On August 16, 2022, President Biden signed the “Inflation Reduction Act of 2022” (the “Act”), which includes the largest single investment in clean energy in United States history. The Act extends and expands existing tax credits and adds several new energy tax credits to encourage the production of electricity using clean energy and reduce carbon emissions. The benefits of this historic legislation for investors, developers, manufacturers, and other participants in the clean energy infrastructure space cannot be overstated.
The Act includes all of the renewable energy tax provisions in the Senate bill introduced by Senator Manchin and Majority Leader Schumer on July 27, 2022 (the “Proposed Senate Bill”) and the 1% excise tax on corporate stock buybacks in the revised version approved by the Senate on August 7, 2022 (the “Senate Bill”), which replaced the removal of the carried interest loophole in the Proposed Senate Bill.
What follows is an overview of how the Act affects the clean energy sector. This overview is not a comprehensive summary of all of the energy tax provisions in the Act.
Changes to the ITC and PTC
- Extension of the investment tax credit (ITC) under Section
- Applies to solar, qualified fuel cell, qualified microturbine, combined heat and power, waste energy, small wind, energy storage, microgrid controller, and qualified biogas projects that start construction through 2024.
- Applies to geothermal projects that start construction through 2034.
- Previously, there was no ITC for stand-alone energy storage, microgrid controllers, or qualified biogas.
- The ITC percentage is 30% for solar, qualified fuel cell, small
wind, waste energy, combined heat and power, geothermal, energy
storage, qualified biogas, and microgrid controllers subject to the
wage and apprenticeship (W&A) requirements described below.
- The ITC is 26% for solar, qualified fuel cell, and qualified small wind projects that start construction after 2019 and are placed in service before 2022.
- The ITC for geothermal projects is subject to a phase out; (i) for projects that start construction after 2032 and are placed in service before 2034, the rate is 26%, and (ii) for projects that start construction during 2034, the rate is 22%.
- ITC prior to the Act:
- The ITC was 10% for combined heat and power and qualified biogas.
- There was a phase out of the ITC for solar, geothermal, qualified fuel cell, and microturbine projects: 26% for such projects if construction starts in 2020 - 2022; 22% if construction starts during 2023; and 10% for solar and 0% for the remaining technologies if construction starts after 2023.
- There was no ITC for stand-alone storage, qualified biogas, or microturbine controllers.
- Storage technology is property that receives, stores, and
delivers energy for conversion to electricity and thermal energy
- It does not include property used primarily to transport goods or individuals or for the production of electricity.
- Thermal energy storage must (i) directly connect to a heating, ventilation, or air conditioning system; (ii) remove heat from or add heat to a storage medium for subsequent use; and (iii) provide energy to heat or cool the interior of a building.
- It does not include a swimming pool, combined heat and power property, or a building, or any structural components of a building.
- Extension of the production tax credit (PTC) under Section 45
at the applicable 2021 credit rate (subject to W&A
requirements) for wind, solar, geothermal, biomass, landfill gas,
solid waste, qualified hydropower, and marine and hydrokinetic
projects that start construction by the end of 2024.
- The maximum 2021 credit was 2.5 cents per kWh (less depending on the technology).
- PTC for solar had previously expired.
- The existing PTC phaseout for wind does not apply to projects placed in service in 2022 or later.
- Reduced ITC and PTC if the facility is financed with tax-exempt
bonds, with the reduction capped at 15%.
- The reduction is calculated using a fraction where the numerator is the aggregate amount of tax-exempt bond proceeds used to finance the facility, and the denominator is the aggregate amount of additions to the capital account for the facility, in each case, for the taxable year and all prior taxable years.
- For the PTC, the Act removes the reduction with respect to government grants, subsidized energy financing, and tax credits for any property included in the project, and lowers the maximum reduction, which was previously 50%.
- For the ITC, the Act removes the reduction for subsidized energy financing, expands the reduction to include all tax-exempt bond financing (rather than only the proceeds from tax-exempt private activity bonds), and revises the reduction calculation to match the PTC approach (as opposed to reducing eligible basis).
