Type: Law Bulletins
Date: 09/15/2022

How the Inflation Reduction Act Changes the Way Energy Tax Credits Are Calculated and Monetized

Introduction

As outlined in Taft's Inflation Reduction Act From 10,000 Feet Tax Bulletin, President Biden signed into law H.R. 5376, the Inflation Reduction Act of 2022 (the Act) on Aug. 16, 2022. Within the Act are two significant overarching changes that alter the way tax credits are generally calculated and how certain taxpayers may claim the credits. First, the Act implements a tiered credit structure to incentivize taxpayers to invest in certain communities, provide higher wages and training, and source materials from the United States. Second, the Act offers taxpayers alternative methods of claiming the various credits, through either (i) electing a direct payment or (ii) engaging in a one-time transfer of the credit. The Internal Revenue Service (IRS) is expected to release further guidance on these changes and how taxpayers can capitalize on them.  

Prevailing Wage, Apprenticeship, Domestic Content, and Energy Community Credit Increases

The Act creates a tiered credit structure that contains a base credit amount that may be increased up to five times — if prevailing wage and apprenticeship requirements are satisfied — and by an additional 10% to 20% — if certain domestic content requirements are met or the property subject to the credit is in an "energy community." Taxpayers can still claim the credits if they do not satisfy these various credit increase requirements, but are limited to claiming them at the lower base rate. Notably, there are two general exceptions to the prevailing wage and apprenticeship requirements: (1) projects that are below a certain minimum capacity (typically 1 megawatt); and (2) taxpayers are deemed to meet these requirements for projects that begin construction prior to 60 days after Treasury or IRS guidance regarding these requirements is released.

Generally, the prevailing wage requirements necessitate that laborers, mechanics, and workers be paid the prevailing wage, as determined by the Secretary of Labor, in the locality of the project. These wages must be paid during project construction or the credit term. The general apprenticeship requirements stipulate that qualified apprentices perform an applicable percentage — between 10% and 15%, depending on when the project begins construction — of total labor hours for the project and contractors or subcontractors employing four or more individuals to perform work on the project must employ at least one qualified apprentice. The apprenticeship requirement is subject to a "good faith effort" exception if the taxpayer satisfies certain criteria. Furthermore, projects that do not meet either of these requirements may also cure their failure through additional payments made to the affected workers, if there is a failure to meet the prevailing wage requirement, or to the government, if the contractor does not satisfy the apprenticeship requirement.

The 10% domestic content bonus is generally available if a certain percentage of components — steel, iron, or manufactured products — are manufactured in the United States. Additionally, a 10% "energy community" bonus is available for projects that qualify. An "energy community" is defined to include brownfield sites, areas with significant employment and tax revenues derived from coal, oil, or natural gas processing, areas with unemployment above the national average for the preceding year, or a census tract — or adjoining tract — where coal mines or coal fired power plants previously operated.

These critical changes impact most of the Internal Revenue Code’s (IRC) tax credits related to energy production and sustainability. Below is a list of some of the more prominent provisions that implement this tiered credit structure:

  • IRC Section 45: Production Tax Credit.
  • IRC Section 48: Investment Tax Credit.
  • IRC Section 45Y: Clean Electricity Production Tax Credit.
  • IRC Section 48E: Clean Electricity Investment Tax Credit.
  • IRC Section 48C: Advanced Energy Project Credit.
  • IRC Section 45Q: Carbon Capture and Sequestration Credit.
  • IRC Section 45U: Zero-Emission Nuclear Power Production Credit.
  • IRC Section 45V: Clean Hydrogen Production Tax Credit.
  • IRC Section 30C: Alternative Fuel Vehicle Refueling Property Credit.
  • IRC Section 30D: Clean Vehicle Credit Modified.
  • IRC Section 45W: Clean Commercial Vehicles.
  • IRC Section 45X: Advanced Manufacturing Credit.
  • IRC Section 45Z: Clean Fuel Production Credit.
  • IRC Section 45L: New Energy Efficient Home Credit.
  • IRC Section 179D: Energy Efficiency Commercial Buildings Deduction.

