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    Taxation and Accounting Fall 2023 Report

    B Benjamin Haas and Martha Groves Pugh

    Sep 19, 2023

    19 min read

    Electricity Energy Federal Agencies Finance & Taxation Labor & Employment Nuclear Energy Oil and Gas Regulation Renewable Energy Specialized Practice Areas State Regulatory

    Summary

    • The Inflation Reduction Act of 2022 extended and modified the current production tax credit for wind and certain other renewable facilities placed in service after 2021 and begin construction before 2025.
    • A taxpayer claiming a 45V hydrogen credit can claim a credit under Internal Revenue Code (IRC) section 45U for existing nuclear plants but cannot claim a carbon capture credit under IRC section 45Q.
    • As taxpayers generate federal tax credits that require adjustments to property basis, a review of the state conformity provisions to the IRC is important to ensure the proper basis is utilized in determining state depreciation expense deductions.
    Taxation and Accounting Fall 2023 Report
    shaunl via Getty Images

    Introduction

    As shared in the Fall 2022 and Spring 2023 IRIS reports, on August 16, 2022, US President Joe Biden signed the Inflation Reduction Act of 2022 (the IRA) into law, which includes $369 billion in energy and climate spending. The IRA includes several new and expanded sources of government support for the development of a domestic clean energy industry and for the gradual transition to a more sustainable energy economy.

    Major provisions of the IRA that are of interest to the energy industry include an extension and expansion of existing investment and production tax credits for renewable energy; a mechanism to sell tax credits for renewable energy; a production tax credit for existing nuclear plants; newly created hydrogen tax credits and many more incentives. The IRA also implements a new alternative income tax on corporations and creates an excise tax on corporate stock buybacks (Please refer to the Spring 2023 Tax Committee Report for updates on these two provisions).

    Please refer to the below sections for further details on the major provisions of the IRA, including updates, where applicable, for regulatory guidance that has been issued by the IRS and Treasury.

    Renewable Tax Credit Provisions

    Extension of PTC and ITC

    The IRA extended and modified the current PTC for wind and certain other renewable facilities that are placed in service after 2021 and begin construction before 2025. The IRA also allows for a PTC for solar facilities placed in service after 2021 and that begin construction before 2025. The extended credit will apply utilizing a base credit of .5 cents/kWh and a bonus credit of five times that amount or 2.75 cents per kWH if the new prevailing wage and apprenticeship requirements are met (“PWA” and as described in greater detail below). Additional bonus credits are available if the qualified facilities meet the domestic content or energy community requirements. Projects that begin construction prior to 60 days after the date the government issues guidance on the PWA requirements will be treated as eligible for the bonus rate even if those requirements are not satisfied.

    The IRA also extended the ITC for qualified energy projects including solar projects. The base credit under the extension is 6% of the basis of qualified energy property and the credit is increased to 30% for projects that satisfy the PWA requirements. The bonus credits are also available for the ITC if domestic content or energy community requirements are met. Additionally, the IRA has a new ITC for stand- alone energy storage. Energy storage technology is property (other than property primarily used in the transportation of goods or individuals and not for the production of electricity) which receives, stores, and delivers energy for conversion to electricity (or, in the case of hydrogen storage, to store energy), and has a capacity of not less than 5 kilowatt hours.

    Technology neutral renewable credits

    After 2024, taxpayers will be able to take advantage of the PTC under section 45Y or the ITC under 48E for a power facility with any technology, so long as the facility’s greenhouse gas emissions rates are at or below zero. For this purpose, the greenhouse gas emissions rate means the amount of greenhouse gases emitted into the atmosphere by a facility in the production of electricity, expressed as grams of CO2e per kilowatt. In the case of a facility which produces electricity through combustion or gasification, the greenhouse gas emissions rate for such facility must be equal to the net rate of greenhouse gases emitted into the atmosphere by such facility taking into account lifecycle greenhouse gas emissions as described under the Clean Air Act. Similar rules regarding PWA requirements will be applicable.