- PTC and ITC are effectively extended for projects placed
in service beginning in 2025 by the addition of a new PTC (Section
45Y) and ITC (Section 48E), as elected by the taxpayer, for
electricity produced by facilities with lifecycle greenhouse gas
emission rates not greater than zero.
- Section 45Y PTC applies to electricity produced at a
zero-emissions generating facility placed in service after
2024 and sold by the taxpayer to an unrelated person (or, in
the case of a qualifying facility owned or operated by an unrelated
person and equipped with a metering device, sold, consumed, or
stored by the taxpayer).
- The credit is equal to the kWh of qualifying electricity for the taxable year multiplied by the base amount.
- The base amount is 1.5 cents if one of the following is true with respect to the qualifying facility: it has a nameplate capacity that is less than 1 MW, construction starts at least 59 days prior to the date the IRS publishes regulations, or the W&A requirements are satisfied. In all other cases, the base amount is 0.3 cents.
- The base rate is adjusted for inflation.
- Section 48E ITC applies to investments in electricity
generation facilities expected to satisfy the zero-emissions rate
requirement and energy storage technology that is placed in service
- The base rate is 30% if one of the following is true: the generating facility has a nameplate capacity that is less than 1 MW, construction of the storage system or generating facility starts at least 59 days prior to the date the IRS publishes regulations, or the W&A requirements are satisfied. In all other cases, the base rate is 10%.
- Whether the greenhouse gas emissions rate does not exceed zero is determined based on IRS published rates for categories of facilities.
- Eligibility does not depend on the type of technology.
- Carbon capture can offset emissions for purposes of determining whether the zero-emissions rate requirement is satisfied.
- Phaseout begins in the second year after the later of (i) 2032, or (ii) the year US greenhouse gas emissions hit 25% of the 2022 rate; the phaseout is 75% of the applicable rate for such second year, 50% of the applicable rate for the third year; and 0% beginning in the fourth year.
- Credit reduction for tax-exempt bond financing.
- Section 45Y PTC applies to electricity produced at a zero-emissions generating facility placed in service after 2024 and sold by the taxpayer to an unrelated person (or, in the case of a qualifying facility owned or operated by an unrelated person and equipped with a metering device, sold, consumed, or stored by the taxpayer).
Other Changes to Existing Tax Credits and Addition of New Tax Credits
- Changes to the Section 45Q Credit for Carbon Oxide
- Credit extended for projects that start construction before January 1, 2033.
- The minimum annual amount of carbon oxide required to be captured to qualify for the credit is lowered to 18,750 tons of emissions for power plants (previously 500,000 tons), 12,500 tons for industrial facilities (previously 100,000 tons), and 1,000 tons for direct air capture facilities (previously 100,000 tons).
- Increased base credit rates, subject to W&A requirements:
- For carbon capture by industrial facilities and power plants, credit is $85 per metric ton for captured CO2 stored in geologic formations, $60 per metric ton for carbon utilization, and $60 per metric ton for CO2 stored in oil and gas fields.
- For direct air capture facilities, the credit is $180 per metric ton for captured CO2 stored in geologic formations, $130 per metric ton for carbon utilization, and $130 per metric ton for CO2 stored in oil and gas fields.
- Addition of the requirement for carbon capture equipment to have a carbon capture design capacity at least equal to 75% of the “baseline carbon oxide” that would otherwise be released by the applicable electricity generating facility. Baseline carbon oxide is based on different periods depending on when construction starts on the carbon capture equipment and the placed in service date for the applicable electricity generating facility.
- The credit reduction for tax-exempt private activity bond financing (adding under the Infrastructure and Investment Jobs Act) is revised to match the reduction for tax-exempt bond financing applicable to the PTC (described above).
- New Clean Hydrogen Production Tax Credit (Section 45V):
- 10-year PTC for qualified clean hydrogen produced at a qualifying facility that starts construction by the end of 2032 and is placed in service after 2022 (taking into account the placed in service date for modifications made to an existing facility to produce clean hydrogen).
