On August 12, after months of false starts and reduced expectations, Congress passed the Inflation Reduction Act (the “IRA”) containing major changes to tax credits available to clean energy technologies. Many of these changes are largely similar to the clean energy tax provisions of the Build Back Better Act (the “BBBA”), which failed to gain sufficient support in the Senate last year. In particular, after the BBBA failed to draw the required unanimous support of democratic Senators necessary to pass through the reconciliation process, there continued to be cautious optimism that a scaled-back version of the BBBA, containing much of the renewable energy tax regime of the BBBA, was still feasible. At times, this hope seemed to flicker as key senators expressed skepticism that a deal could be reached. Hope was renewed when Senators Manchin and Sinema signed onto a revived tax credit package in the form of the IRA that has now passed Congress. The IRA is expected to be signed into law by President Biden today.
The IRA significantly extends the availability of existing clean energy and carbon capture tax credits, creates new clean energy tax credits and enhances the amount of certain tax credits, while imposing additional requirements on full credit eligibility. Of particular interest to industry participants, the IRA introduces the following:
- Creates a two-tier credit system whereby projects must satisfy certain wage and apprenticeship requirements in order to qualify for full credit eligibility;
- Provides for significantly enhanced credit amounts for projects situated in qualifying geographic areas or satisfying certain domestic content requirements;
- Significantly extends the beginning-of-construction deadline for projects seeking to qualify for certain existing clean energy tax credits;
- Allows for solar projects to claim the PTC in lieu of the ITC;
- Extends ITC eligibility to stand-alone storage projects;
- Increases the credit amount available to carbon capture facilities;
- Allows for a limited “direct pay” option for certain tax-exempt entities in respect of applicable clean energy credits, while generally allowing for the sale of such tax credits;
- Adds and expands numerous additional tax credits, including credits for the production of clean hydrogen / clean hydrogen facilities and credits for the production of certain renewable energy components;
- Expands credits available for the sale of electric vehicles and the construction of electric vehicle charging stations; and
- Provides for a new 15% corporate alternative minimum tax generally applicable to corporations with adjusted financial statement income of more than $1 billion. However, the IRA largely allows corporate taxpayers to utilize the clean energy credits described herein and tax depreciation to offset the corporate alternative minimum tax.
Below is a description of certain key tax provisions applicable to clean energy industry participants.
Two-Tier Credit System
- The IRA retains the two-tier credit system previously contemplated by the BBBA for most of the clean energy credits set forth in the IRA. Essentially, the taxpayer is only eligible for a “base rate” of credit equal to 20% of the “full credit” under current law (disregarding phase-outs) unless it meets certain prevailing wage and apprenticeship requirements described below (the “Wage Requirement”) during construction of the project and during the relevant credit period (e.g., the 10-year PTC period or the five-year ITC recapture period).1 For instance, a solar or wind ITC project that fails to meet the Wage Requirement would only be eligible for a 6% ITC, as opposed to a 30% ITC.
- In order to satisfy the Wage Requirement, a taxpayer needs to (a) pay prevailing wages at the local rate in which the project is located (as determined by the Secretary of Labor) for the construction and maintenance of the facilities and (b) ensure that no fewer than the applicable percentage of total labor hours are performed by qualified apprentices in order to meet the Wage Requirement. The applicable percentage is 10% if construction of a project begins prior to 2023, 12.5% if construction of a project begins in 2023 and 15% if construction begins after 2023.2
- Fortunately, the IRA allows taxpayers to take curative action if the taxpayer fails to meet the Wage Requirement. Moreover, a facility is deemed to satisfy the Wage Requirement if construction of the project begins prior to the date that is sixty days following the date on which the Treasury publishes guidance on the Wage Requirement. This provides developers with a runway to establish mechanisms to ensure compliance with the Wage Requirement.
- Another BBBA feature that was reintroduced in the IRA was the allowance of enhanced credits for certain projects: (i) projects that meet a “domestic content” requirement (generally, based on the percentage of domestically sourced content or manufactured products comprising the project) are eligible for a 10% bonus credit; (ii) projects that are located in “energy communities” (generally, communities with significant historic employment relating to traditional fossil fuel operations or brownfield sites) are eligible for a bonus credit of up to 10%; and (iii) projects that are located in certain low-income communities are eligible for a bonus credit of up to 20%.
- The “domestic content” requirement requires the taxpayer to certify that any steel, iron or manufactured product that is a component of the facility was produced in the United States. A manufactured product would be deemed to have been produced in the United States if not less than the “adjusted percentage” of the total costs of such manufactured product is attributable to products that are mined, produced or manufactured in the United States. The “adjusted percentage” is 40% for a facility that begins construction before January 1, 2025 (or 20% for offshore wind facilities), which is adjusted upwards in the following years until it reaches 55% for projects that begin construction after December 31, 2027, allowing taxpayers time to assess and adjust their supply chains for the additional credits.
