Inflation Reduction Act: energy provisions | Baker Tilly
Article
Inflation Reduction Act: energy provisions
2022 year-end tax letter
Oct. 26, 2022 · Authored by Mike Schiavo
The Inflation Reduction Act (IRA) includes a wide range of credits designed to facilitate the transition to cleaner energy production, promote advanced manufacturing, encourage the adoption of clean vehicles (CVs) and reduce greenhouse gas emissions through the use of alternative fuels and energy-efficient technologies. This article focuses on four broad areas of credits: clean energy production and investment, advanced manufacturing, CVs and alternative fuels and energy efficiency. We also discuss the unique structure of the credits, many of which start with a base amount and can be increased by a factor of five if a project pays prevailing wages and employs apprentices, which is obviously a huge incentive to meet those requirements. There are also kickers for domestic content and projects located in energy communities. Finally, we conclude with a brief overview of the provisions in the Act that are designed to help taxpayers monetize the credits.
That said, the tax credit rules are extremely complicated, and it is all too easy to get lost in the weeds. There are detailed definitions and technical requirements, specific construction start date and placed-in-service date cutoffs, phase-in and phase-out dates, domestic content requirements, tax-exempt financing rules and many other nuances. In addition, various technologies may be eligible for multiple credits, but there are rules to prevent double dipping – for example, if a facility gets a credit under the section 45 production tax credit, it is not eligible for the section 48 investment tax credit. Careful analysis is required to choose the right mix of credits and to maximize tax benefits.
This article provides a general overview. Please consult your Baker Tilly advisor for the specific requirements applicable to your projects.
1. Clean energy production and investment
The extension and expansion of the production tax credit (PTC) and the energy component of the investment tax credit (ITC) are major elements of the IRA. The legislation also extends and modifies the carbon oxide sequestration credit (CSC) and adds new credits for clean hydrogen production and zero-emission nuclear production. This article will focus on the PTC and ITC.
Production tax credit – current section 45 and new section 45Y
The section 45 PTC provides a per kilowatt hour (kWh) credit for electricity produced from certain renewable resources, including wind, closed and open-loop biomass, geothermal, solar, municipal solid waste, hydropower and marine/hydrokinetic energy. The credit applies for a 10-year period to energy produced by the taxpayer from qualified resources at a qualified facility and sold to an unrelated party.
Under prior law, the PTC generally was not available for projects that started construction after Dec. 31, 2021. The IRA extends the construction start deadline through the end of 2024. The Act also restructures the credit to a two-tier system — a base amount (0.3 cents per kWh) and bonus amount (1.5 cents per kWh) depending on whether the taxpayer meets prevailing wage and apprenticeship requirements (see discussion below). There are also incentives for domestic content and for locating facilities in energy communities (see below).
After the existing PTC phases out at the end of 2024, the new section 45Y clean electricity production credit will come online. This new credit has the same two-tier structure and 10-year credit period as the existing PTC. However, the credit is technology neutral — if the greenhouse gas emissions rate at the facility producing the electricity is not greater than zero, the facility will be a “qualified facility” for purposes of the credit.
Investment tax credit – current section 48 and new section 48E clean electricity investment credit
Under the section 48 energy credit, which is a component of the investment tax credit, taxpayers get a credit for the “energy percentage” of the basis of energy property placed in service during the taxable year. In contrast to the PTC, the ITC provides an upfront credit for investment in energy property (versus an annual credit during the production period).
While there is a lot of overlap between the technologies eligible for the PTC and the ITC, “energy property” for purposes of the ITC does not include any property which is part of a facility that produces electricity, and which is allowed a credit under the section 45 PTC. However, taxpayers may make an irrevocable election to treat a PTC qualified facility as a qualified investment credit facility (construction must begin before Jan. 1, 2025).
The IRA made numerous changes to the ITC rules, including extending the construction start deadline for several types of projects, restructuring the credit to a two-tier system and expanding the list of technologies eligible for the credit. The legislation also introduced a new technology-neutral clean electricity investment credit (section 48E) for property placed in service after 2024. The new clean electricity investment credit applies to qualified facilities and energy storage technologies with greenhouse gas emissions rates not greater than zero.