- Qualified clean hydrogen is hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate that does not exceed 4kg of CO2e per kg of hydrogen.
- The hydrogen must be produced in the United States for sale or use by the taxpayer at a production facility owned by the taxpayer.
- The credit amount varies for different ranges of emissions rates and is reduced when applicable W&A requirement are not satisfied and if there is tax-exempt bond financing.
- Cannot take both clean hydrogen PTC and Section 45Q credit.
- Credit up to $3 per kg if W&A requirements are satisfied.
- Can elect ITC (at specified rates) in lieu of the Section 45VPTC.
- Electricity used by the taxpayer at the qualified production facility can qualify for the Section 45 PTC.
- New Advanced Manufacturing Production Credit (Section 45X):
- Applies to sales (beginning in 2023) of certain components utilized to construct wind and solar facilities, and energy storage technology.
- Eligible components include photovoltaic cells and wafers, solar grade polysilicon, polymeric backsheets, solar modules, wind energy components (such as blades, towers, and nacelles), torque tubes, structural fasteners, electrode active materials, battery cells, battery modules, inverters, and certain critical minerals.
- The credit amount is different for each eligible component.
- The components must be produced by the taxpayer in the United States and sold by the taxpayer to an unrelated person.
- The credit phases out beginning with sales in 2030, for which the credit is 75% of the stated rate, reducing to 50% of the rate for sales in 2031, 25% of the rate for sales in 2032, and full expiration of the credit for sales after 2032.
- Extension and expansion of the Section 48C Credit for investments in Advanced Energy Projects.
- New tax credits for zero-emissions nuclear power production and transportation fuels with lower emissions rates.
- New PTC for energy produced from an existing qualified nuclear power facility through the end of 2032.
Two-Tier Rate Structure and Bonus Credits
W&A Requirements Need to Be Satisfied in order to Receive the Higher Tax Credit Rate for Credits with a Two-Tier Credit Rate Structure
- Requirements do not apply to (i) projects that start construction on or prior to 59 days after the IRS issues regulations, or (ii) projects with a nameplate capacity of less than 1 MW.
- Credit is 20% of the full rate if the W&A requirements apply and are not met (e.g., the ITC percentage is either 6% or 30%).
- Wage Requirement – contractors and subcontractors must
pay laborers and mechanics employed constructing, altering, or
repairing the facility wages that are at least equal to the
prevailing local wages for similar services, as determined by the
Secretary of Labor.
- For the PTC, the wage requirement with respect to repairs and alterations applies for 10 years after the project is placed in service.
- For the ITC, the wage requirement with respect to repairs and alterations applies during the 5-year recapture period.
- Apprenticeship Requirement – each contractor and
subcontractor must use qualified apprentices to perform at least
the applicable percentage of labor hours to construct, repair, or
alter the facility.
- A qualified apprentice is an employee that participates in a registered program, as defined under Code Section 3131(e)(b)(3).
- The applicable percentage is 10% for projects that start construction before 2023, 12.5% if construction starts before 2024, and 15% if construction starts after 2023.
- There is a good faith efforts exception pursuant to which the requirement is deemed satisfied.
- Additional 10% Credit if the Domestic Content (DC) requirement
- Bonus ITC and PTC apply to projects placed in service in tax years after 2022.
- DC requirement – all steel, iron, or manufactured
products that are components of the completed facility are required
to be produced in the United States.
- For manufactured products to be considered produced in the United States, the total cost of all manufactured products included in the completed facility must be attributable to not less than the applicable percentage of manufactured products (including components) that are mined, produced, or manufactured in the United States.
- The applicable percentage is 40% for the ITC and PTC.
- The applicable percentage for the Section 45Y PTC and Section 45E ITC is 40% for projects that start construction prior to 2025, 45% if construction starts in 2025, 50% if construction starts in 2026, and 55% thereafter.
- The thresholds are lower for off-shore wind.
- The 10% bonus credit for satisfaction of DC content requirements also applies to the Section 48E ITC and the Section 45Y PTC.