Elective Direct Payments and Transferable Credits1

The Act also created IRC § 6417, which permits certain "applicable entities" to make a direct pay election that treats the credit amount as a payment against the taxpayer’s income tax liability. This election is available for tax years beginning after Dec. 31, 2022, and before Jan. 1, 2033. Allowing certain entities to elect a direct payment rather than a credit against income tax is particularly advantageous in situations where the entity’s credit exceeds its liability — or where an entity has no income tax liability at all. Rather than claiming a credit and carrying forward any unused amount — for a limited term of years — these entities can elect to receive a direct payment and any overpayment will result in a refund. "Applicable entities" are defined to include:

  1. Any tax-exempt organization.
  2. State and local governments and any political subdivisions.
  3. The Tennessee Valley Authority (TVA).
  4. Indian Tribal Governments.
  5. Alaskan Native Corporations.

The direct payment regime allows for these tax-exempt entities to utilize and monetize the tax credits via a refund, even though such entities generally do not incur tax liabilities. This change drastically expands the pool of entities that can benefit financially from federal energy and sustainability incentives.

In certain circumstances, taxpayers claiming the IRC Sections 45V, 45Q, and 45X credits are not required to be an "applicable entity" – meaning any taxpayer eligible for these credits may elect to receive a direct payment.

Credits eligible for the direct pay election include:

  • IRC Section 45: Production Tax Credit.
  • IRC Section 48: Investment Tax Credit.
  • IRC Section 45Y: Technology-neutral Production Tax Credit.
  • IRC Section 48E: Technology-neutral Investment Tax Credit.
  • IRC Section 48C: Advanced Energy Project Credit.
  • IRC Section 45Q: Carbon Capture and Sequestration Credit.
  • IRC Section 45U: Zero-Emission Nuclear Power Production Credit.
  • IRC Section 45V: Clean Hydrogen Production Tax Credit.
  • IRC Section 30C: Alternative Fuel Vehicle Refueling Property Credit.
  • IRC Section 45W: Clean Commercial Vehicles.
  • IRC Section 45X: Advanced Manufacturing Credit.
  • IRC Section 45Z: Clean Fuel Production Credit.

Furthermore, the Act created IRC § 6418, which provides that for taxable years beginning after Dec. 31, 2022, eligible taxpayers may make an irrevocable one-time election to transfer all or a portion of certain credits to an unrelated taxpayer. This provides an alternative to the typical tax equity financing currently used in certain projects. The transfer must be made in cash and elected no later than the due date of the tax return for the year in which the credit is to be claimed. Additionally, the amount transferred is not includable in the transferee taxpayer's income nor deductible by the transferor taxpayer. Eligible taxpayers are any taxpayers not defined as an "applicable entity" under IRC § 6417.

Credits eligible for one-time transfer include:

  • IRC Section 45: Production Tax Credit.
  • IRC Section 48: Investment Tax Credit.
  • IRC Section 45Y: Technology-neutral Production Tax Credit.
  • IRC Section 48E: Technology-neutral Investment Tax Credit.
  • IRC Section 48C: Advanced Energy Project Credit.
  • IRC Section 45Q: Carbon Capture and Sequestration Credit.
  • IRC Section 45U: Zero-Emission Nuclear Power Production Credit.
  • IRC Section 45V: Clean Hydrogen Production Tax Credit.
  • IRC Section 30C: Alternative Fuel Vehicle Refueling Property Credit.
  • IRC Section 45X: Advanced Manufacturing Credit.
  • IRC Section 45Z: Clean Fuel Production Credit.

Lastly, the newly enacted IRC Section 6418 provides for a modified three-year carryback period for certain credits, including those under IRC Sections 30C, 45, 45Q, 45X, 48C, and 48.

These changes broadly impact numerous provisions and are important in understanding potential opportunities and planning projects in order to maximize the benefit available. Future editions in this series will address the other substantive provisions contained within the Act.

As mentioned, this is a high-level overview of the Act and its provisions. Taft’s Tax practice will be issuing bulletins regularly to provide a more in-depth analysis of these code provisions and their impact on taxpayers. If you have questions regarding any of these provisions, please contact one of the listed attorneys or another member of Taft’s Tax practice.  

1 Act Section 13801. 

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