The Inflation Reduction Act of 2022 introduced expansive changes to federal income tax benefits for renewable energy. In addition to new clean energy tax credits, it extended the availability of the investment tax credit and the production tax credit, both designed to encourage investment in renewable energy projects. Many of these significant tax code changes are in effect for facilities or equipment placed in service during 2023.
The new tax-and-climate law includes bonus mechanisms for increased credit amounts. For both the ITC and the PTC, it established a two-tiered system based on compliance with new wage and apprenticeship requirements. If the project meets the requirements, the base credit amount can be increased by a factor of five. Taxpayers are also entitled to increased credit amounts for projects located in specified areas or communities or that meet domestic content thresholds for US-sourced steel, iron, and manufactured products.
The new law also allows more taxpayers to readily monetize applicable tax credits. Under the direct pay option, tax-exempt entities, state and local governments, and Native American tribal governments may elect to treat credits as refundable payments of tax and receive cash refunds. Taxpayers ineligible for direct pay can elect to transfer applicable credits to unrelated parties for cash. The option for a third-party sale of credits broadens the pool of potential investors in renewable energy projects, outside traditional financing structures.
The Treasury and IRS have requested comments and issued initial guidance on how to optimize the tax credits. Given the unprecedented ability to exchange clean energy tax credits for cash, even as a tax-exempt entity, taxpayers should take steps to maximize potential credit amounts according to the available guidance.
Prevailing Wage and Apprenticeship Requirements
The new law replaced the existing tax credit regime with a two-tiered system, adding certain labor requirements to qualify for the bonus credit amount five times above the base credit amount. To maximize the available credit under both the ITC or PTC, taxpayers now need to pay workers a prevailing wage set by the Department of Labor and hire registered apprentices. Notice 2022-61 addressed these requirements, now effective for projects that began construction on or after Jan. 29, 2023.
For the prevailing wage requirement, taxpayers must refer to published wage rates for geographic areas and for types of jobs or labor classifications at www.sam.gov. If the Department of Labor has not published a prevailing wage, the taxpayer must contact IRAprevailingwage@dol.gov for a determination.
The request must provide the type of facility being constructed, location, proposed labor classifications, proposed prevailing wage rates, job descriptions and duties, and any rationale for the proposed classifications. A taxpayer may cure a failure to satisfy the prevailing wage requirements by paying the difference, plus interest, as well as paying a $5,000 penalty per underpaid laborer or mechanic.
The apprenticeship requirements set a minimum percentage of labor hours to be completed by qualified apprentices under a registered program. For projects beginning construction before 2023, only 10% of total labor hours need to be completed by a qualified apprentice. The percentage increases to 12.5% for projects beginning construction in 2023 and 15% for 2024 and later. Absent intentional disregard, a taxpayer may cure a failure to satisfy the apprenticeship requirements by paying a penalty equal to $50 per noncompliant labor hour or by establishing a good faith effort to obtain apprentices from programs that denied the request or failed to respond in time.
Low-Income Communities Bonus Credit Program
Notice 2023-17 provides initial guidance on the general requirements for owners of solar and wind facilities eligible for the ITC to participate in the Low Income Communities Bonus Credit Program. Under the program, eligible property placed in service in connection with a solar or wind facility in certain categories of communities may qualify for 10% or 20% increases in the ITC energy percentage. Taxpayers must apply to receive an allocated portion of the overall annual capacity limitation of 1.8 gigawatts from the program.
The IRS will accept applications for 2023 capacity allocations in two phases during 60-day application windows. The first application window is expected to open for qualified low-income residential building projects and qualified low-income economic benefit projects in the third quarter. No estimated timeline was specified for the second application window for facilities located in other eligible areas.
The Department of Energy will review applications and then make recommendations. A lottery system may allocate the limitations if the selected applications collectively exceed the reserves. To claim the increased credit rate, selected applicants must place the eligible property in service within four years. Facilities placed in service prior to an award under the program are ineligible.
It may be worth considering a delay of a potentially eligible solar or wind project to receive an allocation, based on the program’s timeline. If an application isn’t selected, applicants may resubmit in a subsequent year. Taxpayers interested in investing in communities targeted by the program must pay attention to further guidance regarding IRS application procedures and allocation criteria.
Outside the Low Income Communities Bonus Credit Program, there are 10% credit increases for projects that meet the domestic content requirements or are located in “energy communities,” including census tracts in which a coal-fired power plant has closed since 2010 or a coal mine has closed since 2000. Unlike the program, these 10% bonuses apply to both PTC and ITC projects and don’t require an application to the IRS.
As the bonus credit amounts under the new law can stack on a single project, a facility may present a highly tax-favored investment if it satisfies the wage and apprenticeship requirements, is located in a targeted community, and was sufficiently sourced from US products. While many questions remain on the implementation of the clean tax credit changes, taxpayers may rely on the initial guidance issued by the IRS for project planning.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Nancy Dollar is a senior counsel at Hanson Bridgett LLP in San Francisco and advises businesses, owners, and investors on federal income tax matters. Her practice includes planning for specialty credits and incentives, primarily for private companies.
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