    Prevailing Wage and Apprenticeship Requirements

    As mentioned above, the IRA also introduced for the first time the concept of a “base” and “bonus” credit amount, whereby taxpayers who meet comply with the “prevailing wage and apprenticeship” requirements will increase their base credit by a factor of five. In order to satisfy the requirements, any laborers employed by the taxpayer or any contractor or subcontractor in the construction of a qualified facility, and with respect to any taxable year during the “relevant period,” in the alteration or repair of such facility, must be paid wages that are not less than the prevailing wages for the construction, alteration, or repair of a similar character in the location in which such facility is located as most recently determined by the Department of Labor. For this purpose, the relevant period is the 10-year PTC period (12 years for Section 45Q carbon sequestration credits) or the five-year recapture period for the ITC. In order to satisfy the apprenticeship requirements, taxpayers must ensure that (i) the applicable percentage of the total labor hours of the construction, alteration, or repair of the qualified facility is performed by qualified apprentices (12.5% for facilities that begin after December 31, 2022 and before January 1, 2024, and 15% for facilities that begin thereafter), (ii) certain Department of Labor (or applicable state agency) apprentice-to-journeyworker ratios are met (e.g., two journeyworkers for each apprentice) and (iii) every taxpayer, contractor, or subcontractor that employs four or more individuals to perform construction, alteration, or repair of the qualified facility employs at least one apprentice.

    The PWA requirements apply to all IRA credits and is a new concept in the tax law. Given the financial import of the 5x multiplier, taxpayers have been eagerly awaiting regulatory guidance on implementing these new concepts.

    IRS Notice 2022-61

    On November 30, 2022, the IRS issued Notice 2022-61. The Notice features two important aspects of IRS guidance. The first aspect of the Notice describes which projects are exempt from complying with the PWA requirements. Projects that begin construction on or before January 29, 2023 need not comply with the requirements to receive the full value of the tax credit subsidies. The Notice defines beginning of construction by reference to a set of earlier IRS rules that have been published over the past decade. Those rules liberally permit projects to be treated as under construction when some amount of physical work has commenced either at the project site or by a manufacturer of certain critical project components. Projects owners can also incur 5% or more of the project’s cost as a means of establishing that their project is under construction for purposes of those rules (safe harbor rule).

    The second aspect of the Notice fills in some important details about how to apply these rules, largely incorporating the well-established principles of the Davis-Bacon Act. The Davis-Bacon Act was enacted by Congress in 1931 and directs the Department of Labor to determine prevailing wage rates for most contractors and subcontractors performing on federally funded or assisted contracts for the construction, alteration, or repair of public works projects. The Department of Labor has issued numerous pieces of guidance interpreting the Davis-Bacon Act, including defining concepts such as “construction, alteration or repair” and “laborer or mechanic.” Nevertheless, the Notice leaves open a number of important questions that will need to be addressed in supplemental guidance, including the definitions of a contractor and subcontractor.

    Finally, on a matter of practical importance, the Notice requires a taxpayer, along with any contractors and subcontractors, to maintain books of account and records of work performed in sufficient form to establish that the taxpayer, its contractors, and subcontractors have satisfied the PWA requirements with respect to the facility.

    Further, On August 30, 2023, the IRS and Treasury published proposed Treasury regulations (the “PWA Regulations”) providing expansive guidance on the prevailing wage and apprenticeship requirements that taxpayers must satisfy to receive the full credit amount available under the IRA. Taxpayers are permitted to rely on the PWA Regulations with respect to a facility on which construction began on or after January 29, 2023 but before final regulations are published.

