The Inflation Reduction Act of 2022 (the IRA) amended the rules relating to the production tax credit (the PTC) and the investment tax credit (the ITC) to provide increased credit amounts or rates if a project is located within certain census tracts designated as "Energy Communities" (the "Energy Communities Bonus Credit").1
The Energy Communities Bonus Credit generally provides that for qualifying PTC projects, the amount of the credit may be increased by 10% (e.g., a project qualifying for PTCs of $27.50 per MWh would qualify an additional $2.75 per MWh) and, for a qualifying ITC project that satisfies the prevailing wage and apprenticeship requirements, the ITC rate may be increased by 10 percentage points (e.g., for 30% to 40%).2
Notice 2023-29 (the "Notice"), released April 4, 2023, describes certain rules that the Treasury and the IRS intend to include in forthcoming proposed regulations for:
- Determining what constitutes an Energy Community, and
- Determining whether a PTC or ITC project is located in an Energy Community.
This Client Publication describes the guidance under the Notice and discusses certain issues with respect to qualifying for the Energy Communities Bonus Credit.
Determining What Constitutes an Energy Community
The term "Energy Community" refers to any of three location-based categories: (i) the Brownfield Category, (ii) the Statistical Area Category and (iii) the Coal Closure Category.
Brownfield Category. The Brownfield Category includes a "brownfield site" which is generally defined as real property, the expansion, redevelopment or reuse of which may be complicated by the presence of potential presence of a hazardous substance, pollutant or containment and certain mine-scarred land.3 The Notice provides a safe harbor (the "Brownfield Site Safe Harbor") for sites that either (i) already qualify as a "brownfield site" under the general standard, (ii) have completed an ASTM E1903 Phase II Environmental Site Assessment (a "Phase II Assessment"), or (iii) for smaller projects, have completed an ASTM E1537 Phase I Environmental Site Assessment (a "Phase II Assessment").4
Statistical Area Category. The Statistical Area Category includes a metropolitan statistical area (MSA) or non-metropolitan statistical area ("non-MSA") that (i) has 0.17% or greater direct employment (the "Fossil Fuel Employment Requirement") or 25% or greater local tax revenues related to the extraction, processing, transport or storage of coal, oil or natural gas (the "Fossil Fuel Tax Revenue Requirement"), and (ii) has an unemployment rate at or above the national average unemployment rate for the previous year (the "Unemployment Rate Requirement"). Treasury and the IRS intend to issue, annually each May, listings that identify the MSAs and non-MSAs that qualify in the Statistical Area Category based on the Unemployment Rate Requirement.
Coal Closure Category. The Coal Closure Category includes a census tract (or a census tract directly adjoining such census tract) (i) in which a coal mine has closed after December 31, 1999 (a "Closed Coal Mine"), or (ii) in which a coal-fired electric generating unit has been retired after December 31, 2009 (a "Retired Coal-Fired Electric Generating Unit").
Additional Resources Relevant to Identifying Energy Communities. In addition to the Notice, the IRS released (i) Appendix A identifying counties that constitute an MSA or non-MSA, (ii) Appendix B identifying MSAs and non-MSAs that meet the Fossil Fuel Employment Requirement, and (iii) Appendix C identifying census tracts and directly adjoining tracts that have ever had a Closed Coal Mine or a Retired Coal-Fired Electric Generating Unit. Additionally, the Department of Energy released a mapping tool that reflects currently available data relevant to identifying Energy Communities in either the Statistical Area Category or the Coal Closure Category.
Determining Whether a PTC or ITC Project is Located in an Energy Community
Timing; in general. For purposes of the PTC, whether a qualified facility is located in an Energy Community is determined separately for each taxable year of the qualified facility's 10-year credit period. Furthermore, a qualified facility will be treated as located in an Energy Community during a taxable year if the qualified facility is located in an Energy Community during any part of the taxable year. For purposes of the ITC, whether a project is placed in service within an Energy Community is determined as of the placed-in-service date (i.e., the date the ITC is determined).