- Additional 10% PTC or ITC for a qualified facility located in
an energy community, which means one of the following:
- A brownfield site (as defined under section 101(39) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980);
- An area that currently has (or beginning in 2000, had) significant employment related to coal, oil, or natural gas extraction, processing, or transport; or
- A census tract that (A) had a coal mine closed after 1999 or a coal-fired electric generating unit retired after 2009, or (B) directly adjoins a census tract described in (A).
- The 10% bonus credit also applies with respect to the Section 45E ITC and the Section 45Y PTC.
- Additional 10-20% ITC and Section 48E ITC for certain solar and
wind facilities placed in service in connection with low-income
- Only available to facilities that have a nameplate capacity not greater than 5 MW and have received allocations of environmental justice solar and wind capacity limitations by the Secretary.
- 10% bonus credit if the project is located in a low-income community (as defined for new markets tax credit purposes) or on tribal land.
- 20% bonus credit if the facility is part of a “qualifying
low-income residential building project” or the project is a
“low-income economic benefit project.”
- A qualifying low-income residential building project is a residential building project that participates in one of several listed programs.
- A project is a low-income benefit project if at least 50% of the financial benefits of the electricity produced by the project are provided to households with income of less than 200% of the poverty line or less than 80% of the area median income.
- The facility must be placed in service no later than four years from the date of allocation of the environmental justice solar and wind capacity limitation.
- Applicable W&A requirements apply to the bonus credits described above, which means the bonus credit is 20% of the full bonus credit if such requirements are not met. Thus, a 10% bonus ITC would only provide an additional 2% ITC if such requirements are not met (for a total ITC of 8%). Similarly, under current rates, a 10% bonus PTC would result in a total PTC of 0.55 cents per kWh (rather than 2.75 cents per kWh).
Credits Can Be Transferred
- ITC and PTC can be transferred in full or part to an unrelated party for cash.
- Transferability is also available for the Section 45Q Credit, Section 45V PTC, the Section 45X PTC, the Section 45Y PTC, and the Section 48E ITC.
- Provides the ability to monetize the tax credits without using tax equity financing, which can be complicated and expensive.
- Amount paid is not includable in the gross income of the taxpayer or deductible by the transferee.
- The taxpayer must elect to transfer the credits no later than the tax return due date (including extensions), and the election is irrevocable.
- The election is made each year for production tax credits taken over 10 years.
- The transferee cannot transfer the credits to another party.
- The IRS can impose a penalty tax on the transferee if there is an “excess credit transfer,” which might occur if the credit claimed by the transferee exceeds the credit that would otherwise be allowable with respect to such facility or property.
Limited Direct Pay Option
- Tax-exempt and government entities, tribes, rural electricity cooperatives, the Alaska Native Corporation, and the Tennessee Valley Authority can elect to receive a cash payment in lieu of certain energy tax credits (including the ITC, PTC, Section 45Q Credit, Section 45V PTC, Section 45X PTC, Section 45Y PTC, and Section 48E ITC) through the end of 2032, subject to a phase down in the direct pay value for projects that start construction after 2025.
- All taxpayers can elect direct pay in the case of the PTC for clean hydrogen, Section 45Q credit, and the Advanced Manufacturing Credit. This is only available for the first five years of these credits for taxable years ending prior to 2033.
- The IRS may impose a penalty tax if the amount of the direct payment exceeds the amount of the credit that would have been allowed absent the election.
The Act expands the tax incentives related to electric vehicles, including by extending the $7,500 tax credit for purchases of electric vehicles through the end of 2032, removing the manufacturer cap on the number of eligible vehicles, paying the credit at the point of sale rather than as a tax refund, and adding a tax credit up to $4,000 for purchases of used vehicles that cost less than $25,000 and of 30% of the cost for purchases of used vehicles that cost $13,000 or less. The Act includes energy tax benefits for electric vehicle infrastructure, consumers, individuals, residential properties, and agriculture, all of which are beyond the scope of this alert.
1 Unless otherwise stated, all capitalized Section references are to the Internal Revenue Code of 1986, as amended.
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.