    The PWA Regulations provided much needed clarity on the following issues:

    • Allocation of Legal Responsibility for PWA Requirements. The PWA Regulations make clear that the taxpayers who claim or transfer tax credits (and not the contractors or subcontractors of those taxpayers) are ultimately responsible for complying with the PWA Requirements. Thus, the onus is on the taxpayer to carefully monitor compliance with the PWA Requirements, ensure its contractors and subcontractors comply with the PWA Requirements, and maintain adequate records demonstrating compliance with the PWA Requirements. Well-advised taxpayers likely will seek to include provisions in their agreements with contractors to ensure that the PWA Requirements are satisfied and that necessary records and information substantiating the satisfaction of those requirements is maintained.
    • Incentives for Self-Policing. The PWA Regulations encourage taxpayers to carefully monitor failures to meet the PWA Requirements, proactively report these failures to the IRS, and then affirmatively and timely make correction payments. If taxpayers take these steps, as long as the noncompliance is relatively minor, then the PWA Regulations generally allow taxpayers to avoid the application of penalties. Given these benefits, taxpayers will want to put in place procedures for monitoring compliance, including compliance by contractors and their subcontractors.
    • Useful Begun Construction Rule, with Limits. Under the PWA Regulations, prevailing wage determinations generally have to be made only once, in connection with the commencement of construction. This rule does not apply, however, if there is a change in the scope of work originally envisioned. Given that scope changes are relatively common in the course of constructing a facility, this exception could apply relatively frequently. It would be useful if the exception were adjusted to apply in more limited circumstances (g., to major changes that result in a more than 10 percent adjustment to the contract price).[30]
    • Enhanced Apprenticeship Requirements. The PWA Regulations would tighten significantly the rules applicable to the Apprenticeship Requirements, including by limiting the scope of the Good Faith Effort Exception by providing that denial of a request for qualified apprentices lasts only 120 days after the submission of the request. This rule will make it necessary for developers to approach registered apprenticeship programs repeatedly. The IRS and Treasury’s further clarification that it may be necessary to make inquiries to multiple registered apprenticeship programs suggests that the IRS and Treasury are very focused on making sure that apprentices receive training opportunities, even if doing so imposes incremental compliance burdens.
    • Incentives for Entering into Qualifying Project Labor Agreement. Under the PWA Regulations, if a Qualifying Project Labor Agreement (e.g., collective bargaining agreement meeting certain criteria) is entered into, various penalties can be eliminated as long as any needed correction payment is made before the credit is claimed. This rule will provide some level of incentive for developers to pursue these types of agreements.
    • Helpful Rule for Offshore Wind Projects. The PWA Regulations include a helpful convention for offshore wind projects. Rather than requiring that each offshore wind project make a request for an individualized supplemental wage determination (given that general Department of Labor data is unlikely to cover offshore sites), the PWA Regulations allow use of the generalized information prepared by the Department of Labor for the closest geographical area.
    • Scope of Apprenticeship Requirements. The Code contains an ambiguity concerning whether the Labor Hours Requirement and Participation Requirements apply only to the “construction” of a facility (as opposed to the Prevailing Wage Requirements, which apply to both the construction phase of a facility and alteration and repair work performed after the construction phase with respect to the facility). Interestingly, the PWA Regulations suggest that the Participation Requirement would apply only to the construction phase of a facility (but would apply to all alteration and repair work, if any, occurring during that construction phase). In contrast, the PWA Regulations suggest that the Labor Hours Requirement would apply to both the construction of the facility and alteration and repair work performed after the construction phase with respect to the facility. It would be helpful for the IRS and Treasury to state its interpretation explicitly and to clarify this apparent discrepancy in the preamble to the final regulations. Further, more examples of the application of these and other rules that are more fact-intensive in application (including, for example, the secondary site rule) would be especially helpful.

    Direct Pay and Transferability

    The IRA created new IRC Sections 6417 (“Direct Pay”) and 6418 (“Transferability”). Section 6417 allows for Direct Pay for the first five years of the project, meaning a taxpayer can receive cash from the Treasury for the value of credit. Alternatively, Section 6418 allows for energy credits to be transferred for cash to a third party in a nontaxable transaction to the seller. The transfer of credits allows for a producers of clean energy who may not have the ability to utilize credits, to nonetheless monetize the credit through the sale and potentially eliminating the need for a traditional tax equity structure.