- “Energy Communities” are defined as (a) census tracts where a coal mine closed after December 31, 1999 or where a coal-fired electric generating unit has been retired after December 31, 2009 (or which is directly adjoining such census tracts); (b) areas that: (i) have or had (since December 31, 2009) 0.17% or greater direct employment or 25% or greater local tax revenues related to the extraction, processing, transport or storage of coal, oil or natural gas and (ii) have an unemployment rate at or above the national average unemployment rate for the previous year; and (c) “brownfield sites” (generally, real property, the use of which may be complicated by the (potential) presence of a hazardous substance, pollutant or contaminant).
- “Low-income communities” are defined as (a) census tracts where the poverty rate is at least 20% or in which the median family income for such tract does not exceed 80% of statewide median family income (or the metropolitan area median family income if the tract is within a metropolitan area), (b) Indian land or (c) a qualified low-income residential building project or a qualified low-income economic benefit project.
The aforementioned “bonus credits” are in addition to the credits generally permitted for qualifying facilities (including the “additional credits” for projects satisfying the Wage Requirement) and would significantly enhance the value of credits generated by projects that meet one or more of these criteria. These bonus credits generally would be applicable to qualifying projects placed in service after 2022.
Modifications to Existing Production Tax Credits and Investment Tax Credits
- The beginning-of-construction deadline to qualify for the full PTC or ITC is extended to December 31, 2024. Absent the IRA revisions, the PTC phases out wind projects that began construction after December 31, 2016—and the PTC was completely unavailable for projects that began construction after December 31, 2021. Likewise, without the IRA extensions, there is a similar phase out for solar projects that began construction after December 31, 2019.
- Importantly, this revision would apply to projects that are placed in service after December 31, 2021—meaning projects under development that were relying on safe harbored equipment would now be eligible for the full PTC irrespective of costs incurred or work performed prior to 2021 (subject to the Wage Requirement described above).
- The IRA also makes solar projects eligible to claim the PTC rather than the ITC. Solar PTC eligibility would apply to projects placed in service after December 31, 2021. The Solar PTC provides industry participants with the flexibility to determine whether the PTC or ITC provides greater economic benefit based on the expected generation of a solar project, the timing of credit recognition and the cost of the project.
- Historically, in order to qualify for the ITC, a storage facility was required to be associated with a project (e.g., a solar or wind facility) that qualified for the ITC—that is, the storage project was only treated as qualifying ITC property by virtue of the fact that it was charged from the qualifying renewable project. The IRA provides for a “stand-alone” storage ITC, with the result that this requirement would no longer be applicable to qualifying storage projects placed in service after December 31, 2022.
- The ITC for stand-alone storage property would apply to projects satisfying the beginning-of-construction deadlines described above. As noted, the IRA also provides that the storage ITC would only apply to storage projects placed in service after December 31, 2022. As a result, a storage project placed in service this year would only be ITC-eligible to the extent it qualified under prior law—meaning, it is questionable whether a storage project associated with a solar or wind project that claims the PTC would be ITC-eligible. There is also ambiguity as to whether a taxpayer can claim the ITC with respect to a storage project (even if placed in service after 2022) associated with a solar or wind project that is claiming the PTC, but subject to further guidance, we expect that projects claiming separate ITCs / PTCs with respect to the such facilities is consistent with the policy behind the IRA.
- Subject to the applicable rules discussed above, eligibility for the “full credit” would be contingent on satisfying the Wage Requirement.
Carbon Capture Credits
- The IRA significantly extends the beginning-of-construction deadline for carbon capture projects eligible for the carbon capture credit (i.e., the 45Q credit)—projects that begin construction prior to January 1, 2033 are now eligible for the 45Q credit.
- Moreover, the IRA significantly increases the amount of the 45Q credit available to qualifying projects. The credit amount for typical carbon capture processes under the IRA is (i) $60 per metric ton of carbon oxide captured and used in a traditional industrial process and (ii) $85 per metric ton of carbon oxide captured and sequestered. In the case of projects that utilize the now-nascent direct air carbon capture technology, the credit is even greater: (i) $130 per metric ton of carbon oxide captured and utilized and (ii) $180 per metric ton of carbon oxide captured and sequestered.3
- The IRA also significantly reduced the threshold amount of annual carbon required to be captured in order for a facility to qualify for 45Q credits from at least 500,000 metric tons of qualified carbon oxide during the taxable year for an electric generating facility and at least 100,000 metric tons of carbon oxide per taxable year for any other facility to at least 18,750 metric tons of qualified carbon oxide during the taxable year from an electricity generating facility and 12,500 metric tons of carbon oxide per taxable year for any other facility. Direct air capture facilities may be eligible for the credit as long as they capture at least 1,000 metric tons of carbon oxide per taxable year.
