The Impact of the Inflation Reduction Act on the Energy Investment Tax Credit and Certain Other Energy Tax Provisions
Gibbons Corporate & Finance News – Legislative Tax Alert
September 8, 2022
On August 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022 (the “Act”), which includes a number of tax provisions related to green energy. This article highlights the impact of the Act on the energy investment tax credit (ITC) of Internal Revenue Code (IRC) Section 48. Many of the Act’s changes are technical in nature, and the application of several of the significant policy changes will depend heavily on future guidance to be provided by the Treasury.
Separately, as has been well-publicized, the Act imposes a 15% corporate alternative minimum tax on large corporations with an average of $1 billion of adjusted financial statement income. In addition, the Act imposes a new excise tax of 1% of the fair market value of stock repurchased by a publicly traded U.S. corporation or certain of their affiliates or related parties.
Prior Law With Respect to Energy ITC
Until somewhat recently, taxpayers could obtain a 30% ITC for purchasing and placing in service qualifying energy property, especially solar power systems. For energy property for which construction began in the years 2020 through 2022, the energy percentage had been reduced to 26% as part of what had been a gradual phase-out, with the energy percentage dropping to 22% for property on which construction begins in 2023 (but the property needs to be placed in service before January 1, 2026).
Main Revisions to Energy ITC – New Base Credit Percentage of 6%
Critically, the new Act reduces the base energy percentage to just 6% unless certain prevailing wage requirements and apprenticeship requirements are met. Taxpayers will qualify for a 30% ITC (instead of the base 6% credit) only if they meet the new prevailing wage requirements and the apprenticeship requirements.
The Prevailing Wage and Apprenticeship Requirements
The prevailing wage requirements require that all laborers and mechanics employed by the taxpayer and all contractors or subcontractors of the taxpayer who are working on the energy project are paid the prevailing wage of the locality of the project (as determined by the Secretary of Labor) for the period of five years beginning when the project is placed into service. The apprenticeship requirements require that a certain percentage of the labor be performed by individuals employed through registered apprenticeship programs. The percentage is based on the ratio of labor hours performed by apprentices, which must be 10% for projects beginning construction before January 1, 2023, 12.5% for projects beginning construction after January 1, 2023 but before December 31, 2023, and 15% for projects beginning construction thereafter.
Note that there are two other ways of qualifying for the enhanced 30% credit: projects with a maximum net output of less than 1 megawatt of energy, or a project which begins no later than 60 days after the Treasury Secretary publishes rules on the prevailing wage and apprenticeship requirements.
The Act also adds energy storage technology, qualified biogas property, and microgrid controllers as new types of Energy Property that qualify for the ITC.
Bonus ITC: Domestic Content and Energy Communities
In addition to the base credit of 6% (or 30% enhanced credit, as applicable), a tax credit equal to 2% of the eligible cost basis (or 10% if the above described prevailing wage and apprenticeship requirements are met) will apply when certain domestic content requirements are met. To fulfill the domestic content requirement, taxpayers must ensure that the steel, iron, or other manufactured products that comprise the project are substantially produced in the United States. Generally, a manufactured product will be considered manufactured in the United States if a specified percentage (generally 40%) of the total cost of the components is attributable to components that are mined, produced, or manufactured in the United States.
Additionally, another 10% (or 2% if the prevailing wage and apprenticeship requirements are not met) credit will apply where a project is established in an energy community. An energy community is defined as (i) a brownfield site; (ii) a community that (a) at any time after 2009 had employment or tax revenues in excess of certain thresholds that are attributable to the extraction, processing, transport, or storage of coal, oil, or natural gas industries, and (b) had an unemployment rate at or above the national unemployment rate for the prior year; or (iii) a community located in a census tract (or a census tract directly adjoining a census tract) in which a coal mine has been closed after 1999 or a coal-fired electric generating unit has been retired.
Bonus ITC: Solar and Wind Facilities in Low-Income Communities
Finally, an additional credit of either 10% or 20% is provided for a wind or solar project of 5 megawatts or less that (i) receives an allocation of environmental justice wind and solar capacity limitation from the Treasury Secretary (no more than 1.8 gigawatts during each of 2023 and 2024 and eliminated thereafter unless there is carryover from 2023 or 2024); (ii) qualifies for the ITC under Section 48; and (iii) is (a) located in a low-income community or on American Indian land (10%) or (b) is part of a qualified low-income residential building (20%).
Energy-Efficient Commercial Buildings Deduction
The Act alters the maximum deduction allowable under IRC Section 179D in the year when eligible building systems are placed in service. To the extent that a taxpayer fulfills the prevailing wage requirement and the apprenticeship requirement (discussed above in the context of the amendments to IRC Section 48) with respect to a property, the taxpayer may take a deduction equal to $2.50 per square foot less any previously used deductions under this provision arising from the property. The rate may be increased in increments of $0.10 for each percentage point above 25% that the taxpayer is able to reduce the property’s total annual energy and power costs.
Transfer of Eligible Credits
The Act permits a taxpayer to elect to transfer all or a portion of an eligible credit to an unrelated eligible taxpayer, but the recipient taxpayer may not in turn transfer any portion of the transferred credit. This provision is applicable following the 2022 tax year. Eligible credits include:
- The business credit portion of the alternative fuel vehicle refueling property credit
- The renewable electricity production credit
- The carbon oxide sequestration credit
- The zero-emission nuclear power production credit
- The clean hydrogen production credit
- The advanced manufacturing production credit
- The clean electricity production credit
- The clean fuel production credit
- The energy investment credit
- The qualifying advanced energy project investment credit
- The clean electricity investment credit
Eligible credits cannot be transferred to a tax-exempt entity, state or local government, or political subdivision.
We would be happy to talk with current and potential clients who have questions on the Inflation Reduction Act or on federal or New Jersey taxation in general. Please contact Peter Ulrich at 973-596-4635 or firstname.lastname@example.org.