    On June 14, 2023, the IRS and Treasury issued proposed regulations on Direct Pay and temporary regulations on Transferability (“DP&T Regulations”). The DP&T regulations address several issues:

    • Consistent with the statute, the election, by either an applicable entity or an electing taxpayer, is treated as the payment of estimated tax.
    • The DP&T Regulations also confirm that an applicable entity that wholly owns a disregarded entity may make an election with respect to the applicable credit property held directly by the disregarded entity.
    • The DP&T Regulations also specifically address the treatment of partnerships where one of the members of the partnership is an applicable entity. In this regard, the DP&T Regulations state that the election must be made at the partnership level, thereby precluding members of a partnership that is an applicable entity from making the election. This means that tax-exempt entities cannot take advantage of direct pay if participating in a project through a partnership.
    • Timing: The DP&T Regulations provide that the election must be on the “annual tax return” filed not later than the due date (including extensions of time) for the original return for the taxable year for which the applicable credit is determined. This will be the year in which the property giving rise to the credit is placed in service. The annual tax return is a term that is introduced in the DP&T Regulations. In general, this means that the direct pay credit may not be claimed until the filing of the annual tax return in the tax year after the year the qualifying project is placed in service.
    • Registration requirement: Under the DP&T Regulations, in order to make an election for a direct payment, both applicable entities and electing taxpayers must register on an IRS portal. An entity must obtain a registration number prior to filing its tax return in which an elective payment is to be claimed. The IRS, in turn, will issue a registration number. The registration number is only valid for one year. The information needed as part of the return is extensive and is designed to allow the IRS to validate the claim for the direct payment. The DP&T Regulations implement the registration requirements, effective for taxable years ending on or after the date of publication in the Federal Registrar. The IRS is still working to create the registration site for direct pay and transferable credits.

    Hydrogen IRA

    The IRA introduces a new tax credit specifically for hydrogen production. Starting in 2023 and running ten years for projects placed in service prior to January 1, 2033, the new section 45V credit allows for a production tax credit (PTC) or an investment tax credit (ITC). The base amount of the PTC is $.60 cents/kg of clean hydrogen produced and can be increased to $3/kg if wage and apprenticeship requirements are met.

    In order to qualify for the maximum amount of the PTC, the underlying source producing the hydrogen generally needs to come from green hydrogen and the project needs to be located in the United States. The hydrogen can be produced and available for sale or for use in the ordinary course of the taxpayer’s trade or business. Alternatively, a taxpayer can claim an ITC with a base rate of 6% of the eligible costs and can be increased to 30% if the prevailing wage and apprenticeship requirements are met. Similar rules apply for the ITC in that the credit can qualify for either direct pay or may be transferred. Below is a chart summarizing the qualifications of the 45V hydrogen credit based upon CO2E emissions and corresponding credit:

    CO2E emissions equivalent per kg hydrogen PTC Base Rate Bonus Rate ITC Base Rate Bonus Rate
    Less than .45 kg  $.60/kg  $3 6% 30%
    Between .45 kg and 1.5 kg  $.20/kg  $1 2% 10%
    Between 1.5 kg and 2.5 kg  $.15/kg  $0.75 1.50% 7.50%
    Between 2.5 kg and 4 kg  $.12/kg  $0.60 1.20% 6%

    To satisfy the new PWA requirements (see above) for the bonus credit rates, a taxpayer needs to pay laborers and mechanics (and subcontractors) in construction or repair of the project must be paid prevailing wages for that region as defined by the Department of Labor (DOL) which publish such rates. Additionally, there needs to be an apprentice program for the project, meaning a certain number of the total labor hours on a project need to be filled by qualified apprentices, which again coincide with ratios published by the DOL by geographic region and job type. The domestic content requirement refers to the sourcing of the materials for the hydrogen project, but generally requires the steel and iron to be sourced in the U.S. and a minimum percentage of manufactured products must come from the U.S. A taxpayer claiming a 45V hydrogen credit can also claim a credit under IRC section 45U for existing nuclear plants but cannot claim a carbon capture credit under IRC section 45Q.

