The Inflation Reduction Act: Renewable Energy Tax Credits

The Inflation Reduction Act of 2022, signed into law by President Joe Biden on August 16, 2022, includes $369 billion in spending and tax credits for climate and energy programs over 10 years. The Act is a smaller version of the Build Back Better Act (BBBA) passed in the House of Representatives in November 2021, but it includes a number of the renewable energy tax provisions originally in the BBBA and remains the largest U.S. investment in greenhouse gas reduction to date.

Overview

The main renewable energy tax incentives contained in the Act are:

  • The extension and expansion of the renewable electricity production tax credit (PTC) and energy tax credit (ETC);
  • New “technology-neutral” clean electricity production and investment credits;
  • A zero-emissions nuclear power production credit;
  • A clean hydrogen production credit;
  • Expansion of the credit for carbon capture and storage; and
  • Energy manufacturing credits.

Bonus Credit

For most of the credits, the Act provides a base credit and a bonus credit for projects that meet certain prevailing wage and apprenticeship requirements during construction and for a specific time after the facility is placed in service. As a result, the Act does more than simply extend credits. Further, the prevailing wage and apprenticeship requirements (discussed below) may significantly reduce the value of these credits.

Projects may also receive an additional 10 percent bonus credit if they use U.S. produced steel, iron, or manufactured products that are components of the renewable energy facility. The domestic content is calculated using the “adjusted percentage” (generally 40 percent) of the total cost of the components. Additionally, qualified projects located in an “energy community,” defined in the Act, can receive another 10 percent bonus credit.

Tax-Exempt Financing

The Act also changes the credit reduction rate for projects that use tax-exempt bonds for financing from 50 percent to the lesser of: (i) 15 percent; or (ii) the fraction of the proceeds of a tax-exempt obligation used to finance the project over the aggregate amount of the project’s financing costs. The Act also allows certain eligible taxpayers and certain entities to elect to receive direct payment of the tax, with the election made for each project. Certain taxpayers can also transfer credits to another taxpayer in exchange for cash, and the payment is not taxable to the transferor and not deductible by the transferee.

Prevailing Wage and Apprenticeship Requirements

Under the Act, projects that do not satisfy the wage and apprenticeship requirements are not eligible for the bonus credit. The new labor standards have two important exceptions: they do not apply to projects with a capacity of less than 1 megawatt nor do they apply to any project that “began construction” earlier than 60 days after the Treasury Department issues guidance on both the prevailing wage and the apprenticeship requirements.

Under the prevailing wage requirement, a taxpayer must ensure that any laborers and mechanics are paid “prevailing wages” during the construction of a project and, during the relevant credit period, for the alteration and repair of such project. Subject to certain exceptions, the apprenticeship requirement requires a taxpayer to ensure that no less than the “applicable percentage” of total labor hours for the construction of the project are performed by qualified apprentices. There are cure options in the event of failure to satisfy either requirement.

The prevailing wage and apprenticeship requirements will challenge the economics of projects for taxpayers seeking a bonus tax credit. Careful analysis will be necessary to determine whether the benefits of the bonus credit outweigh the additional costs of satisfying the prevailing wage and apprenticeship requirements.

Transferability of Credits

The Act introduces a brand-new transferability feature which was not in any other recent legislative proposals related to renewable energy tax incentives. The transferability feature would permit a taxpayer to sell the tax credits to an unrelated party for cash beginning after 2022. Compensation received by the transferor in connection with the transfer of a credit would not be taxable and no deduction would be available to the transferee for the amount paid for a credit.

The transferability feature in the Act could reduce the complexity involved in monetizing a tax credit by allowing a buyer with enough tax “appetite” to simply purchase a tax credit directly without otherwise acquiring a long-term ownership stake in a project. However, this method fails to monetize a project’s depreciation benefits, and it is also unclear whether the price a buyer would be willing to pay under this structure would necessarily result in a better value for the sponsor than tax equity financing.

Extension of Renewable Electricity Production and Energy Tax Credits

The Act provides $30 billion to extend the Internal Revenue Code (IRC) Section 45 PTC and $10 billion to extend the IRC Section 48 ETC. The credits are also expanded to cover additional technologies.