For most energy property, the baseline energy credit percentage is 6%, and the bonus energy credit percentage is 30% (if prevailing wage and apprenticeship requirements are met, see discussion below). The kickers for domestic content and energy communities also apply.
2. Advanced manufacturing
Advanced energy project credit (section 48C)
The advanced energy project credit is a competitive application-based program run by the Treasury Department and the Department of Energy. The IRA allocated $10 billion in new funding for these credits, $4 billion of which is reserved for projects located in energy communities. Taxpayers who win an allocation award and receive project certification will get a credit based on their investment in qualifying advanced energy projects. The credit is 30% of the qualifying basis if the project meets the prevailing wage and apprenticeship requirements discussed below. The term “qualifying advanced energy project” means a project which re-equips, expands or establishes an industrial or manufacturing facility which is used to produce or recycle a wide range of clean energy technologies; which re-equips an industrial or manufacturing facility with equipment designed to reduce greenhouse gas emissions by at least 20%; or which re-equips, expands or establishes an industrial facility for the processing, refining or recycling of critical materials.
Advanced manufacturing production credit (section 45X)
The new advanced manufacturing production credit applies to components produced and sold after Dec. 31, 2022. The amount of the credit varies by the type of component and depends on a host of technical factors (for example, capacity of a photovoltaic cell, size in square meters of a photovoltaic wafer, capacity of a completed wind turbine project). The credit covers a wide range of components used in solar energy, wind energy, certain inverters (related to solar and wind), qualifying battery components and applicable minerals. While the prevailing wage and apprenticeship bonus amounts are not available for this credit, taxpayers can utilize the direct pay and transferability options (see discussion below on monetizing credits). The credit phases down for components sold after Dec. 31, 2029.
3. Electric vehicles and alternative fuels
Clean vehicle credit (section 30D)
The Act overhauls the credit under section 30D for new qualified plug-in electric drive motor vehicles, resulting in the CV credit. Broadly, a CV is a motor vehicle that, among other requirements:
Is purchased new and placed in service by the taxpayer for use or lease (not for resale),
Is made by a qualified manufacturer (generally, one that enters into an agreement with the Treasury secretary to provide periodic information regarding the vehicles it manufactures),
Has a gross vehicle weight rating less than 14,000 pounds,
Is propelled to a “significant extent” by an electric motor that draws electricity from a battery with a capacity of at least 7 kWh and is capable of being recharged, and
The final assembly of which occurs in North America.
Critical limitations: The credit is unavailable for vehicles with manufacturers’ suggested retail prices that exceed certain thresholds ($80,000 for vans, SUVs and pickup trucks; $55,000 for any other vehicle). Additionally, no credit can be claimed by a taxpayer whose modified adjusted gross income (MAGI) exceeds certain amounts ($300,000 for joint filers, $225,000 for head of household, $150,000 for all other filers).
Similar to the previous electric vehicle credit, the maximum CV credit remains $7,500, though the manner in which it is computed has changed. The first $3,750 is contingent upon the percentage of the vehicle’s battery that is made up of critical materials (i.e., aluminum, lithium, zinc, etc.) that were either:
Extracted or processed in the U.S. or any country with which it has a free trade agreement, or
Recycled in North America.
For vehicles purchased and placed in service prior to 2024, at least 40% of the critical materials making up the vehicle’s battery must meet one of these two requirements for the first $3,750 of credit to be available. This percentage threshold increases annually up to a maximum threshold of 80%, for all vehicles placed in service after 2026. Presumably, this is to accommodate the need to develop the critical materials supply chain within North America, as currently, the vast majority are exported from overseas.
The second $3,750 depends on the percentage of the vehicle battery’s remaining components (other than critical minerals) that are manufactured or assembled in North America. For vehicles purchased and placed in service before 2024, at least 50% of the components must be manufactured or assembled in North America. This percentage threshold increases annually by 10% up to 100% for vehicles placed in service after 2028.
