The Inflation Reduction Act (IRA) signed into law on August 16, 2022 has generated explosive interest in clean and renewable energy investment in the United States. The IRA reflects the U.S.’s unequivocal expression of its ambition to become “the global leader in clean energy technology, manufacturing, andThe approximately $740 billion package, with nearly $400 billion earmarked for energy and climate projects, has prompted the European Union to put forward a Green Deal Industrial Plan to enhance the competitiveness of Europe’s clean energy and the United Kingdom to propose a set of energy security and climate change
Treasury and the IRS have published notices seeking public comments on various clean energy tax credit provisions and issued guidance on some key aspects of those provisions. The government has also ramped up coordination with other federal agencies such as the Department of Energy and the Environmental Protection Agency to implement thePart I of this article gives an overview of the energy tax credit provisions in the IRA. Part II discusses guidance issued to date. Part III identifies some remaining questions and challenges.
I. Overview of the IRA’s Energy Tax Credits
The investment tax credit (ITC) was first enacted in the Energy Tax Act of 1978 as a temporary ten percent tax credit for certain energy property and equipment using energy resources other than oil or naturalThe Energy Policy Act of 1992 passed the first production tax credit (PTC), an inflation-adjusted tax credit equal to 1.5 cents per kilowatt-hour of electricity generated using wind or closed-loop biomass Over the next decades, Congress revised both the PTC and ITC and introduced new energy tax credits to support U.S. commercialization of innovative renewable energy technologies in the U.S. Key concepts such as “beginning of construction” and “placed in service,” used to determine when a taxpayer can claim a tax credit and in what amount, also evolved through IRS
The IRA similarly expanded existing energy tax credits. For example, the IRA restored the section 45 PTC and the section 48 ITC to their full pre-phaseout rates and expanded the section 48 ITC to cover standalone energy storage (including battery storage as well as hydrogen storage). There are, however, several changes that distinguish the IRA from its predecessors.
First, the IRA created a new two-tier rate structure that applies to most PTCs and ITCs, consisting of a base credit amount and an additional credit amount above the base credit for projects that meet certain labor requirements, known as the prevailing wage and apprenticeship requirements. The base credit amount is one-fifth of the full rate. For example, if an ITC-eligible solar power plant with a cost basis of $1 million satisfies all relevant section 48 requirements including the labor requirements, the plant would be eligible for an ITC equal to 30 percent of its cost basis, or $0.3 million. If, however, the solar power plant fails to meet the labor requirements, the available ITC is reduced to 6 percent of its cost basis, or $60,000. Whether an energy project satisfies the labor requirements thus has a material impact on the economics of the project.
Second, under the prevailing wage requirement, all laborers and mechanics employed by a taxpayer or its contractors or subcontractors in the construction, alteration, or repair of a project must generally be paid the same local prevailing wages paid on federal construction jobs. Under the apprenticeship requirement, taxpayers must demonstrate that a certain percentage of total labor hours of the construction, alteration, or repair work (including work performed by any contractor or subcontractor) is performed by qualified apprentices and that a certain number of apprentices are employed in such work. The Department of Labor oversees setting wage and apprenticeship standards, and many interpretive issues are tied to labor provisions in the Davis-Bacon Act of 1931 and similar state prevailing wage laws.
Third, the IRA provides three types of bonus credits that further increase the available PTC and ITC: (1) the “energy communities” bonus, (2) the “low-income communities” bonus (application only to the ITC), and (3) the domestic contentDepending on the location and domestic content use of the energy project, projects placed in service after 2022 may be eligible for up to 10 percentage points (in the case of ITC-eligible projects) and 10 percent (in the case of PTC-eligible projects). For example, if the solar power plant project assumed above satisfies all relevant section 48 requirements and is placed in service in an energy community and satisfies the domestic content bonus requirement, it may be eligible for a 50 percent ITC (i.e., the 30 percent full credit plus 10 percent energy community bonus plus 10 percent domestic content bonus), or $0.5 million.
Fourth, the IRA introduced two new mechanisms to monetize energy tax credits. Renewable energy developers often have not had enough tax capacity to utilize the tax credits and depreciation deductions generated by energy projects and so have traditionally monetized those tax benefits by bringing tax equity investors with sufficient tax liability into the projects through joint ventures. These “tax equity” or “flip partnership” deals are relatively complex and consequently had a limited pool of potential investors. The IRA changed this dynamic by providing two alternatives to a tax equity structure. 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 taxUnder the section 6418 transferability mechanism, most taxpayers other than tax-exempt and governmental entities eligible for direct pay 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. The transferee cannot transfer the credit further.