    Fall 2023 Update

    It is expected that the IRS will issue guidance in the Fall of 2023 (missing the August 16th, 2023 statutory deadline). Part of the reason for the delay in issuing guidance is a relatively novel issue called additionality which has been promoted by academia and environmental groups. The additionality argument proposes that green hydrogen (qualifying for the maximum PTC) can only be sourced from newly built renewable or clean energy sources. Their reasoning is if an electrolyzer is drawing power from any existing resource (clean or otherwise), then those MWs can only be replaced on the grid by power generation that emits increased greenhouse gases (such as coal or natural gas). It remains to be seen which way Treasury will go with the guidance and how much the White House may influence such guidance.

    Nuclear

    A new zero-emission clean nuclear power production credit is created under section 45U for electricity generation using nuclear energy at a qualified nuclear power facility and sold to an unrelated third party over the 10-year period after 2023 and through 2032. Qualified nuclear power facilities must be placed in service before the date of enactment of this section and do not include an advanced nuclear power facility defined under section 45J(d)(1).

    The base PTC amount is 0.3 cents/kWh of electricity produced and sold (subject to an inflation adjustment), which exceeds the reduction amount for the taxable year. The associated bonus PTC is multiplied by five or 1.5 cents/kWh if certain wage requirements are met. The 5x multiplier for the 45U credit does not include an apprenticeship requirement that is present for many of the other renewable energy credits.

    The 45U credit is reduced as the sale price of such electricity increases. The credit for any taxable year is reduced by 16% of the excess gross receipts from any electricity produced and sold by the qualified nuclear power facility over the product of 2.5 cents multiplied by the amount of electricity sold during the year. Therefore, facilities with receipts of less than 2.5 cents/kWh or $25/MWh would be eligible for the full credit amount. The reduction amount for any taxable year is the lessor of (1) the PTC amount multiplied by the electricity generated and sold, or (2) the amount equal to 16% of the excess gross receipts from any electricity sold over 2.5 cents (subject to inflation) multiplied by the amount of electricity sold.

    The gross receipts shall include any amount received by a taxpayer during the taxable year with respect to the qualified nuclear power facility from a zero-emission credit program, except if the full amount of the credit calculated is used to reduce payments from such zero-emission credit program. Zero-emission credit program means any payments with respect to a qualified nuclear power facility as a result of any federal, state, or local government program for (in whole or in part) the zero-emission, zero-carbon, or air quality attributes of any portion of electricity produced by such facility. For purposes of determining the amount received during such taxable year, the taxpayer shall take into account any reductions required under such program.

    Like the other credits included in the IRA, nuclear PTCs generated under Section 45U are eligible to be transferred. Therefore, in lieu of using the tax credits to offset their own tax liability, taxpayers that own nuclear assets that generate PTCs may elect to sell the PTCs to unrelated parties. The proceeds from such transfers are nontaxable to the taxpayer that generated the PTC.

    Due to the significance of the reduction amount in the PTC calculation and its incorporation of the term “gross receipts,” significant open questions remain on how this term will be defined for purposes of computing the reduction amount. In an attempt to seek clarity, the industry is currently working together to solicit administrative guidance from Treasury and the Internal Revenue Service on how to define “gross receipts.”

    Fall 2023 Update

    Treasury has yet to issue any guidance on the 45U nuclear PTC and it is likely that guidance with not be forthcoming until the Q1 of 2024.

    State Tax Implications of the IRA

    With the Internal Revenue Code (IRC) receiving yet another set of legislative changes, after the Tax Cuts and Jobs Act in 2017 (TCJA) and the Coronavirus Aid, Relief, and Economic Security Act in 2020, how states incorporate the Act into their own tax laws is an important issue taxpayers must consider when determining the full impact of the Act on their business operations.

    State Conformity to Internal Revenue Code

    States generally incorporate the IRC into their own tax laws through two main methodologies, “rolling conformity” and “static conformity.” States that utilize “rolling conformity” adopt the IRC as amended and do not need the state legislature to act for new provisions of the IRC to be incorporated into the states’ tax laws. Conversely, states that utilize “static conformity” adopt the IRC as of a specific date. Here, the state legislature must act to advance the conformity date for any new provisions of the IRC to be incorporated into the state’s tax laws. It should be noted that a small number of states utilize neither rolling conformity nor static conformity, but rather conform to only specific provisions of the IRC or adopt changes to the IRC only if certain conditions are met such as revenue impact.

