Inflation Reduction Act Would Extend Renewable Tax Credits

Legal Alert

On July 27, Senate Democrats released the draft text of the Inflation Reduction Act of 2022 (the Act). The Act includes a number of climate and energy-related provisions similar to those that were included in the Build Back Better Act (the BBBA), which stalled in Congress at the end of last year and earlier this year. The Senate is expected to consider the Act this week. Following is a summary of some of the highlights of the Act related to renewable energy tax credits.

PTC and ITC Extensions

The Act would extend the availability of the full production tax credit under Section 45 of the Code (the PTC) and the investment tax credit under Section 48 of the Code (the ITC) for certain renewable energy projects construction of which begins before December 31, 2024. The PTC extension would apply to wind facilities, closed- and open-loop biomass facilities, landfill gas facilities, trash facilities, and qualified hydropower facilities. The ITC extension would apply to, among others, solar energy generation property, qualified fuel cell property, and waste energy recovery property. The currently applicable phase-down of the PTC and the ITC, including those applicable to the PTC for wind facilities and the ITC for solar energy generation property, would be eliminated, except in the case of certain projects that were placed in service before January 1, 2022. The December 31, 2024 sunset date is a two-year reduction from the December 31, 2026 extension proposed in the BBBA.

PTC and ITC Base Credits and Multipliers

The Act establishes a new reduced base credit amount for the PTC and ITC. For an otherwise eligible project, the new base credit amount for the PTC would be 0.3 cents per kWh (subject to adjustment for inflation) and the new base credit amount for the ITC would be 6%. If, however, a project satisfies newly added prevailing wage and apprenticeship requirements, or if those added requirements are not applicable, the base credit amount for both the PTC and the ITC would be multiplied by five.

Prevailing Wage and Apprenticeship Requirements

The prevailing wage provisions require that a taxpayer satisfy certain prevailing wage requirements for laborers and mechanics, including those employed by contractors and subcontractors, for wages paid during the construction of the project and for any repairs or alterations during the applicable tax credit period. The prevailing wage requirement, including the amounts of applicable prevailing wages, would be determined by the Secretary of Labor in guidance to be issued after the Act is enacted.

The apprenticeship provisions require that no fewer than the “applicable percentage” of total labor hours of construction work prior to the project being placed in service be performed by “qualified apprentices.” The applicable percentage would be between 10% and 15%, depending on the year in which construction of the relevant project began.

The Act would allow taxpayers to cure any failure to satisfy prevailing wage or apprenticeship requirements by making true-up payments to workers, plus interest, and paying a per-worker penalty to the Department of Treasury.

The prevailing wage and apprenticeship requirements would not apply to any project the construction of which begins prior to the date that is 60 days after guidance regarding those requirements is published. A project construction of which begins prior to that date would qualify for the multiplier without regard to whether it satisfies these requirements.

Domestic Content and Community Enhancements

The Act adopts a 10% adder for eligible PTC and a 10-percentage point adder for eligible ITC projects which satisfy “domestic content” requirements or are located in certain “energy communities.” In general, the domestic content requirement is met if the taxpayer certifies that any steel, iron, or manufactured product which is a component in the applicable project was produced in the United States. “Energy communities” include brownfield sites, certain areas with significant employment related to coal, oil, or nature gas and certain areas with closed coal mine or coal-electric generating plants.

The Act also adopts an up-to-20 percentage point adder to the ITC for solar and wind projects located in certain low-income communities or Indian land.

Each of these additional credits would apply only to property placed in service after December 31, 2022.

Solar and Geothermal Projects Treated as Qualified Facilities for Purposes of PTC

Under prior law, a solar energy facility or a facility using geothermal energy could be considered a “qualified facility” eligible for the PTC. The Act would reinstate the PTC for both solar energy and geothermal facilities construction of which begins before January 1, 2025.

Expansion of the ITC

The Act would expand the types of investments in certain renewable energy property that are eligible for the ITC to include energy storage technology, qualified biogas property, and microgrid controllers. In addition, the Act would extend the option for a taxpayer to claim the ITC in lieu of the PTC for certain qualified facilities, without a phase-down, to align with the extensions to the PTC and ITC.

The expansion of the ITC to these additional types of investments apply only to property placed in service after December 31, 2022. In the case of energy storage technology, the new rules in the Act do not, on their face, modify existing rules regarding the ITC for battery storage that is part of an otherwise ITC-eligible solar energy project.

