The Inflation Reduction Act of 2022 proposes significant changes and expansions to the existing federal income tax benefits for renewable energy, fuel production, and other green technologies.

US Senators Joe Manchin and Chuck Schumer announced an agreement in principle on a legislative proposal known as the Inflation Reduction Act of 2022, HR 5376, 117th Cong. (Act), on July 27. The Act includes a range of measures to address consumer energy costs and carbon emissions, Medicare’s ability to negotiate drug prices, an extension of benefits under the Affordable Care Act, and federal deficit reduction. It includes approximately $700 billion in expenditures, with additional costs of the Act intended to be offset, at least in part, by new tax revenue generator provisions, including a new minimum tax on larger corporations (LawFlash forthcoming) and an alteration of the taxation of “carried interests.”

Approximately $370 billion of the Act’s expenditures are devoted to energy and climate spending, much of which pertains to significant changes to the Internal Revenue Code of 1986, as amended (Code),[1] that would extend and expand tax benefits for “green” energy and other technologies. Many of these proposed changes are based on similar provisions in the Build Back Better Act passed by the House in November 2021. However, by comparison, the Act introduces many additional significant changes to the Code, especially with regard to the monetization of applicable tax credits.

Although very welcome by the green technology industry, the Act’s green technology tax benefits provisions are complicated, entangling the current tax credit framework with newer provisions that will take time for the industry to digest and for the IRS to develop the necessary compliance protocols. These new provisions will also require Treasury and the IRS to develop implementation guidance on an accelerated timeline for many of the provisions to be workable from a practical perspective for most taxpayers.

The below discusses many of the Act’s proposed changes with respect to tax benefits for green technologies.

Renewable Energy and Energy Storage

Alteration of Existing Credit Framework

The Act would extend, with modifications and expansions, the current general framework for renewable energy tax credits for projects that “begin construction” before 2025. Specifically, the Act would extend the existing Section 45 production tax credit (PTC) and Section 48 investment tax credit (ITC) for wind and solar power facilities and other renewable energy facilities. New solar energy facilities would also be eligible for the PTC in addition to the ITC. Certain interconnection costs for smaller facilities (not more than 5 megawatts (MWs)) would also become eligible for the ITC.

The Act would also remove the current ITC and PTC sunset and stepdown provisions for renewable energy facilities placed in service after 2021. But, eligibility for a full ITC or PTC and even an enhanced credit would be subject to several new requirements described below.

The Act would also expand the ITC/PTC to apply to new technologies. The ITC would now apply to energy storage facilities (i.e., stand-alone energy storage facilities), qualified biogas facilities, and microgrid controller equipment. The Act would also expand eligibility for the PTC to electricity generated by a renewable energy facility but not sold to an unrelated person if such electricity is used to produce Section 45V tax credit qualified clean hydrogen (discussed below). A separate production tax credit would be provided for existing nuclear power facilities not eligible for the Section 45J tax credit for “advanced nuclear power facilities.”

Specific to energy storage, the Act would also provide an election out of the Section 50(d)(2) “public utility property” limitation for larger energy storage facilities (capacity in excess of 500 kilowatt hours (KWhs)) and an exception to the deemed service contract rules under Section 7701(e) for energy storage facilities. Energy storage facilities would also be treated as five-year property under the “modified accelerated cost recovery system” (MACRS) rules for depreciation purposes.

These energy storage–related provisions have long been sought by the green energy industry, as the current rules are very cumbersome and a roadblock to incentivizing grid stabilization through storage build-out. This is due to the operation of the current ITC rules, which require storage to augment solar or wind ITC generation property and allow for only limited grid charging. The election out of public utility property status for larger energy storage projects should also enable larger regulated utilities to spearhead storage expansion as part of their infrastructure spending.

New Consolidated Production Tax Credit and Investment Tax Credit

The Act would greatly streamline the rules for tax credits for renewable energy (or potentially any energy) and energy storage facilities that do not begin construction before 2025 by providing two general credits for these facilities: the new Section 45Y clean electricity production credit (CEPTC) and the new Section 48D clean electricity investment credit (CEITC).

