Inflation Reduction Act Offers Significant Tax Incentives Targeting Energy Transition and Renewables
16 min read
The Inflation Reduction Act of 2022 (the "IRA"), signed into law on August 16, 2022, is already causing shock waves in the renewables industry and energy transition space. Specifically, the IRA includes significant tax credit incentives for a variety of renewable energy resources that could revolutionize the tax landscape and pace of investment in energy transition. While the provisions addressing climate and energy programs are similar to predecessor provisions in the Build Back Better Act (the "BBBA"), there are several new provisions that the industry has only begun to digest. The following is a high-level summary of some of the most impactful renewables and energy transition tax provisions in the IRA.
Major provisions and developments include the following, which are described in additional detail below:
- New tax credit rate structure based on compliance with new wage and apprenticeship requirements, with bonus tax credits available for projects meeting domestic content requirements, projects located in certain low-income areas, or projects in so-called "energy communities"
- Extension of wind and solar tax credits
- New ability to take the production tax credit ("PTC") for solar deals
- Expansion and increased value of tax credits for carbon capture
- New "technology neutral" PTCs and investment tax credits ("ITC"s)
- New tax credit for clean hydrogen production
- New tax credit for zero emission nuclear power production
- New "manufacturing production" Tax credit for producers of eligible project components
- New mechanism that allows for the direct transfer or sale of renewable tax credits to third parties
- "Direct pay" provisions available to certain entities and with respect to certain tax credits
New Rate Structure; Wage and Apprenticeship Requirements
Similar to the BBBA, the IRA proposes a set "base" rate for certain renewable energy tax credits, which can be adjusted for inflation. The credit amount can be increased by a factor of five if the project meets prevailing wage and apprenticeship requirements (the "Wage and Apprenticeship Requirements"), as determined by Department of Labor standards.
The project owner must ensure laborers employed by the contractors and subcontractors are paid prevailing wages both during construction and for any repairs or alterations needed during the applicable tax credit period. Prevailing wages are defined as wages at rates for similar work in the location of the project site as determined by the U.S. Secretary of Labor.
A project owner who does not meet these requirements can cure this failure by paying each worker the difference between the prevailing wage and the wage actually paid, plus $5,000-per-worker and an interest charge, though the cost is higher if the failure to satisfy the wage requirement was intentional.
The IRA requires a percentage of labor hours, defined as the minimum amount of hours of the construction, alteration, or repair work with respect to a facility, to be performed by qualified apprentices. The required percentage of labor hours varies depending on the year in which construction begins.
|Project Construction||% of Apprentice Labor Hours|
|If construction begins before January 1, 2023||10%|
|If construction begins on or after January 1, 2023 and before January 1, 2024||12.5%|
|If construction begins on or after January 1, 2024||15%|
Limited transition relief from Wage and Apprenticeship Requirements
Projects that begin construction before the date that is 60 days after the date official guidance is published regarding the Wage and Apprenticeship Requirements are exempt from such requirements and will automatically qualify for the increased (5x) credit rates mentioned above (the "60 Day Grandfather Period"), and projects with a maximum output of less than one megawatt are exempt altogether from the Wage and Apprenticeship requirements.
Commentary: In many cases, because the PTC and ITC have already begun to sunset, the new rate structure under the IRA should cause wind and solar projects to immediately enjoy a substantially higher credit amount than previously expected. Consider a case where a wind project was underway and seeking to establish beginning of construction prior to 2018 in order to claim 80% of the full PTC rate rather than the 60% rate that would be available if construction began in 2019. Under the new law, due to the 60 Day Grandfather Period mentioned below, such project potentially could be entitled to a full 100% of the PTC as long as it was not ultimately placed in service prior to 2022, irrespective of whether the project meets the new Wage and Apprenticeship Requirements.
Wind and Solar Tax Credits (PTCs and ITCs)
The IRA includes an extension of the PTC and ITC for wind and solar projects (including geothermal and hydropower) beginning construction before January 1, 2025. This represents a three-year extension for PTCs and a one-year extension for ITCs. In addition, solar projects may now also take the PTC in lieu of the ITC. The PTCs and ITCs as amended will apply to facilities placed in service after December 31, 2021.