Timing; Beginning of Construction safe harbor. For purposes of either the PTC or the ITC, if a project begins construction within the applicable IRS rules in a location that is an Energy Community as of the beginning of construction date, then, with respect to that project, the location will continue to be considered an Energy Community for the duration of the PTC credit period or the placed-in-service date for an ITC project (the "Beginning of Construction Safe Harbor").5
Location. A PTC or ITC project is treated as "located in" or "placed in service within" an Energy Community if the project satisfies either the Nameplate Capacity Test (if the project has a nameplate capacity) or the Footprint Test (if the project has no nameplate capacity).
The "Nameplate Capacity Test" is satisfied if 50% or more of the project's nameplate capacity is in an area that qualifies as an Energy Community, determined by dividing the nameplate capacity of the project's energy-generating units that are located in an Energy Community by the total nameplate capacity of all the energy-generating units of the project.6 The "Footprint Test" is satisfied if 50% or more of the project's square footage is in an area that qualifies as an Energy Community, determined by dividing the square footage of the project that is located in an Energy Community by the total square footage of the project.
The Notice helps to clarify certain key questions and open issues surrounding the Energy Communities Bonus Credit. The further clarification on applicable qualification requirements, and the Department of Energy's mapping tool, should help parties more easily determine whether a particular project is eligible for a bonus credit amount.
One primary clarification provided by the Notice is that the determination for qualification of ITC projects is generally based on the year the project is placed in service. Prior to the Notice, there was uncertainty as to what the statute's use of "the previous year" refers to for purposes of satisfying the Unemployment Rate Requirement for the Statistical Area Category.
Projects will not always be completed and placed in service in the year in which construction commences. Thus, there is the risk that projects that would qualify under the Statistical Area Category in an applicable year but are not placed in service until a subsequent year, may ultimately not be eligible if the applicable "prior year" employment statistics do not meet the Unemployment Rate Requirement, which will not be known until employment statistics are released in May of the year of placement in service. Additionally, for PTCs, since the qualification determination is generally made annually, projects located in a Statistical Area Category that rely on the Unemployment Rate Requirement to qualify would be at risk of losing the bonus credit yearly based on shifting employment rates in the applicable MSA or non-MSA.
These general rules create uncertainty regarding qualification for financing purposes with respect to certain projects, in particular projects located in (or intended to be located in) a Statistical Area Category. The impact of this uncertainty may be potentially significant because the vast majority of the areas that qualify for the Energy Communities Bonus Credit are located in Energy Communities that are expected to qualify based on the Statistical Area Category which, as described above, is subject to yearly determination.
To alleviate this potential qualification uncertainty, the Notice provides the Beginning of Construction Safe Harbor that allows a project that "begins construction" (as defined under the applicable IRS rules) in a location that qualifies as an Energy Community (under either category) as of the beginning of construction date to be deemed to comply with the Energy Community requirements when the project is placed in service and throughout the entire credit period. While some may bemoan the returned prominence of the guidance underlying the Beginning of Construction Safe Harbor that was otherwise becoming less important after the tax credits step downs were eliminated as part of the IRA, the application of the Beginning of Construction Safe Harbor in the Energy Communities Bonus Credit context should be helpful and allow developers and financing parties some certainty around the available tax credit amount. The Beginning of Construction Safe Harbor does, however, still leave some ambiguity as to the applicability to projects that were already under construction at the time of the Notice.
Overall, the Notice brings some needed clarity to the Energy Communities Bonus Credit and should allow developers and financing parties to more comfortably take the Energy Communities Bonus Credit into account in their transactions. On the margins, however, the placed in service/yearly determination timing, coupled with the application of the trailing employment rate data applicable to the vast majority of the eligible Energy Community areas, will create additional complexity.