For purchases of CVs after 2023, a taxpayer can make an election to transfer the credit to the dealership, in exchange for cash or a credit toward payment for the CV. This creates neither an income event for the purchaser nor a deduction for the dealership. However, if the credit ultimately is not allowable under the provision’s numerous rules (for instance, if the buyer’s AGI is too high), the purchaser’s tax liability for the tax year they placed the vehicle in service would be increased by the amount of payment they received from the dealership.
The Act eliminates the per manufacturer limitation on the number of credit-eligible vehicles, effective for those sold after 2022. After 2023, a vehicle’s battery components must not have been manufactured or assembled by a “foreign entity of concern,” for vehicles placed in service after 2024, no credit is available for any vehicle whose battery’s critical minerals were extracted, processed or recycled by a “foreign entity of concern.” The credit expires after 2032.
Previously owned CVs (section 25E)
A new credit is available under section 25E for certain used CVs acquired after 2022 and before 2033, equal to the lesser of $4,000 or 30% of the vehicle’s sales price. In addition to other requirements, the CV must have a model year at least two years older than the year in which the taxpayer purchases it from a licensed dealer, at a price of $25,000 or less. The CV must also not have been previously resold since the passage of the Act. Eligibility for the used CV credit is not contingent upon the vehicle’s place of final assembly or the source of its battery’s critical materials or other components.
Taxpayers whose MAGI for the year of purchase or the preceding year exceeds $150,000 in the case of a joint filer or surviving spouse, $112,500 for a head of household, or $75,000 for others, are ineligible for the credit.
New credit for qualified commercial CVs (section 45W)
Businesses are now eligible for a credit for qualified commercial CVs placed in service after 2022 and before 2033. The credit is the lesser of:
15% of the CV’s basis (30%, if the CV is not powered by a gasoline or diesel internal combustion engine), or
The CV’s “incremental cost” — broadly, the amount by which the CV’s purchase price exceeds the price of a comparable vehicle, defined as a vehicle similar in size and use that is powered solely by a gasoline or diesel internal combustion engine).
The maximum credit for a CV with a gross vehicle weight rating of less than 14,000 pounds is $7,500; for all other vehicles, $40,000.
Alternative fuel vehicle refueling property (section 30C)
The Act extends the credit for 30% of alternative fuel refueling property placed in service through 2032. The credit is reduced to 6% for depreciable property used in a trade or business unless it satisfies wage and apprenticeship requirements discussed below. The credit is limited to $100,000 per property placed in service after 2022 if used in a trade or business, and $1,000 if installed for personal use (the credit limit applies on a per location basis for property placed in service prior to 2023). To be credit-eligible, property placed in service after 2022 must be either in a low-income or rural area.
Biodiesel and renewable diesel used as fuel credit (section 40A)
The credits for biodiesel and diesel fuel mixtures, and biodiesel used or sold by a taxpayer in their trade or business, and the production of qualified agri-biodiesel are extended through 2024.
Alcohol fuel, biodiesel and alternative fuel mixtures credit (section 6426)
The excise tax credits for alcohol fuel, biodiesel and other alternative fuels sold or used by the taxpayer in their trade or business are extended through 2024.
New sustainable aviation fuel credit (section 40B)
The Act creates a new credit for the mixture of sustainable aviation fuel and kerosene produced by the taxpayer in the U.S. and sold or used in its trade or business in 2023 or 2024. The credit is calculated by multiplying the number of gallons of sustainable aviation fuel the mixture contains by a $1.25 base, with the base amount increasing up to an additional 50 cents if certain greenhouse gas emissions reductions are met.
New clean fuel production credit (section 45Z)
A new credit is available for clean fuel produced by the taxpayer at a qualified facility (which notably excludes any facility on which the credits for the production of clean hydrogen or carbon oxide sequestration are claimed) from 2025 through 2027. The credit is computed by multiplying a 20-cent base amount (35 cents in the case of sustainable aviation fuel) per number of gallons sold for qualifying uses by certain emissions reduction factors. The base amount increases to $1 ($1.75 in the case of sustainable aviation fuel) if certain prevailing wage and apprenticeship requirements discussed below are met.
