax credits for energy efficient homes and a tax deduction for energy efficient commercial buildings.

The bill reforms the current incentive for energy efficient homes. The credit for new homes is set to $2,500 for homes meeting Energy Star requirements and $5,000 for homes meeting the Zero Energy Ready requirements. To qualify for the incentive, contractors must comply with prevailing wage requirements and utilize registered apprenticeship programs. The bill also provides homeowners with a tax credit equal to the lesser of 30 percent of the cost or $500 per eligible improvement, with an overall annual limit of $1,500 for all home improvements.

The bill amended the Section179D benefit by adjusting the deduction limitation to operate on a sliding scale, with taxpayers qualifying for an incentive so long as they make at least a 25 percent improvement over the required baseline, with the deduction limitation increasing for larger efficiency gains. The maximum value of the deduction ranges from $2.50 per square foot up to $5.00 per square foot for efficiency upgrades that result in efficiency gains of 25 to 50 percent over the required baseline. To qualify for the incentive, taxpayers must comply with prevailing wage requirements and utilize registered apprenticeship programs.

The CEAA also increases the credit for geothermal heat pump systems in commercial buildings to 30 percent and makes it permanent. Homeowners installing heat pumps are provided an increased credit or $800 for air-source heat pumps or $10,000 for ground-source heat pumps.

Potentially Concerns with CEAA Proposal

While the CEAA provides for a very broad extension and expansion of available tax credits and other benefits, certain aspects of the proposal seem likely to raise concerns and may potentially require further refinement.

  • Labor/Prevailing Wage Requirements

The CEAA prevailing wage requirement could impact the development and financing of projects in various ways. First, mandating prevailing wage would increase developments costs, which may cause certain projects under development to no longer be financially viable. Additionally, recapture risk for failure to meet prevailing wage requirements would likely be a significant 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. One particular concern would appear to be wage reclassification disputes that might have the effect of retroactively changing the prevailing wage determination. If the prevailing wage requirement is maintained in the CEAA, it may require some softening or clarification to alleviate these concerns, such as safe harbor provision for initial compliance, that eliminate the risk of any retroactive recapture.

  • Sunset Dates/Tax Credit Arbitrage

The increased ITC and PTC would be available for projects placed in service after 2022, while projects with earlier completion dates would receive the existing lower tax credits. This arbitrage is likely to make some developers consider delaying certain projects; however, it is unclear whether the new tax credits can be claimed on projects on which construction started for tax purposes before 2023. The bill has provisions that bar claiming both the new tax credits and tax credits under existing law. Further clarity on the transition from the existing tax credit regime would seem to be required. It would also make sense to consider increasing current tax incentives during the transition period to match the new tax credit amounts in order avoid this sort of arbitrage and misalignment of incentives that may cause developers to delay the start of construction on projects, which is contrary to the stated legislative goals.

  • Obligation for Early Election of Direct Payment

As discussed above, for certain incentives taxpayers are provided the option of receiving credits as direct refunds; however, those wishing to avail themselves of this election must inform the Treasury Department before the facility starts construction. Once the election is made, the election is irrevocable. This is a departure from the prior direct payment option available pursuant to the Section 1603 Grant Program, which did not require any early election. It is not immediately clear why such an early election would be necessary. Since developers may not have tax credit financing in place at the time of construction commencement, it is easy to imagine many projects making the direct payment election on a protective basis at the time construction commences, in order to ensure direct payment is available for a project. Since the direct payment option under the CEAA does not apply any haircut or reduction to the available tax benefits if direct payment is chosen, there would appear to be little downside to making such election even if direct payment is not necessary to finance the project.

  • Emission Standard/Credit Expiration

There is no fixed end date for any of the tax credits included in the CEAA. For example, the credit amounts for energy production decrease to 75 percent of the full amount for projects commence construction two years after the year in which annual greenhouse gas emissions for the applicable sector have declined by at least 75 percent from 2021 levels to 50 percent for projects commencing construction the next year and to 0 percent. While tying the available benefits to the achievement of greenhouse gas emissions goals makes sense, if budget reconciliation process is required to move the legislation through the Senate, the open-end termination date could present a problem. Budget rules limit provisions that would add to the federal deficit after the applicable 10-year budget period.

Final Analysis

The CEAA 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. There are some obvious complications that arise making such significant changes to existing law, particularly during the transition period. The ultimate policy issue, however, is whether adopting the changes proposed by the CEAA in a single action is preferable toa more incremental approach that would be less disruptive; something we consider in the companion article comparing the approach of the CEAA to the more conventional proposal in the GREEN Act available here.

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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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