    Energy Credits & Transferability

    For tax years beginning after 2022, the IRA provides that a taxpayer may elect to transfer the PTC and/or ITC to an unrelated taxpayer for a cash payment and exclude such sale proceeds from gross income. The transferability election must be made annually and separately with respect to each facility. Transferability has never been available for federal tax credits, and it remains to be seen how the market for the tax credits and the associated tax credit sale transactions develop.

    From a state perspective, the starting point for determining state taxable income is federal taxable income. Under the IRA, proceeds from the sale of federal energy credits would not be included in the state taxable income starting point – assuming the state conforms to the current version of the IRC. In states that have static conformity to the IRC as of a date prior to August 16, 2022, or if a state decouples from IRC section 30D, a situation arises where the proceeds from the transfer of PTC or ITC credits may create state taxable income, while being excluded from federal taxable income. Furthermore, if a state should require the proceeds be included in the taxpayer’s state taxable income base, then consideration should also be given as to how those proceeds should be represented in the taxpayer’s state apportionment formula. The sale of credits is likely not considered the sale of tangible personal property, and therefore, taxpayers will need to pay special attention to the state rules that control how to properly source the sale of intangible assets.

    The transferability of federal energy credits will impact the project finance landscape by changing the way developers and their financial partners can share the economic benefit of the incentives. If taxpayers have plans on generating new ITC or PTC credits with the intent to sell those credits, additional consideration should be given on where a project is placed and how that state conforms to the IRA. This will help to avoid any surprises where income excluded from tax at the federal level may be subject to tax at the state level. On a related point, taxpayers should also analyze whether state specific credits are available based on the type of project being commenced in the state. With the IRA generating a lot of attention of the credits available at the federal level, state credits can provide additional tax benefits that taxpayers can take advantage of.

    Energy Credits and Basis Adjustments

    If taxpayers claim an ITC, the basis of property must be reduced by 50% of the credit amount. While not a new provision of the IRA, it is important to remember how state depreciable basis interacts with the basis utilized for federal depreciation purposes. In most cases, state depreciable basis will reference the depreciable basis utilized at the federal level. For instance, New York provides that “Depreciable basis is the cost or other basis reduced by the part of the basis you elected to amortize or expense under IRC section 179, and any federal investment credit subtracted when computing the federal unadjusted basis of the asset.” Given the mechanics of determining depreciable basis in New York, any reduction in basis at the federal level relating to ITC credits awarded, is likely to also reduce the New York asset basis. Conversely, California explicitly decouples from IRC Section 48, the Section which authorizes the ITC. Because of this, depreciable basis for California purposes is without consideration of any reduction required by claiming an ITC.

    As taxpayers generate federal tax credits that require adjustments to property basis, a review of the state conformity provisions to the IRC is important to ensure the proper basis is utilized in determining state depreciation expense deductions.

    Tax Extenders

    Congress failed to pass any 2022 year-end tax extenders. The most significant omission which affects nearly all taxpayers was the reversion of Section 174 expenses that was set to sunset as a result of the TCJA. Therefore, starting with tax returns for the 2022 tax year, a taxpayer must now amortize Section 174 research expenses over a 15-year period. The IRS issued Revenue Procedure 2023-08 which provides taxpayers an automatic method change to be included on 2022 tax returns to now amortize Section 174 research expenditures. Taxpayers are able to include a statement with their 2022 tax return in lieu of filing a Form 3115 Method Change with the IRS. Taxpayers failing to make the automatic change on their 2022 tax returns, will be required to submit a Form 3115 for years ending after 12/31/2023.

    Looking to the end of 2023 and the prospect of any tax extenders, on the table would be the change to immediate expensing for Section 174 costs which has bipartisan support. However, it is likely that if any business tax package were to pass, the legislation would need to include an individual tax component as well, focusing on an expansion of the existing Child Tax Credit. It is too early to tell how far this may get in the current Congress but is worth monitoring as the year comes to a close.

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