4. Energy efficiency
Many of the credits in the energy efficiency category will be familiar to individual taxpayers, particularly those in the real estate industry.
Nonbusiness energy property credit (section 25C)
The personal credits for energy-efficient improvements a taxpayer makes to their principal residence have been extended and enhanced. Under prior law, the available credit for exterior windows and doors, insulation material, electric heat pumps, high-efficiency central air conditioners and other property meeting specified energy efficiency standards a taxpayer placed in service prior to 2022 was generally subject to a lifetime limitation of $500. The IRA extends the credit for such property placed in service prior to 2033 and replaces the $500 lifetime limit with a much more favorable $1,200 annual limit. The credit is broadly calculated as 30% of the sum of the taxpayer’s qualifying expenditures made during the year, now to include amounts paid for home energy audits and certain biomass and renewable fuels used as heat sources and, for certain fuels produced after 2024, transportation. Additional limitations are placed on credit-eligible amounts by property types. Changes are effective for property placed in service after 2022, and the credit as calculated under prior law is available for property placed in service prior to 2023. The credit expires after 2032.
Residential clean energy credit (section 25D)
The Act extends through 2034 the residential energy-efficient property credit and retitles it as the residential clean energy credit. The preexisting credit of 26% of qualifying expenditures for solar electric, solar water heating, fuel cell, small wind energy, geothermal heat pump and biomass fuel property placed in service in connection with the taxpayer’s residence remains available through 2021. The residential clean energy credit remains largely unchanged from its predecessor, with the exception of replacing eligible expenditures for biomass fuel property with expenditures for qualified battery storage. The credit percentage for qualifying expenditures increases to 30% for property placed during 2022 through 2032, reverts to 26% for property placed in service during 2033, and drops to 22% for property placed in service during 2034, the last year the credit is available.
New energy-efficient home credit (section 45L)
The credit available to eligible contractors for newly built energy-efficient homes acquired for use as a personal residence is extended through 2032. For homes acquired after 2022, the maximum credit is increased to $5,000 from $2,000, and the energy saving requirements a home must meet are changed. Under previous law, a home must be certified to provide a level of heating and cooling energy consumption that is at least 50% below that of a particular “reference” home to be eligible for the maximum $2,000 credit. The Act updates the energy saving requirements to conform to certain Energy Star national program requirements, and the zero-energy ready home program of the Department of Energy.
Prior section 179D allows, subject to limitation, a deduction equal to the cost of energy-efficient commercial building property (EECBP) placed in service during the taxable year. To qualify as EECBP, property must be:
Depreciable, or amortizable in lieu of depreciation,
Installed on or in any building both located within the U.S., and within the scope of specified energy standards for buildings issued by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE),
Installed as part of the building’s interior lighting systems, the heating, cooling, ventilation and hot water systems, or envelope, and
Certified in accordance with certain rules prescribed by the IRS and Treasury, that among other things, the property is part of a plan to reduce the building’s energy consumption by 50% or more relative to the aforementioned ASHRAE standards.
The maximum deduction allowed with respect to any building for a taxable year is the building’s square footage multiplied by $1.80, less the total deductions claimed with respect to that building in all previous tax years. For example, consider a taxpayer who in 2020 installed $50,000 of EECBP in a building with a square footage of 100,000 feet. If the same taxpayer claimed deductions for EECBP installed in the same building in all previous years totaling $150,000, the taxpayer’s 2020 deduction would be limited to $30,000 as follows: 100,000 building square footage multiplied by $1.80 equals $180,000; less the $150,000 total deductions claimed in all previous tax years. Partial deductions are available in certain instances in which property installed meets the first three of the four above-listed requirements.