For projects placed in service in 2022 or later, the base credit amount for wind projects is worth 0.3 cents/kWh, and is worth 1.5 cents/wKH if the Wage and Apprenticeship Requirements are met (subject to applicable inflation adjustments). The ITC offers a base rate of 6% (as a percentage of the tax basis of eligible energy property) with an increased rate of 30% if the Wage and Apprenticeship Requirements are met. There are also additional "bonus" tax credits available (generally available in an amount up to a value of 10% of the credit amount, but up to 20% in some cases) where domestic content requirements are met, or where the project is located in certain "energy communities" or low-income communities.
Commentary: This largely echoes what was in the BBBA. Congressional Democrats have made it a point since before the BBBA to introduce legislation designed to raise the wages of laborers (especially construction workers) involved in renewables projects and to ensure that projects benefit domestic manufacturers.
Commentary: While the PTC and ITC are only extended for a modest amount of time (i.e., in both cases, to account for projects beginning construction through 2024), projects beginning construction in the years to come could continue to qualify for renewable energy tax credits under the "technology neutral" clean electricity PTC and ITC discussed below.
Commentary: It is anticipated that a significant number of solar projects will look to claim PTCs rather than ITCs on a going-forward basis, as such projects could not only avoid potential risks associated with basis step-up uncertainty and recapture, but in certain cases could also earn a higher dollar-value credit amount.
When domestic content requirements are met, 10% is added to the PTC or ITC for projects which incorporate a certain amount of steel, iron or manufactured products that were produced in the U.S. Under a "phased-in" approach, the amount of domestic content required to obtain this bonus tax credit increases over time, as shown below.
|Project Construction||Required % of Domestic Content||Required % of Domestic Content for Offshore Wind|
|If construction begins before January 1, 2025||40%||20%|
|If construction begins on or after January 1, 2025 and before January 1, 2026||45%||27.5%|
|If construction begins on or after January 1, 2026 and before January 1, 2027||50%||35%|
|If construction begins on or after January 1, 2027 and before January 1, 2028||55%||45%|
|If construction begins on or after January 1, 2028||55%||55%|
Additionally, other cumulative "bonus amounts" are potentially available:
- Up to an additional 10% is added to the PTC or ITC for projects in certain "energy communities," which include brownfield sites, areas that meet certain employment percentages relating to coal, oil or natural gas, and areas in which a coal mine or coal-fired electric generating plant has closed.
- Up to an additional 20% can be added to the ITC for solar and wind projects located in certain low-income communities, low-income residential buildings, or on American Indian land.
Commentary: Because of the 60 Day Grandfather Period, it is expected that projects that do not expect to qualify for the Wage and Apprenticeship Requirements may end up rushing to begin construction. Conversely, because bonus tax credits generally are available only for projects that are placed in service after 2022, projects that are on the verge of being placed in service but that otherwise could qualify for such bonus tax credits will be incentivized to instead "drag their feet."
Carbon Capture/Section 45Q Credits
The IRA extends the section 45Q carbon oxide sequestration tax credit ("45Q Credit") for projects beginning construction before January 1, 2033, from the current deadline of January 1, 2026. The credit amount is also increased (particularly in the case of direct air capture facilities), and the minimum capture requirements have been reduced, as shown in the charts below. This 45Q Credit as amended will apply to facilities or equipment placed in service after December 31, 2022.
|End Use||Current Amount||IRA Amount w/out Wage and Apprenticeship Requirements||IRA Amount with Wage and Apprenticeship Requirements|
|Traditional Carbon Capture: Carbon Oxide Used or Utilized||$35||$12||$60|
|Traditional Carbon Capture: Carbon Oxide Sequestrated||$50||$17||$85|
|Direct Air Capture: Carbon Oxide Used or Utilized||$35||$26||$130|
|Direct Air Capture: Carbon Oxide Sequestrated||$50||$36||$180|
|Facility||New Minimum Capture Threshold under the IRA|
|Direct air capture facility||1,000 metric tons (previously 100,000 metric tons)|
|Electricity generating facility||18,750 metric tons + the facility must have a capture design capacity of at least 75% of the baseline carbon oxide production of such unit|
|Any other facility||12,500 metric tons|
Commentary: As discussed further below, the 45Q Credit is also one of the primary beneficiaries of the new direct pay incentives, which could revolutionize the way the 45Q Credit and its associated projects will be monetized and structured. In practice, the direct pay incentives should attract a more diverse range of companies participating in carbon capture projects by largely removing the need for a tax equity investor for many project companies.