Production Tax Credit

The Act extends the Section 45 PTC to projects that begin construction by January 1, 2025. This includes wind facilities, biomass, solar, landfill gas, municipal solid waste, hydropower, marine and hydrokinetic renewable energy facilities, and geothermal energy. The amendments to IRC Section 45 generally apply to facilities placed in service after December 31, 2021.

It is important to note that the Act adds solar energy back to the PTC (the solar energy PTC previously applied only to facilities placed in service before January 1, 2006). Solar projects will likely claim the PTC rather than the ETC in order to reduce the risk of credit recapture on projects held less than five years.

The current PTC phase-out for projects beginning construction after December 31, 2016, would continue to apply for any project that is placed in service before January 1, 2022. However, projects placed in service after December 31, 2021, would not be subject to the PTC phase out.

The base credit amount is 0.3 cents per kilowatt hour and a bonus credit amount of 1.5 cents per kilowatt hour is available if the prevailing wage and apprentices requirements are satisfied. Additional credit amounts for meeting domestic content requirements and locating the project in an energy community are available.

Energy Tax Credit

The Act extends the IRC Section 48 ETC (also commonly referred to as the investment tax credit or ITC) to solar, wind, geothermal, fuel cell, combined heat and power systems, and waste energy recovery projects that begin construction by January 1, 2025. For equipment that uses the ground or ground water as a thermal energy source, the begin construction date is extended to January 1, 2035. The Act also extends the ETC to energy storage with a capacity of at least 5 kilowatt hours, qualified biogas, microgrid controllers, and certain interconnection property.

The base credit is sixpercent and a bonus credit of 30 percent is available if the prevailing wage and apprentices requirements are satisfied. Like the PTC, projects can receive additional credit amounts for meeting domestic content requirements and locating the project in an “energy community.”

Solar and Wind Credit for Low-Income Communities

The Act adds IRC Section 48(e) to establish a 10 percent bonus credit for solar and wind facilities, including storage, that are placed in service in low-income communities (as defined in IRC Section 45D(e)), or on Indian land. To receive the credit, the Treasury must allocate an “environmental justice solar and wind capacity limitation” to qualified solar and wind facilities with a maximum of 1.8 gigawatts of capacity for calendar years 2023 and 2024. Unused allocations can be carried over.

There is an additional 20 percent bonus credit if a project is a “qualified low-income residential building project” or a “qualified low-income economic benefit project.” A qualified low-income residential building project is a facility that is installed on a residential rental building that participates in a housing program, and the financial benefits of the electricity produced by the facility are allocated equitably among the occupants of the building. A qualified low-income economic benefit project is one in which at least 50 percent of the financial benefits of the electricity produced by the facility are provided to households with income of less than 200 percent of the poverty line, or less than 80 percent of area median gross income.

Technology-Neutral Clean Electricity Credits

The Act also creates technology-neutral tax credits to supplement the PTC and the ETC. The Clean Electricity Production Tax Credit (CEPTC) applies to emissions-free electricity generation, and the Clean Electricity Investment Tax Credit (CEITC) applies to both emissions-free electricity generation and storage. Both credits apply to properties that are placed in service after December 31, 2024, and that have a greenhouse gas emission rate that is “not greater than zero.” The credits will remain in effect until the later of 2032 or when the annual U.S. greenhouse gas emissions from the production of electricity is equal to or less than 25 percent of greenhouse gas emissions for 2022. The credits will then phase out over four years.

The existing PTC and ETC regime, set to phase out under the terms of the Act after 2024, effectively serves as a transition period until projects shift to this new technology-neutral tax credits regime.

Clean Electricity Production Tax Credit

The CEPTC under the new IRC Section 45Y provides a base PTC of 0.3 cents and a bonus credit of 1.5 cents if prevailing wage and apprentices requirements are met. The electricity must be either sold to an unrelated person or consumed or stored by the taxpayer. The credit is available for 10 years following the facility’s placed in service date. There are also additional 10 percent bonus credits for domestic content requirements and for projects located in an “energy community.”

Clean Electricity Investment Tax Credit

The CEITC under the new IRC Section 48E provides a base ETC of 6 percent and a bonus credit of 30 percent if prevailing wage and apprentices requirements are met. As with the PTC, the 10 percent bonus credits for meeting domestic content requirements and for locating projects in an “energy community” apply.