The Section 45Y CEPTC would provide a tax credit for a 10-year period based on kilowatts (KWs) of electricity produced at a qualified facility and (1) sold to an unrelated person or (2) for a facility equipped with a metering device owned and operated by an unrelated person, sold, consumed, or stored by the taxpayer. The CEPTC rate would be based on the current PTC rate, subject to an inflation factor adjustment, and increased or decreased based on whether certain standards, discussed below, are satisfied. Eligibility for the CEPTC would not be based on the generation technology employed. Instead, it would be based on the facility’s “greenhouse gas emissions rate” (generally based on the amount of greenhouse gases emitted into the atmosphere by a facility in the production of electricity, but which is subject to a Treasury–published emissions rate standard for facilities that produce electricity through combustion or gasification) not exceeding zero.

Separately, the Section 48D CEITC would provide a front-loaded investment tax credit for qualifying energy production and energy storage facilities. The CEITC rate would be based on the current ITC rate of 30%, subject to increase or decrease based on whether certain standards, discussed below, are satisfied. The qualified facility standard would be identical to the CEPTC standard, except that the CEITC standard would be based on a certified anticipated level of the “greenhouse gas emissions rate” not being greater than zero. All or a portion of the credit could be recaptured during the five-year ITC recapture period (under Section 50) if a facility emissions–based standard is violated.

Each of these credits would survive at their maximum rate for facilities that begin construction before 2034. A facility beginning construction in a later year may be eligible for all or a stepped-down percentage of the maximum rate depending on if and when Treasury determines that the annual greenhouse gas emissions from the production of electricity in the United States are equal to or less than 25% of such amount for 2022 (i.e., greenhouse gas emissions fall by at least 75% from 2022 levels).

Credit Haircuts and Enhancements

The Act includes certain standard-based incentives and disincentives with respect to these and other green technology tax credits that could significantly impact the amount of the applicable tax credit.

For disincentives, the Act includes a wage and apprenticeship standard. Aside from certain limited exceptions (most notably, for smaller facilities with a maximum output of less than 1 MW), a failure to meet this standard generally results in an 80% reduction in the current “full” tax credit (e.g., the ITC rate would be reduced from 30% to 6%). The wage requirement (with rates based on the US Department of Labor’s published prevailing rates for such work in a particular locality) must be satisfied for all contractor and subcontractor laborers for the initial construction of the facility, as well as any alteration or repair of the facility during the applicable 10-year PTC period or 5-year ITC recapture period. A method for curing a violation (and associated penalties) of the wage requirement would be provided. The apprenticeship standard would require that qualified apprentices (participants in registered apprenticeship programs under the National Apprenticeship Act) participate in an increasing percentage (based on beginning of construction year and generally maxing out at 15%) of total labor hours of the construction, alteration, or repair work (both contractor and subtractor) with respect to a facility. A good-faith efforts standard could also apply to deem satisfaction of the qualified apprentice requirement in certain circumstances.

For incentives, the Act generally provides a 10% increase in the credit for a facility if it satisfies a “domestic content” standard or is located in an “energy community.”

The domestic content standard would require that any steel, iron, or manufactured product that is a component of the facility be produced in the United States, as determined under the federal Buy America Requirements standards. The Act would deem a manufactured product to be produced in the United States if a particular percentage of total costs of all such manufactured products of the facility are attributable to manufactured products (including components) that are mined, produced, or manufactured in the United States. The applicable percentages increase over time from 40% to 55% (after 2026), although a more relaxed standard is provided for offshore wind facilities.

Separately, an energy community is a “brownfield site” or an area determined by Treasury or under census measurements where there had been significant employment related to fossil fuel, extraction, processing, transport, or storage (including where a coal mine/coal-fired electric power plant closed).

The Act provides a separate 10% and possible 20% credit enhancement for certain smaller energy facilities (based on a less-than-5 MW standard) located in designated low-income communities or projects based on Treasury allocations of designated “environmental justice solar and wind capacity limitation” with respect to the facility.

