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10 Things to Remember About the IRA and Renewable Energy Tax Credits

Published by Forrest D. Milder on Monday, November 6, 2023

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The passage of the Inflation Reduction Act (IRA) in August 2022 began a new era for clean energy tax incentives, as the legislation included provisions that expanded and enhanced existing green tax incentives and created more.

As we progress through Year 2 of the IRA era, here are 10 key items about the landmark legislation and IRS guidance that projects sponsors and investors should know:

1. Solar and wind have the clearest guidance. It’s not surprising, but so far, Internal Revenue Service (IRS) guidance specifically identifies solar and wind far more than other technologies. Energy storage runs a somewhat distant third and other technologies haven’t gotten much coverage so far. For example, the IRS guidance on “begun construction” has been endorsed as continuing to apply to projects going forward, and the great bulk of it is related to solar and wind, although other technologies make occasional appearances. The domestic content guidance provides illustrations of which components and products must be analyzed for wind, solar and storage, but not for other technologies.

2. PWA. Prevailing wages and apprenticeship (PWA) rules apply to construction, alteration and repair. Taxpayers generally need to meet PWA requirements under the IRA in order to qualify for increasing the base amounts of certain clean energy tax incentive by five times. It should be expected that taxpayers will pay the penalties and back wages to protect the 5x multiplier. Although the IRA describes the tax credit rates as 6% for the investment tax credit (ITC) and 0.3 cents for the production tax credit (PTC), it should be expected that taxpayers with 1 megawatt or above facilities that began construction post-January 2023 (when PWA went into effect) will claim the five-times larger amount (30% and 1.5 cents, adjusted for inflation to 2.75 cents). Of course, this can involve penalties and the payment of back wages, but it’s going to be hard for a project sponsor to attract investors to a project that only claims 20% of the possible tax credits.

3. Policy objectives. The overarching purpose of the IRS is to enforce tax law, not to create social policy. There are those who expect that the IRS will liberally interpret some of the domestic content rules to encourage renewable projects generally. This doesn’t seem all that likely, although the IRS has issued the occasional favorable rule, like nonstructural steel treatment for flanges, which are part of wind towers. However, project developers and investors should not expect policy-driven guidance to appear in any kind of general way. Note that the IRS’s ability to waive the domestic content rules applies to projects sponsored by tax-exempt organizations and governments, where failure to meet the domestic content rules will mean a small reduction in credits, and the elimination of the credit for projects starting in 2026 and later. This waiver treatment is not available for credits claimed by for-profit entities.

4. A new constituency in the tax equity space. The domestic content rules have dragged the manufacturing community into the tax credit world, possibly making it possible for purchasers to figure out their profits because of the way that the IRS does its calculations. Remember that manufacturers are generally three or four steps removed from the person claiming the credits–the manufacturer sells to the contractor, who sells to the developer, who sells to the company that places the facility in service, with an investor who has tax counsel. So, it may be a while before the marketplace figures out just how much the manufacturer is responsible for with the actual tax credit claimant to whom it has no direct connection.

5. Staying under the 1MW and 5MW tests. The IRS has not written new guidance on what causes two facilities to be treated as one for purposes of the 1MW prevailing wage and 5MW environmental justice tests, but it did write a useful set of “you know it when you see it” tests in its begun construction guidance that dates to 2013. Notice 2013-29 provides the following factors, which it observes are not exclusive: (a) The facilities are owned by a single legal entity; (b) The facilities are constructed on contiguous pieces of land; (c) The facilities are described in a common power purchase agreement or agreements; (d) The facilities have a common intertie; (e) The facilities share a common substation; (f) The facilities are described in one or more common environmental or other regulatory permits; (g) The facilities were constructed pursuant to a single master construction contract; and (h) The construction of the facilities was financed pursuant to the same loan agreement.

6. Energy community adders. The 10% (PTC)/10% (ITC) adder for energy communities is the easiest one to sell to investors. Whether it is due to being a brownfield, or being on one of the IRS-published lists that applies to the statistical category (SMSAs and non-SMSAs that have at least 0.17% fossil fuel employment and above the national average unemployment) or to the “closed coal” category (census tracts and adjacent census tracts with closed coal mines or closed coal-fired generators) there is a pretty easy way to determine whether a project qualifies for an adder.

7. When did you begin construction? As noted above, the IRS is continuing to apply its begun construction guidance that was published in the roughly 10-year period before the passage of the IRA. However, remember that the IRS guidance has two components–not only must you start construction before the applicable date, but you must also pass a continuity test and the IRS provided a four-year safe harbor for the latter requirement. Under the IRA’s prevailing wage requirement (which provides an exemption if the project began before the end January 2023), it’s not clear what you should do if the project began long enough ago that it will have a more than four-year (sometimes longer on account of COVID-19 extensions) development/construction period. For example, suppose a project began construction in 2017 and then stopped until 2022, when it resumed and expect to finish in 2024. Did it “begin construction” before 2023 to avoid the prevailing wage and apprenticeship rules? If you decide that it began construction in 2022, are the expenditures incurred before 2022 eligible for the credit? It seems that a project sponsor is well advised to have a “diary” with photos and other supporting documentation as the best defense of these facts. And, in appropriate circumstances, the developer may be able to rely on the lists of permitted exceptions (like weather, work stoppages and certain financing issues that have appeared in the IRS guidance).

8. Environmental justice adder. Remember that the environmental justice adder is the one that must be applied for and awarded, and which can be 10 or 20 percentage points, depending on the category (the adder only applies to the ITC). There are lots of timing constraints attached to “environmental justice” adder. The window that opened Oct. 19 favors applications submitted in the first 30 days, which are all considered to have come in Oct. 19. After that, it’s first come, first served. And don’t forget that this adder is not available if the project is placed in service before the adder is awarded. Note that the environmental justice adder does not end after two years; instead, it jumps to the “technology neutral” Section 48E that applies to many renewable facilities placed in service after 2025.

9. Selling credits under Section 6418. Credits must be sold to unrelated persons. So, a housing partnership with a 99.99% investor in low-income housing tax credits (LIHTCs) can’t sell its energy credits to that same partner. It can still allocate the renewable credits to that investor, subject to the tax credit allocation rules which are different for the two credits. For the LIHTC, the 99.99% LIHTC investor must have a 99.99% interest in depreciation; for renewable investment tax credits, the 99.99% investor must have a 99.99% interest in profits. Developers in the LIHTC world know well that investors claiming renewable ITCs will restructure a sponsor’s incentive fees to assure that the IRS doesn’t consider them to be an interest in profits that might force the allocation of the renewable credit to the sponsor.

10. Sales of credits are subject to other limitations as well. The at-risk rules apply to the seller, which complicates the sale of credits by a closely-held owner of a facility. And the cash payment for the sold credits must be received no earlier than the year the facility is placed in service and no later than when the required election is filed, which can be no later than when the seller’s return, with extensions, is due, but not later than the earlier of when the buyer or seller files their actual return.

Sorting Out the New Law, Guidance

Any time there is a change in tax equity law, it takes the industry some time to absorb the changes and devise new strategies. Here, we not only have substantial statutory changes, but we also have comprehensive and detailed IRS guidance to review and analyze. And, of course, no matter how excellent a job the IRS does (as it has here), there will continue to be lots of smart practitioners and industry participants producing both clever strategies and vexing problems that are somehow not covered by the IRS guidance. So, it’s going to take some amount of time to sort this out.

Forrest Milder is a partner at Nixon Peabody.

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