Zero-Emission Nuclear Power Production Tax Credit

The Act establishes a new IRC Section 45U PTC for power produced at qualified nuclear power facilities and sold to an unrelated person. The Act provides a base credit of 0.3 cents per kilowatt hour and a bonus credit of up to 1.5 cents per kilowatt hour if the facility satisfies the prevailing wage and apprentices requirements. The new PTC applies to electricity produced and sold after December 31, 2023, and the credit ends for taxable years beginning after December 31, 2032. The credit amount is reduced if the price of electricity increases. A qualified nuclear power facility is one that is not an advanced nuclear power facility under IRC Section 45J and was not placed in service prior to enactment of the Act. Unlike other energy credits, there are no additional credits for meeting domestic content requirements or for investments in an “energy community.”

Clean Hydrogen Production Credit

The Act also creates a Clean Hydrogen Production Tax Credit (CHPTC) under IRC Section 45V. The CHPTC applies to clean hydrogen production after December 31, 2022, at a facility that began construction before January 1, 2033. The base credit is 60 cents per kilogram multiplied by a percentage determined by the applicable lifecycle greenhouse gas emissions rate. There is a bonus credit of five times the base credit if prevailing wage and apprenticeship requirements are met along with additional credits for meeting domestic content requirements and investments in an “energy community.” As with the other credits, the credit is reduced for projects that use tax- exempt bonds for financing. The IRC Section 45V credit is not allowed, however, if the facility includes carbon capture equipment for which an IRC Section 45Q credit (discussed below) is allowed.

Carbon Capture and Sequestration Tax Credit

The Act extends the IRC Section 45Q carbon capture and sequestration tax credit to projects that begin construction before January 1, 2033. This credit is available for a carbon capture, direct air capture, or carbon electricity generation project. The Act significantly reduces the yearly threshold amount of carbon oxide that must be captured for a facility to qualify for the credit. Specifically:

  • An electricity generating facility must capture at least 18,750 metric tons of carbon oxide annually, and must have a capture design capacity of not less than 75 percent of the baseline carbon oxide production of the unit;
  • A direct air capture facilities must capture at least 1,000 metric tons of carbon oxide during the tax year; and
  • Other facilities must capture at least 12,500 metric tons of carbon oxide annually.

The extension generally applies to facilities or equipment placed in service after December 31, 2022.

The Act provides a base credit rate of $17 per metric ton and a bonus credit rate of $85 per metric ton of carbon oxide captured and sequestered in geological formations.

The base credit rate is $12 per metric ton and the bonus credit rate is $60 per metric ton for carbon oxide captured and used in an enhanced oil recovery project or other use. For direct capture facilities, the base rate is $36 per metric ton and the bonus rate is $180 per metric ton of carbon oxide captured for storage in geological formations, and there is a base rate of $26 and a bonus rate of $130 per metric ton of carbon captured and used by the taxpayer.

Energy Manufacturing Tax Credits

The Act extends the IRC Section 48C advanced energy project ETC and provides an additional $10 billion in credits allocable to qualified investments. Of this, a maximum of $6 billion can be for investments outside of energy communities. The credit has a base credit of six percent and a bonus credit of 30 percent if wage and apprenticeship requirements are met. There are no additional credits for meeting domestic content requirements or for investments in an “energy community.” Also, taxpayers are not eligible for the credit if they received prior credits under IRC Sections 48, 48A, 48B, 48E, 45Q or 45V.

The Act also creates the IRC Section 45X advanced manufacturing PTC for eligible equipment produced in the United States and sold between December 31, 2022, and December 31, 2032. The amount of the credit depends on the specific eligible component being manufactured. These include photovoltaic cells, photovoltaic wafers, solar grade polysilicon, polymeric backsheet, solar modules, wind energy components, torque tubes, structural fasteners, inverters, electrode active materials, battery cells, battery modules, and critical minerals. The credit begins to phase out in 2030.

For more information about these renewable energy tax credits, contact us. We are here to help.

Authored by Phil MacFarlane.

©2022

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Mark Watson

Mark Watson

Partner-in-Charge, Tax Quality and Risk Management

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Mark Watson, CPA, CFP, joined Weaver in 2013 and has more than 25 years of experience providing tax compliance and…

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