Expansion of energy tax credits under the Inflation Reduction Act

February 14, 2024

The Inflation Reduction Act (IRA) of 2022 ushered in an era of renewed interest in clean and renewable energy investments, earmarking $400 billion in federal funds for energy and climate projects. The IRA incentivizes a broad array of clean energy projects from personal endeavors like purchasing electric vehicles to larger-scale projects designed to impact entire communities. 

For project developers and industry innovators involved in energy storage technologies, microgrid controllers, fuel cells, geothermal initiatives, microturbines, and solar and wind technology, the IRA provides some significant tax incentives. 

Expansion of energy tax credits under the IRA

Energy tax credits have long been a lever for businesses to invest in sustainable energy solutions. With the IRA, these opportunities have been expanded considerably.

Initially introduced decades ago, the Investment Tax Credit (ITC) and Production Tax Credit (PTC) have evolved significantly over time. In a nutshell, the PTC is a subsidy for the production of clean electricity, while the ITC supports new investments in clean electricity installations. Generally, the PTC can be claimed by those generating electricity via solar, wind, geothermal, or hydroelectric technologies (among others). The ITC can be claimed by those investing in things like energy storage, fuel cells, and microturbines. It’s important to note that a given project can benefit from either the PTC or the ITC, but not both. 

The ITC started as a temporary 10% tax credit for non-fossil fuel energy property, while the PTC was introduced as an inflation-adjusted tax credit for electricity generated using wind or biomass systems. The IRA has not only extended the lifespan of these credits but has also introduced new definitions and provisions, making the credits more robust. 

Treasury proposes to amend several regulations

In late November 2023, the Treasury proposed to amend four provisions in the regulations. Notable changes include increased credit amounts for fulfilling prevailing wage and apprenticeship requirements, and special rules tailored to the current energy landscape. 

New Rate Structures for PTCs and ITCs

The IRA introduced a two-tier rate structure for both the PTC and ITC, offering a base credit and some additional bonus credits. The base credit for the ITC is worth roughly 6% of a project’s cost basis. For the PTC, credits are awarded on a kilowatt-hour basis but are roughly comparable to 6% of the project’s value like the ITC (a detailed calculation is beyond the scope of this article, so we will use a 6% base rate to simplify the example). However, by meeting labor standards, the credits can be boosted to 30%.

For example, an ITC-eligible solar power plant with a $1 million cost basis can receive a 6% credit ($60,000), or if it meets the new labor standards, it can receive a 30% credit worth $300,000. 

To meet the labor standards and receive the full credit, projects must meet prevailing wage and apprenticeship requirements. 

The prevailing wage requirement mandates that laborers and mechanics be paid the same local prevailing wages (which differ by state and region) paid on federal construction jobs. For ITC projects, all wages paid for the first five years of a project must be prevailing wages. For PTC projects, prevailing wages must be paid for the first ten years of a project. 

The apprenticeship requirement calls for a certain percentage of construction labor hours to be performed by an apprentice, and the percentage increases over time from 12.5% to 15%.

Bonus Credits for Special Categories

The PTC and ITC may qualify for additional credits (beyond 30%) depending on the project’s location and use of domestic materials. 

Energy community bonus: projects in designated ‘energy communities,’ including brownfields, certain statistical areas, and coal closure tracts, can qualify for this bonus. This is a bonus of up to 10% for developers locating projects in communities historically dependent on fossil energy jobs and tax revenues. This bonus can be applied to the PTC or ITC. 

Low-income communities’ bonus: exclusively applicable to the ITC, this bonus supports projects in low-income areas. A 10% increase is available to eligible solar and wind facilities installed in low-income communities or on Indian land, and a 20% credit increase is available to eligible solar and wind facilities that are part of a qualified low-income residential building or a qualified low-income economic benefit project. 

Domestic content bonus: this credit boosts projects using domestic materials. The credit requires that all iron and steel and at least 40% (increasing over time to 55%) of the cost of all manufactured products that are components of a project upon completion of construction must be produced in the US. 

These bonuses can be combined. For instance, the same qualifying solar power plant, if meeting all labor requirements in an energy community with domestic content, could be eligible for a 50% ITC.

Monetization of Tax Credits

The IRA offers novel ways for businesses to capitalize on their tax credits. Under the section 6417 direct pay mechanism, certain tax-exempt and governmental entities can elect to receive cash payments from the IRS in lieu of claiming tax credits. 

Under the section 6418 transferability mechanism, most taxpayers (other than tax-exempt and government entities) can instead sell all or a portion of their tax credits to an unrelated party in exchange for cash. The cash is neither includible in the income of the transferor nor deductible by the transferee. There is an IRS pre-filing registration process and special rules applicable to partnerships and S corps. 

This article is intended to provide a brief overview of proposed amendments to certain energy credits under the IRA. The world of energy tax credits is dynamic and complex, so it is advisable to speak with an expert advisor if you’re considered a qualified energy project. For more information, please contact our office.

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