New “ Technology Neutral ” Clean Electricity PTC and ITC
The IRA introduces a new "technology neutral" PTC and ITC for projects that generate electricity and yield zero greenhouse emissions. The tax credit applies to facilities placed in service after 2024 and phases down until the latest of (i) 2032 or (ii) the year certain emissions thresholds are achieved. Similar to current PTCs, the new PTC is worth 0.3 cents/kWh, and can be increased to 1.5 cents/wKH if the Wage and Apprenticeship Requirements are met. Similar to current ITCs, this tax credit has a base rate of 6% (as a percentage of the tax basis of eligible energy property), and can be increased to 30% if the Wage and Apprenticeship Requirements are met. This tax credit will apply to facilities placed in service after December 31, 2024.
Commentary: As mentioned above, these tax credits appear to serve in part as a way for wind and solar projects beginning construction in 2025 or later to still obtain the benefit of PTCs and ITCs, notwithstanding the fact that traditional PTCs and ITCs would no longer be available.
Commentary: Interestingly, and in contrast to, for example, employing a life cycle analysis to determine zero greenhouse emissions for these purposes (in which the taxpayer would have to go through the process of proving out its compliance with applicable admissions standards), it appears that the statute will instead simply list types of facilities that count as causing zero greenhouse emissions, which should have the dual effect of putting taxpayer claimants at ease and reducing potential compliance costs.
New Clean Hydrogen Tax Credit
The IRA offers a new 10-year production tax credit based on the kilograms of qualifying hydrogen produced at a facility that begins construction prior to January 1, 2033. The credit rate is based on $0.60/kg multiplied by a percentage based on the level of greenhouse gas that remains after the hydrogen production process. To receive the full tax credit, the Wage and Apprenticeship Requirements must be met, and emissions must meet certain requirements under a life cycle analysis. This tax credit will apply to property placed in service after December 31, 2022. Projects that began construction prior to January 1, 2023 will be eligible for this tax credit based on the date that modifications to the facility required to produce clean hydrogen are placed into service.
An ITC is also available for clean hydrogen facilities. The ITC is equal to a percentage of the cost of the facility. The tax credit amounts vary and depend on the level of greenhouse gas that is removed.
|CO2/kg of H2 Remaining||PTC Credit %||ITC Value|
|Not greater than 4kg and less than 2.5kg||20%||1.2%|
|Less than 2.5kg and not less than 1.5kg||25%||1.5%|
|Less than 1.5kg and not less than .45kg||33.4%||2%|
|Less than .45kg||100%||6%|
Commentary: Like the analogous provisions in the BBBA, the focus here is on the result, not the origin or source (e.g., the "hydrogen color wheel" is more or less irrelevant).
Commentary: The specific terms in the IRA for hydrogen tax credits are slightly less favorable than in the BBBA, as the IRA sets a higher floor for hydrogen to qualify as clean and decreases the applicable percentage more rapidly than its BBBA counterpart. However, along with 45Q Credits, this tax credit is also subject to direct pay on a widely available basis, as mentioned below.
New Nuclear Power Production Tax Credit
This tax credit (the "Nuclear PTC") applies to projects using nuclear power to generate electricity (where there is an unrelated offtaker), and applies only to projects placed in service before the date of enactment of the IRA. The Nuclear PTC rate is 0.3 cents/kWh of electricity produced by the taxpayer at a qualified nuclear power facility. Similar to other tax credits, a "full credit" equal to five times the base credit can be received assuming compliance with new prevailing wage requirements. The Nuclear PTC will apply to electricity produced and sold after December 31, 2023 and will terminate on December 31, 2032.
Extension of the Advanced Energy Project Credit
The IRA provides additional allocations of funding for the qualified advanced energy manufacturing tax credit, a 30% tax credit for investments in projects that reequip, expand or establish certain energy manufacturing facilities. Along with an expanded definition of "qualifying advanced energy projects," an additional $10 billion in allocations will be provided with at least $4 billion to be allocated to energy communities.
The base rate for the tax credit is 6% and can be increased to 30% if the Wage and Apprenticeship Requirements are satisfied. The Secretary of the Treasury will establish a program to award tax credits to qualifying advanced energy project sponsors. Awarded programs will have two years to provide evidence that the requirements of the certification have been met and to place the property in service. This tax credit will take effect on January 1, 2023.
New Advanced Manufacturing Production Credit
The IRA creates a new PTC for the domestic production and sale of qualifying solar and wind components. Components for these purposes are very broadly defined, including solar components such as photovoltaic wafers, wind components such as blades, nacelles and towers, and even certain "critical minerals," such as aluminum, graphite, vanadium and among many others. The credit rate varies depending on the component. This tax credit will apply to components produced and sold after December 31, 2022.