A special provision allows for the deduction attributable to EECBP installed on or in government property to be allocated to the taxpayer primarily responsible for designing the property, in lieu of the property’s owner.
The IRA makes several significant permanent changes to the section 179D deduction, including (but not limited to):
Reducing the energy consumption reduction percentage qualifying property must satisfy to 25% from 50%.
Reducing the dollar amount multiplied by the building’s square footage to determine the allowable deduction to a base 50 cents amount from $1.80. This base figure can be increased up to $1 per square foot, by 2 cents for each percentage point the building’s energy and power costs are reduced by a percentage greater than the aforementioned 25%.
The 50-cent base amount is increased to $2.50 if the property is placed in service in connection with a project that meets the prevailing wage and apprenticeship requirements discussed below. Further, the $1 per square foot maximum for such projects is increased to $5, by 10 cents for each percentage point the building’s energy and power costs are reduced by a percentage greater than 25%.
The per property lifetime cap on the maximum deduction allowed is replaced with a three-year cap (i.e., the deduction claimed in a given year will only be reduced by the total deductions claimed with respect to the property over the three previous tax years, rather than all previous tax years).
Taxpayers can elect to claim an alternative deduction for energy-efficient retrofit building property, in the tax year the retrofitting plan is certified as reducing the building’s energy usage intensity by at least 25% (in lieu of the reduction of energy consumption required by the standard 179D deduction).
Providing tax-exempt entities owning eligible property the ability to allocate the deduction to the property’s (or qualified retrofit plan’s) designer.
Allowing a REIT’s earnings and profits to be reduced by the full amount of the 179D deduction (previously, it was deductible from earnings and profits ratably over a five-year period).
These changes apply to taxable years beginning after 2022, with the exception of the alternative deduction, which is effective for property placed in service after Dec. 31, 2022, pursuant to a retrofit plan established after such date.
5. Credit structure
The Act completely revamps the structure of many of the energy credits to include a base amount and a bonus amount equal to five times the base. The legislation also includes “kickers” for domestic content and energy communities.
To qualify for the bonus credit, taxpayers must comply with prevailing wage requirements and apprenticeship requirements. This new structure is designed to encourage competitive wages and job growth in the renewable energy sector and applies to most of the clean energy production credits as well as the advanced energy project credit (section 48C), clean fuel production credit (section 45Z), the energy-efficient commercial buildings deduction (section 179D) and several other credits.
Perhaps recognizing the urgency of the climate situation, Congress included a big incentive to get more clean energy projects off the drawing board and under construction as soon as possible. Specifically, projects that begin construction before 60 days after Treasury and the IRS issue guidance are automatically deemed to meet the prevailing wage and apprenticeship requirements, and thus will be eligible for the bonus credit. There are several methods under existing guidance to determine the construction start date, such as starting “physical work of a significant nature” or meeting a safe harbor for a percentage of total costs incurred.
Note: Given global supply chain issues and inflationary pressures, it remains to be seen how much this incentive will do to accelerate these projects.
Projects involving qualified facilities with a maximum net output of less than 1 megawatt will also be automatically deemed to meet the prevailing wage and apprenticeship requirements (regardless of when construction begins).
Prevailing wage and apprenticeship requirements
Prevailing wage requirement. Any laborers or mechanics employed by the taxpayer during construction of the energy project must be paid prevailing wages for the locality in which the project is located. The prevailing wage rate is determined by the Department of Labor. Further, prevailing wages must be paid for repairs or alterations to the facility for a period after the project is placed in service, for example, five years for the section 48 ITC and 10 years for the section 45 PTC. If a taxpayer fails to pay prevailing wages, they can correct the deficiency by making the workers whole (plus interest) and paying a $5,000 per worker penalty to the IRS (increased to $10,000 per worker for intentional disregard of the rules).