- The enhanced 45Q credit provisions would apply to projects placed in service after December 31, 2021. Again, eligibility to claim the full 45Q credit would require that the project satisfy the Wage Requirement to the extent applicable to the relevant project. Carbon capture facilities are also eligible for the bonus credits available based on the criteria described above.
- The enhanced 45Q credit set forth in the IRA would be available to carbon capture facilities or equipment placed in service after December 31, 2022.
- Recognizing that new clean energy technologies are likely to emerge in the coming years, the IRA provides for technology-neutral clean energy tax credits in a manner similar to that contained in the BBBA. In particular, qualifying generation projects (essentially net zero carbon projects) that are placed in service after 2024 would be eligible for credits analogous to the PTC or ITC, as applicable, if the relevant project begins construction prior to the later of the first calendar year following (i) December 31, 2032 and (ii) the date the Treasury determines that greenhouse gas emissions from the production of electricity are less than 25% of such emissions for 2022. Projects beginning construction after these dates would be subject to phase-outs with respect to credit eligibility. In addition, satisfaction of the Wage Requirement discussed above would be required to claim the full credit and a qualifying project would be also eligible to claim the bonus credits described above if it meets the relevant criteria.
- The technology-neutral credit serves as a replacement credit for the existing PTC and ITC, as these credits become inapplicable to projects beginning construction after 2024.
Direct Pay / Credit Transferability
- The BBBA contained a “direct pay” feature for many of the traditional clean energy credits—essentially allowing taxpayers to treat the credits as a payment of taxes and, thereby, receiving a cash refund from the Treasury to the extent the taxpayer was treated (as a result of this deemed payment) as making payments in excess of its actual tax liability. The IRA significantly restricts this provision by limiting the direct pay option to certain categories of tax-exempt entities. However, other entities would be eligible to elect direct pay for certain tax credits, including the 45Q credit, for the first five years of the credit period. This exception would not apply to the wind or solar PTC / ITC.
- Although the direct pay option is only available to a limited set of taxpayers, the IRA provides that most renewable energy tax credits (including the credits discussed above, the clean hydrogen credit, the credit for the production and sale of applicable renewable energy components and the credit for specified renewable manufacturing facilities) generally may be transferred/sold to unrelated parties. This represents a significant change to prior statutory and case law regarding the availability of tax credits to taxpayers. The transfer election is made on a facility-by-facility basis, which may provide flexibility for project owners to claim credits with respect to certain “facilities” within a project (e.g., a turbine) and sell the credit applicable to other facilities. Credits once transferred cannot be subsequently transferred to another transferee.
- The ability of project owners to sell tax credits could, in some circumstances, present an alternative to traditional tax equity investment, attract a new group of investors beyond traditional tax equity investors and provide the sponsor/developer greater flexibility and options regarding monetization of the credits. However, as was the case with the prior 1603 cash grant regime introduced as part of the 2009 stimulus package, the benefits of such an option would not fully allow developers with limited tax capacity to effectively capture the value of project tax attributes (in particular, accelerated depreciation). Thus, a sponsor or developer with limited tax capacity would still need to seek tax equity investment to monetize these tax benefits.
- Taxpayers may transfer all or portion of credits, which may allow sponsors/developers to finance part of a project using the typical tax equity structure and fund the remainder by entering into long-term agreements with unrelated parties for the transfer / sale of the unallocated credits.
Additional Clean Energy Tax Credits
Clean Hydrogen Credits
- The IRA creates new tax credits with respect to the production of clean hydrogen. For qualified clean hydrogen production facilities that begin construction prior to January 1, 2033, taxpayers may claim a PTC for clean hydrogen produced by such facility during the ten-year period following the facility’s placed-in-service date. The amount of the PTC scales based on the amount of carbon dioxide remaining after the hydrogen production process. 4 Likewise, taxpayers may claim an ITC in lieu of the PTC, which also scales based on the amount of carbon dioxide remaining after the process. Such credits are subject to the Wage Requirement mechanic.
Credit for the Production of Certain Renewable Energy Components
- Another clean energy incentive introduced by the IRA is a credit for the production of renewable energy components (e.g., solar, wind energy components, certain energy storage components such as battery cells and modules and critical minerals) and sold to an unrelated taxpayer after December 31, 2022. The amount of the credit varies based on the type of component produced. The credit begins to phase out in 2030 through 2032—the credit is phased out by 25% for components sold in 2030, 50% for components sold in 2031, 75% for components sold in 2032 and is eliminated thereafter.
Expanded ITC for Certain Renewable Manufacturing Facilities
- The IRA provides for the expansion of the ITC under Code Section 48C for facilities that produce certain renewable energy equipment to include facilities that produce energy storage systems and components, grid modernization equipment or components, carbon sequestration technology, energy conservation technology, electric or fuel cell vehicles (including technologies, components or materials for such vehicles and associated charging or refueling infrastructure) and technology that re-equips a manufacturing facility with equipment to reduce greenhouse gas emissions by 20%.