For ITC projects that expect to qualify for an Energy Communities Bonus Credit under the Statistical Area Category, but do not rely on the Beginning of Construction Safe Harbor, and are placed in service early in an applicable year (e.g., prior to May), the wait for the release of the previous year's unemployment data in May will potentially create some financing complexity. Parties will need to build in contingencies into various transaction documents to deal with situations where an expected Energy Communities Bonus Credit is not received, or potentially where a project unexpectedly becomes eligible for an additional credit after the fact. For PTCs projects that do not comply with the Beginning of Construction Safe Harbor, if the Energy Communities Bonus Credit must be included as part contingent "pay-go" obligations, it would limit the amount of other PTCs that could otherwise be included in the pay-go category while still complying with the applicable IRS safe harbor regarding a cap on contingent payments.
As with many other aspects of the IRA, the Energy Communities Bonus Credit provides additional value to qualifying projects but also bring some additional complexity and variability that will need to be taken into account. With such a large swath of the United States potentially qualifying for the Energy Communities Bonus Credit, it will be interesting to see how market practices develop in incorporating the credit value into various transaction structures.
1. More specifically, the IRA (i) amended sections 45 (PTC) and 48 (ITC) to provide increased credit amounts or rates if certain requirements pertaining to Energy Communities are satisfied, and (ii) added new sections 45Y (PTC) and 48E (ITC) that provide increased credit amounts or rates for certain qualified facilities, energy projects or energy storage technologies that satisfy similar requirements and that are placed in service after December, 31, 2024.
2. See Notice 2022-61 for guidance with respect to the prevailing wage and apprenticeship requirements.
3. See section 3.02 of Notice 2023-29, defining "brownfield site" by cross-reference to the definition of such term for purposes of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) (42 U.S.C. § 9601(39)(A)). A brownfield site does not include the categories of property described in 42 U.S.C. § 9601(39)(B) (providing exclusions from the term "brownfield site").
4. More specifically, the Brownfield Site Safe Harbor provides that the site must not be described in 42 U.S.C. § 9601(39)(B) and must meet one of the following conditions: (1) the site was previously assessed as meeting the definition of a brownfield site under 42 U.S.C. § 9601(39)(A), including a site listed under the category Brownfield Properties of the EPA's Cleanups in My Community webpage or on similar webpages maintained by states, territories or for federally recognized Indian tribes, available at https://java.epa.gov/acrespub/stvrp/; (2) a Phase II Assessment has been completed with respect to the site in accordance with the most current applicable version of the Standard Practice for Environmental Site Assessments: Phase II Environmental Site Assessment Process of ASTM International and such Phase II Assessment confirms the presence on the site of a hazardous substance as defined under 42 U.S.C. § 9601(14), or a pollutant or contaminant as defined under 42 U.S.C. § 9601(33); or (3) for projects with a nameplate capacity of not greater than 5MW (AC), a Phase I Assessment has been completed with respect to the site in accordance with the most current applicable version of the Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process of ASTM International.
5. Very generally, taxpayers may use one of two methods to establish that a PTC or ITC project has begun construction: the Physical Work Test (e.g., starting physical work of a significant nature) or the Five Percent Safe Harbor (e.g., paying or incurring five percent or more of the total cost of the qualified facility). Both methods require continuous progress towards completion once construction has begun (the Continuity Requirement). Section 4.01(2) of Notice 2023-29 includes citations to various items of guidance for determining when construction begins, which discuss the specific requirements and rules with respect to the Physical Work Test, the Five Percent Safe Harbor, the Continuity Requirement, and other relevant issues.
6. For an electrical generating unit, the nameplate capacity means the maximum electrical generating output in megawatts (MW) that the unit is capable of producing on a steady-state basis and during continuous operation under standard conditions, as measured by the manufacturer and consistent with the definition provided in 40 CFR § 96.202. Energy-generating units that generate direct current (DC) power before converting to alternating current (AC) should use the nameplate capacity in DC, otherwise the nameplate capacity in AC should be used. For energy storage devices, the nameplate or maximum rated capacity means the storage device's usable energy capacity (MWh) – i.e., the electric storage device capacity (in MWh) multiplied by the duration hours of that storage capacity (h). Where applicable, the International Standard Organization (ISO) conditions are used to measure the maximum electrical generating output or usable energy capacity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.