The tax credit will begin to phase out at a rate of 25% per year for components sold after December 31, 2029, and no tax credit will be available for components sold after December 31, 2032. There is, however, no phase-out applied to the production of components in the "critical minerals" category.
The IRA generally allows for the transfer of renewable tax credits between taxpayers, provided, for example, the tax credits are paid for in cash, and provided the amount paid is neither taken into income by the seller nor deducted by the buyer. There are limited exceptions to this ability to transfer tax credits, including in the case of, for example, certain tax-exempt transferors and government entities.
Commentary: This provision of the bill could be very significant in the industry and could substantially minimize the importance of the partnership flip structure on an ongoing basis, since the existence of the partnership flip is premised on the baseline principle that income tax credits cannot be bought and sold between taxpayers. If the tax credits can be sold, the flip structure's utility may tend to be limited to cases where the value of non-credit attributes such as depreciation continue to be demanded by tax equity investors who seek disproportionate allocations of such benefits.
Direct Pay Provisions
Direct pay (i.e., a refund from the Treasury for the amount of tax credit claimed) is as a general matter available with respect to the majority of the renewables incentives mentioned above. However, in most cases, direct pay is limited to taxpayer claimants who are, for example, tax-exempt entities, government entities, Indian Tribes or Alaska Native Corporations. Under some key exceptions, direct pay is generally available to taxpayers of all profiles. These exceptions include carbon capture facilities taking the 45Q Credit, hydrogen facilities taking clean hydrogen tax credits and taxpayers taking advanced manufacturing production tax credits. Even in the case of tax-exempt entities, there are new provisions in the case of the ITC and PTC that have the effect of reducing or phasing down the amount of the direct pay, for example, based on meeting of domestic content requirements. Further, in the case of 45Q and hydrogen projects (but not in the case of the advanced manufacturing tax credit) the IRA limits the ability to claim direct pay to the first five years after the applicable project or equipment is placed in service as opposed to the entire tax credit period.
Methane Emissions Reduction Program
The IRA proposes a fee on methane emissions from certain oil and gas facilities such as production, storage and pipeline facilities that emit more than the equivalent of 25,000 tons or more of carbon dioxide a year. The thresholds under which the fee applies vary by type of oil and gas facility. Once those thresholds are met, the initial fee would be $900 per ton of methane emitted in 2024, escalating to $1,500 per ton in 2026. By 2030, the Congressional Budget Office estimates that the methane emissions fee will generate over $1 billion per year in gross revenue.
Natural gas distribution systems would not be subject to the fee. In addition, facilities that are subject to previously proposed federal Clean Air Act methane emissions requirements would be exempt. The federal Environmental Protection Agency would also be given discretion to exempt other facilities from the fee. This proposed fee regime would be turned into law by amending the Clean Air Act to create what is called a Methane Emissions Reduction Program and authorizing the federal Environmental Protection Agency to promulgate regulations to implement the program. The federal Environmental Protection Agency has not yet proposed actual text for these regulations. Therefore, there are uncertainties associated with how this fee will ultimately work.
Commentary: This is an unprecedented federal government policy initiative to impose a federal fee on greenhouse gas emissions. The oil and gas industry has expressed concern over the uncertainty of future costs of compliance with the methane reduction charge and frustration that the IRA targets a single industry. Proponents of the IRA's methane provisions point to the role to be played by the $1.55 billion in grants, rebates and loans available to oil and gas companies who engage in efforts to reduce methane emissions from their operations toward IRA's overall target of reducing carbon emissions by approximately 40% by 2030.
Other Notable Incentives and Developments
- New Standalone Storage/Microgrid Incentives: The IRA expands the definition of ITC eligible energy property to include storage property, qualified biogas property and microgrid controllers.
- Expands and extends renewable and clean fuel production tax credits. The rate for this tax credit is determined by the applicable amount per gallon. The base rate is $0.20/gallon, and $1.00/gallon if the Wage and Apprenticeship Requirements are met. This amount is increased to $0.35/gallon (and $1.75/gallon with Wage and Apprenticeship Requirement compliance) for sustainable aviation fuel.
- The credit carryback period for renewables tax credits is extended from one year to three years.
- Transmission line and transmission property tax credits
- Provisions linking renewable project income to publicly traded partnership or "master limited partnership" qualified income
While renewable energy companies and broader energy transition industry are still digesting these significant changes, there can be no doubt that the impact of these developments will be far-reaching.
This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2022 White & Case LLP