A great time to be green
Top 10 federal tax incentives under the Inflation Reduction Act
Jennifer Pusch, Esq and William Howieson, Esq. | August/September 2023 Footnote
In August 2022, Congress passed the largest single investment ever in clean energy. Among other things, the Inflation Reduction Act (IRA”)
[1] boosts investment in clean energy production, storage and U.S. manufacturing by providing tax incentives for both the industry and consumers.
In this article, we highlight 10 takeaways from the IRA, including the two-tier credit system (with “base” and “bonus” amounts), expanded and new federal tax credits, and the new “direct pay” and transferability mechanisms provided by statute. We also look at some of the expanded tax benefits for consumers.
Industry incentives
1. Two-tier credit system
The IRA introduced a two-tiered system for many of the expanded or newly created tax credits. For applicable credits, a set base amount can be increased to a bonus amount if certain “prevailing wage and apprenticeship requirements” are met, or an exception applies. The amount of a credit may increase further if other bonus credits apply, such as the domestic content bonus.
2. Prevailing wage and apprenticeship requirements
The IRA’s wage and apprenticeship requirements are meant to ensure that the U.S. invests not only in clean energy, but in good, well-paying American jobs. To meet the requirements and, thus, qualify for the additional credit, taxpayers must follow two general standards.
First, the taxpayer must ensure that any laborers and mechanics employed by the taxpayer (or any contractor or subcontractor) are paid at “prevailing rates” in the locality in which the project is located.
[2] This rate is determined by the U.S. Secretary of Labor and applies during both the initial construction and subsequent alterations or repairs of a project.
Second, taxpayers must ensure that, with respect to the construction of a qualified project, no fewer than the “applicable percentage” of total labor hours are performed by qualified apprentices.
[3] A “qualified apprentice” is an individual who is “participating in a registered apprenticeship program.”
[4]
3. Expanded credits
For
investment in clean energy projects, such as wind or solar farms, the IRA extends the existing Energy Investment Tax Credit (Section 48, ITC) for most projects that begin construction by Dec. 31, 2024.
[5]For
production of electricity using renewable energy resources, such as wind, solar energy, or geothermal energy, the IRA extends the existing Renewable Electricity Production Tax Credit (Section 45, PTC) to most projects that begin construction by Dec. 31, 2024. When the base rates are combined with the prevailing wage and apprenticeship requirements, PTC credits can be up to 2.6 cents/kilowatt hour (“kWh”) and ITC credits can be up to 30%.
[6] These rates may be even higher if other bonus credits apply.
4. New credits
For property placed in service on or after Jan. 1, 2025, the IRA effectively replaces the PTC and ITC with corresponding technology-neutral credits. These flexible “emissions-based incentive[s]” include the new Section 48E Clean Electricity Investment Credit (the CEITC), and the new Section 45Y Clean Electricity Production Credit (the CEPTC).
[7] Like their predecessors, meeting the prevailing wage and apprenticeship requirements (and other bonus credits) can significantly increase the amount of the CEITC and CEPTC.
The IRA also enacted the Section 45X Advanced Manufacturing Production Credit, meant to incentivize development of a U.S.-based supply chain for renewable energy technology and storage. The Section 45X credit equals a specific dollar-amount per “eligible component” produced and sold during the tax year. For example, producing a battery cell may generate a credit of $35 multiplied by the capacity of the battery cell (on a kWh basis).
[8] Other notable new credits include Section 45V Clean Hydrogen Production Credit and Section 45Z Clean Fuel Production Credit.
5. Domestic content, energy community and low-income community (AKA more bonus)
Certain credits may expand even further under the IRA. For example, the combined base and bonus credit under Sections 48 and 48E (i.e., the base plus the bonus of meeting the prevailing wage and apprenticeship requirements) may be increased by an additional
10 percentage points if certain “domestic content” requirements are met.
[9] In particular, taxpayers who ensure that the steel, iron and “manufactured products” that comprise the relevant project are produced in the U.S. may qualify for the bonus.
[10] (The increase drops to 2 percentage points if prevailing wage and apprenticeship requirements are not met.)
Additionally, projects located in a statutorily defined “energy community” may qualify for an additional bonus (by 10 percentage points or 10% of the credit amount depending on the underlying credit).
[11] Energy communities include (1) brownfield sites, (2) statistical areas with specific levels of employment in, or tax revenue generated by, the fossil fuel industry, and (3) a census tract where a coal mine or coal-fired electric generating unit used to operate. Likewise, a wind or solar project located in a statutorily defined “low-income community” may qualify for a similar increase.
[12]
Importantly, taxpayers may qualify for more than one of these incremental bonus credits. For example, if a wind project (i) qualifies for the ITC base amount, (ii) meets the prevailing wage and apprenticeship requirements, (iii) satisfies the domestic content requirement, and (iv) is located in an energy community,
the project could qualify for an ITC equal to 50% of the eligible basis.
6. Direct pay
The IRA also created Section 6417, which allows “applicable entities” to elect to receive a refundable credit on certain applicable credits.
[13] In other words, certain organizations can receive an actual payment from the federal government for qualifying tax credits. This mechanism is often referred to as “direct pay.”
Applicable entities are usually limited to tax-exempt organizations, state and local governments (and subdivisions), tribal governments, certain electric cooperatives, and the Tennessee Valley Authority. However, the “applicable entity” requirement may not apply to every credit, such as Sections 45X or 45V.