Apprenticeship requirement. To meet this requirement, taxpayers must ensure that an applicable percentage of total labor hours for construction, repair or alteration of an energy facility is performed by qualified apprentices. The term qualified apprentice means an individual who is employed by the taxpayer or by any contractor or subcontractor and who is participating in a registered apprenticeship program. The applicable percentage increases over time: 10% for construction that begins before 2023, 12.5% for construction that begins during 2023 and 15% for construction that begins after 2023. If a taxpayer fails to meet the apprenticeship requirements, the penalty is $50 multiplied by the shortage in hours ($500 per hour for intentional disregard).
Domestic content. The domestic content bonus credit or “kicker” applies to the existing PTC (section 45) and ITC (section 48) and the new clean energy production (section 45Y) and investment (section 48E) credits. To be eligible for the kicker, the taxpayer must certify that any steel, iron or manufactured product which is a component of a qualified facility was produced in the U.S. Manufactured products are deemed to meet the domestic content requirement if a certain percentage of the total cost of all manufactured products in the facility are attributable to products that are mined, produced or manufactured in the U.S. Note that there are special domestic content rules for offshore wind projects.
The kicker is 10% for the PTCs and either 2% (for projects that don’t meet the prevailing wage and apprenticeship requirements) or 10% for the ITCs and applies to projects placed in service after 2022.
Energy communities. The energy community applicable credit rate increase applies to the same credits as the domestic content bonus. The kicker is 10% of the PTCs and either 2% or 10% for the ITCs. The term “energy community” means brownfield sites; communities involved in the extraction, processing, transport or storage of coal, oil or natural gas; communities with an unemployment rate at or above the national average for the previous year; a census tract (or adjoining tract) where a coal mine closed after 1999 or a coal-fired electric generating unit was retired after 2009.
6. Monetizing the credits
Sponsors or developers often cannot fully utilize the credits generated by clean energy projects because they do not have sufficient taxable income. Rather than let excess credits go to waste, many projects utilize tax equity financing structures to bring in a third-party owner such as a bank or insurance company. Tax equity investors can efficiently apply the credits — as well as accelerated depreciation deductions — against their taxable income.
While tax equity transactions such as partnership flips, inverted leases and sale-leasebacks get the tax credits to parties who can use them, these structures may be time-consuming, costly and complicated to implement. The IRA contains several important provisions designed to help taxpayers monetize clean energy credits without forming a partnership or executing a complex leasing transaction. These new rules may also help broaden the pool of potential investors in energy credits.
Direct pay. New section 6417 allows applicable entities to make a direct pay election, which treats certain credits as taxes paid on a return — essentially, generating refundable credits. The election is available for the PTC, ITC, CSC, the manufacturing credits and certain vehicle and alternative fuel related credits. Applicable entities are limited to tax-exempt organizations, state and local governments, the Tennessee Valley Authority, tribal governments, Alaska native corporations and certain rural electric cooperatives. The election applies to taxable years beginning after 2022.
The Act includes an important exception to the applicable entity rules: Any taxpayer can make the direct pay election for the clean hydrogen production credit (section 45V), the advanced manufacturing credit (section 45X) and the CSC (section 45Q). This exception applies for the first five years of the clean hydrogen production credit and the CSC, and for any five years within the credit period for the advanced manufacturing credit.
Transferability. For taxable years beginning after 2022, new section 6418 allows a one-time transfer of certain credits to unrelated taxpayers for taxpayers who are not eligible to make the direct pay election. This new provision will provide additional flexibility for clean energy project developers looking to monetize tax credits (although, unlike tax equity arrangements, this option will not monetize accelerated depreciation deductions). The transferability rules apply to the PTC, ITC, CSC, the manufacturing credits and certain alternative fuel related credits. Consideration must be paid in cash, is not included in income of the seller and is not deductible by the buyer.
Carryback and carryforward provisions. Finally, the IRA modifies the credit carryback and carryforward periods. The carryback period is extended to three years and the carryforward period is extended to 22 years for numerous credits, including the ITC, CSC, clean hydrogen production credit, manufacturing credits and several other credits. These changes apply to tax years beginning after 2022.
For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
2022 year-end tax planning
Want to read the full 2022 year-end tax letter? Interested in signing up for the webinar series?