Addition of New Credits

The Act creates two new credits, the Clean Electricity Production Credit and the Clean Electricity Investment Credit. The Clean Electricity Production Credit, which operates similarly to the PTC, would allow a credit equal to 0.3 cents per kilowatt hour of electricity produced by a qualified facility and sold to an unrelated party during each year of a 10-year credit period. The credit would be multiplied by five, for a total credit of 1.5 cents per kilowatt hour, if the applicable prevailing wage and apprenticeship requirements are satisfied. The Clean Electricity Investment Credit, which operates similarly to the ITC, would provide for a credit equal to 6% of the basis of a qualified facility subject to a five times multiplier (for a total credit of 30%) if the applicable prevailing wage and apprenticeship requirements are satisfied. Both credits would be subject to a phase-out for qualified facilities that begin construction after the later of (i) a calendar year in which the Secretary of Treasury determines that annual greenhouse emission from the production of electricity in the US are equal to or less than 2022 emissions, or (ii) 2032. For purposes of the Clean Electricity Production Credit and the Clean Electricity Investment Credit, a qualified facility is a facility that is used for the generation of electricity, which is placed in service after December 31, 2024, and for which the “anticipated greenhouse gas emissions rate * * * is not greater than zero.” The Secretary would annually publish a table that sets forth the greenhouse gas emissions rates for types or categories of facilities. Both credits would also be increased for qualified facilities that satisfy “domestic content” and “energy community” requirements like those for the PTC and ITC described above. In addition, the Clean Electricity Investment Credit would include an up-to-20 percentage point increase for certain solar and wind projects located in certain low-income communities or Indian land or that are part of a qualified low-income resident building project or a qualified low-income economic benefit project.

Carbon Oxide Sequestration Credit Extension and Modification

The Act would extend the Section 45Q credit for qualified carbon oxide sequestration facilities the construction of which begins before 2033. Under current law, construction of such facilities must begin construction before 2026 to qualify for the credit. The Act would also increase the amount of the credit and significantly reduce the minimum carbon oxide capture requirements. However, the Act also adds a requirement for carbon capture equipment for an “applicable electric generating unit” to have capture design capacity of 75% of “baseline carbon oxide” released by a facility and includes detailed rules for determining that baseline. The changes in the amount of the credit would apply to facilities or equipment placed in service after December 31, 2022 and the changes to the minimum carbon oxide capture requirements would apply to facilities or equipment the construction of which begins after the date of enactment of the Act.

Direct Pay, Credit Transferability and Extended Carryback

The Act, like the BBBA, would provide a “direct pay” election that would allow certain taxpayers to elect to receive cash payments (in the form of tax refunds) instead of claiming certain tax credits, including the PTC and ITC. Unlike the BBBA, which included a direct pay election that was generally applicable to most taxpayers, the Act restricts the direct pay election to tax-exempt entities, any state or local government (or political subdivision thereof), the Tennessee Valley Authority, and Indian tribal government or Alaska Native Corporation. The direct pay election also is available to taxpayers that are not tax-exempt entities, but only with respect to the clean hydrogen credit, the carbon sequestration credit, and the advanced manufacturing credit, and only for tax years beginning before 2023.

For taxpayers that are not eligible to make the direct pay election, the Act would permit a taxpayer to sell certain tax credits, including the PTC and ITC, to an unrelated party for cash. This transferability provision would be effective for years beginning after 2022, and the credit must be transferred by the due date of the tax return for the taxable year in which the credit is determined. The seller of the tax credits would not recognize taxable income from the sale and the buyer of the tax credits could not claim a deduction for the price paid for the tax credit. In the case of partnerships and S corporations, the election would be made at the entity level rather than the owner level, but the tax-exempt treatment of income from the sale of the tax credits would pass-through to owners. Tax credits would be transferrable only once. This provision does not allow for the transfer of tax losses that can be generated by accelerated depreciation deductions available for most renewable projects.

The Act also extends the one-year carryback applicable to unused tax credits to a three-year carryback for credits eligible for the direct pay election.

The direct pay provision, the credit transfer provision, and the changes to the credit carryback rules would apply for taxable years beginning after December 31, 2022.

“Beginning of Construction”

The Act does not alter the guidance issued by the IRS regarding the beginning of construction. The notices issued by the IRS regarding the physical work test, 5% safe harbor, and other applicable rules would remain in place unless and until modified by the IRS.

Overall, the Act would provide welcome relief to developers of and investors in renewable energy projects. This relief is particularly welcome in light of existing supply chain and other issues creating challenges satisfying the beginning of construction requirement in the near term. Whether and when Congress will pass the Act, and whether any bill that is passed will contain the same provisions as the bill that was circulated, remains to be seen.

(Originally published August 2, 2022. Updated to include the Additions of New Credits section.)

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