7. Transferability
In addition to the direct pay option, the IRA authorizes the transfer of certain eligible credits, including the ITC and PTC (and their successors), through Section 6418.
[14] This provision allows for the monetization of tax credits outside of the traditional tax equity financing structure.
Any payments made in connection with a transfer must (1) be paid in cash, (2) are not includable in the transferor’s taxable income, and (3) are not deductible to the transferee. Credits cannot be transferred more than once and, to the extent ITCs (or CEITCs) are transferred, they are subject to the basis reduction and recapture rules of Section 50.
Consumer benefits
8. Residential Clean Energy Credit
For consumers, the IRA extended the Residential Clean Energy Credit under Section 25D through 2034 and expanded applicable rates. As of today, the credit is 30% of the costs of new, “qualified” property installed in your home, such as solar electric property costs, solar water heating costs and geothermal heat pump property costs.
[15] Under the IRA, battery storage technology is now an eligible expenditure for this credit. While the credit is nonrefundable, it may be carried forward.
9. Energy Efficient Home Improvement Credit
The IRS also extended and expanded the Energy Efficient Home Improvement Credit under Section 25C. Individuals can receive a credit for 30% of the total amount paid for (1) qualified energy efficiency improvements (such as energy efficient building envelope components, like doors or windows), (2) residential energy property expenditures (i.e., costs spent on qualified energy property, like energy efficient air conditioners, water heaters or furnaces), and (3) home energy audits. Currently, there is a $1,200 aggregate tax credit maximum for these items. However, a separate Section 25C credit, up to an annual $2,000 limit, applies to electric or natural gas heat pump water heaters or biomass boilers. Therefore, this credit may be as much as $3,200.
10. Electric Vehicle Credit
The final highlight from the IRA is the modifications to the Clean Vehicle Credit under Section 30D. The IRA requires that new eligible vehicles must “undergo final assembly in North America.”
[16] Additionally, the credit may be reduced if a certain percentage of the “applicable critical minerals” contained in the electric vehicle’s battery are not (1) extracted or processed in the U.S. or in a country with which the U.S. has a free trade agreement, or (2) recycled in North America.
[17] The credit maxes out at $7,500 annually and imposes an income limit of $150,000, or $300,000 for joint filers.
It’s not easy being green
Overall, the IRA introduces a wealth of tax incentives and opportunities for the clean energy industry and consumers. While the IRS continues to develop proposed regulations, revenue notices and other guidance, as tax practitioners, we know that with greater tax credits comes greater audit risk. However, we are cautiously optimistic. The IRA allocated nearly $80 billion in funding to the IRS. Between new technology and more employees, we look forward to a fair — and perhaps quick — administration of these credits.
Jenny Pusch is a senior associate at Fredrikson & Byron, P.A. She represents clients in all types of tax disputes and controversy, including federal and state audits, administrative appeals and litigation. She also provides tax advice to renewable energy companies at both the federal and state levels. You may reach her at jpusch@fredlaw.com or 612-492-7210.
Will Howieson is an associate attorney at Fredrikson & Byron, P.A. He is a practical tax and business attorney who partners with clients to solve complex legal problems involving federal, state and local tax issues. You may reach him at whowieson@fredlaw.com or 612-492-7451.
[1] Pub. L. 117–169.
[2] Section 45(b)(7)(A). Unless otherwise specified, all references to “Section” are to the Internal Revenue Code of 1986, as amended.
[3] Section 45(b)(8)(A). This percentage increases over time. Id.; see also Rev. Not. 2022-61.
[4] Section 45(b)(8)(E)(ii).
[5] A project’s eligibility for a specific credit under the IRA may depend on when (a) construction began on the project or (b) when the project was placed in service. The type of project also impacts this analysis.
[6] The IRA also expands available amounts under Section 179D, for energy efficient commercial building deductions.
[7] Bipartisan Policy Center, “Inflation Reduction Act Summary: Energy and Climate Provisions,” at 5–6, available at https://www.energy.gov/sites/default/files/2022-10/IRA-Energy-Summary_web.pdf.
[8] Section 45X(b)(1)(K). Under Section 45X(b)(4), a battery cell’s capacity cannot exceed a capacity-to-power ratio of 100:1. The capacity-to-power ratio is the ratio of the capacity of the cell to the maximum discharge of the cell.
[9] Rev. Not. 2023-38. The total amount of the combined base and bonus credit under Sections 45 or 45Y may be increased by 10% (not 10 percentage points). Id.
[10] Rev. Not. 2023-38. A “manufactured product” is considered manufactured in the U.S. if a specified percentage of the total cost of components is attributable to components that are mined, produced, or manufactured in the U.S. Id.
[11] Section 45(b)(11)(B); see also Rev. Not. 2023-29; Rev. Not. 2023-45; Rev. Not. 2023-47.
[12] Section 48(e)(2)(A)(iii)(I); Section 45D(e).
[13] Section 6417.
[14] Section 6418; see also 88 Fed. Reg. 40496 (proposed June 21, 2023).
[15] Section 25D(g)(3).
[16] Section 30D(d)(1)(G); see also Rev. Not. 2023-1.
[17] 88 Fed. Reg. 23370 (proposed April 17, 2023).