- The total amount of such credits claimable by taxpayers in the aggregate is capped at $10 billion ($6 billion of which must be allocated to facilities not in “energy communities”) and taxpayers must apply for certification from the Treasury and place the relevant facility in service within two years of certification. The amount of credit is determined based on the two-tiered credit system similar to the other renewable energy credits, with a base rate of 6% that may increase up to 30% subject to the taxpayer satisfying the Wage Requirement. These credits may be further enhanced subject to the facility satisfying the bonus credit requirements described above.
Electric Vehicle and Related Credits
The Clean Vehicle Credit
- The existing clean vehicle credit was phased out with respect to electric vehicles when the manufacturer had sold 200,000 such vehicles. The IRA removes this restriction; however, it also modifies certain eligibility requirements.
- In general, in order to qualify for the full credit (generally $7,500), the vehicle must satisfy (i) a “critical mineral requirement” (generally, meaning the requisite value of the minerals comprising the vehicle’s battery must be extracted or processed in a country with which the United States has a free trade agreement or be recycled in North America) and (ii) a “battery component” requirement based on the percentage of the value of the vehicle’s battery components that were manufactured or assembled in North America. The requisite percentage of minerals / components for these purposes increases on an annual basis. The final assembly of a vehicle must also take place in North America in order to qualify for the credit.
- Moreover, vehicles that contain critical minerals or battery components extracted, processed or manufactured by entities owned or controlled by “foreign entities of concern” (e.g., North Korea, China, Russia and Iran) are ineligible for this credit. The IRA also limits the eligibility of taxpayers to claim this credit if the taxpayer’s adjusted gross income exceeds specified limitations.
The credit would apply to vehicles sold after 2022.
Additional Electric Vehicle Credits
- The IRA further provides tax credits for qualifying sales of used electric vehicles and commercial electric vehicles. Taxpayers who acquire a used electric vehicle before January 1, 2033 would be eligible claim credit equal to the lesser of $4,000 or 30% of the purchase price. The credit would be based on the taxpayers adjusted gross income and can be claimed multiple times (once every three years for electric vehicles purchased for $25,000 or less). The commercial electric vehicle credit amount generally is based on the “incremental cost” of the vehicle—the excess of the cost of the electric vehicle over the cost of a “comparable vehicle”—and is limited to a percentage of the basis of the vehicle (15%, or in the case of a vehicle not powered by gasoline or diesel fuel, 30%).
- The IRA also restores tax credits for qualifying alternative refueling property (e.g., electric vehicle charging stations). Taxpayers are eligible for 30% of the cost of the property (for credits up to $100,000 for each items of refueling property at a facility) and the property must be placed in service before January 1, 2033.
Corporate Alternative Minimum Tax
- The IRA also adds a 15% alternative minimum tax on a corporation with an annual adjusted financial statement income over $1 billion (determined based on the average of the preceding three years and based on the corporation’s GAAP financials with certain adjustments). Renewable energy credits and tax depreciation are generally available to reduce alternative minimum tax liability. The AMT will be effective beginning December 31, 2022.
For further information on the major changes made by the IRA to the tax credits available to clean energy technologies see our additional alerts at the following links:
- Inflation Reduction Act and Its Impacts on Private Equity and Energy Industries
- Changes to U.S. Taxation of Carried Interest Dropped from Proposed Inflation Reduction Act of 2022
- Schumer-Manchin Proposed Inflation Reduction Act of 2022 Would Have Significant Implications for the Taxation of Carried Interest
1The IRA directs the Treasury to publish regulations or other guidance to implement the Wage Requirement (e.g., potential reduction or recapture of credits for projects that fail to satisfy the Wage Requirement during the credit period and record keeping requirements for projects subject to the Wage Requirement).
2The IRA contains an exception to the apprenticeship requirement if the taxpayer can demonstrate that it made certain good faith efforts to meet the apprenticeship requirement.;
3Absent the changes introduced by the IRA, the amount of 45Q credit available to taxpayers is up to $35 per metric ton for carbon oxide used in EOR and other prescribed processes and up to $50 per metric ton for carbon oxide that is captured and permanently sequestered.
4The amount of clean hydrogen credit is calculated based on a two-tiered credit system with a base rate of $0.60 per KG of qualified clean hydrogen that would be multiplied by an “applicable percentage.” The “applicable percentage” varies from 20% to 100% based on the lifecycle greenhouse gas emissions rate.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Arthur V. Hazlitt, an O’Melveny partner licensed to practice law in New York, Alexander Roberts, an O’Melveny partner licensed to practice law in New York, and Dawn Lim, an O’Melveny counsel licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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