Carbon Capture

The Section 45Q carbon capture and sequestration credit would also be extended and modified by the Act. The Act would extend the credit eligibility date to facilities beginning construction before 2033 (from 2026). The Act would also significantly reduce the amount-based qualified carbon oxide (generally, carbon dioxide) capture standard for a facility to be eligible for the credit.

The Act would also alter the rate structure for the credit and provide a significantly enhanced credit amount for direct air capture facilities, ostensibly recognizing the potential carbon emissions reduction value and current high costs of this relevantly nascent technology. The Act would add a new relative emitted carbon capture standard with respect to carbon capture equipment for an electric generating facility. In general, the “Credit Haircuts and Enhancements” rules described above would apply for the Section 45Q credit.

Fuel Production

The Act would modify, expand, and extend tax credits for the production of certain types of fuels. The Act would extend certain existing fuel production tax credits that have expired or are scheduled to expire at the end of 2022 through 2024. For tax years after 2024 through 2027, a new Section 45Z clean fuel production tax credit would provide a per-gallon for qualifying transportation fuel (i.e., suitable for use in a highway vehicle or aircraft) sold to an unrelated person for their use as end user, for production of a fuel mixture, or for sale at retail to another person and places such fuel in the fuel tank of such other person. The fuel must satisfy an emission-based standard to be eligible for the Section 45Z credit. The Section 45Z tax credit would be subject to an inflation factor increase, provide an enhanced credit for “sustainable aviation fuel,” and be subject to adjustment for failure to meet the wage and apprenticeship standard mentioned above.

The Act would establish a separate credit for the production of clean hydrogen in new Section 45V. New Section 45V would provide a per-kilogram credit for qualified clean hydrogen produced at a qualified clean hydrogen production facility for a 10-year period for sale or use by the taxpayer as verified by an unrelated party. The applicable inflation-adjusted tax credit rate is multiplied by an “applicable percentage” based on the level of emissions associated with the production of the hydrogen (ranging from 20% to 100%). The taxpayer can alternatively elect to claim a Section 48 ITC in lieu of a Section 45V production tax credit with respect to such an eligible facility (subject to similar adjustments based on the emissions-based “applicable percentage”). The tax credit decrease for failure to satisfy the wage and apprenticeship standard rules would apply to the Section 45V credit. The credit would expire for facilities that begin construction after 2032.

Manufacturing and Related Activities and Investments

The Act would revive and expand the now dormant Section 48C investment credit for expenditures on advanced energy production facilities. Under this program, Treasury would authorize up to $10 billion of Section 48C credits, although the amount authorized for facilities located outside of an energy community, described above, may not exceed $6 billion.

Eligible facilities would include plants that manufacture or recycle renewable energy generation equipment; energy storage equipment; grid modernization equipment; carbon capture and sequestration equipment; certain electric, fuel cell, or hybrid vehicles and equipment; other energy conservation equipment; and equipment designed to refine, electrolyze, or blend any fuel, chemical, or product that is renewable or low carbon and low emission. The credit would also apply to qualifying expenditures that reequip an existing industrial or manufacturing facility with equipment designed to reduce greenhouse gas emissions by at least 20%, or that reequip, expand, or establish a critical materials (designated pursuant to the Energy Act of 2020) processing, refining, or recycling facility. The tax credit rate would be 30%, subject to an 80% reduction if the facility does not satisfy wage and apprenticeship standards.

In order to receive an allocation of Section 48C credits, the Act would require a taxpayer to submit an application to the government for Section 48C certification, the government to accept such application, and the taxpayer to satisfy certain construction and substantiation requirements, including that the project be placed in service within two years of receiving government certification. A project would not be so eligible to receive Section 48C credits if it is located in a census tract that had received a certification and allocation of credits under the existing (dormant) Section 48C credit.

The Act would also add a new Section 45X advanced manufacturing production credit for applicable components produced and sold after 2022. The credit would apply to a qualifying component (either individually or integrated into another eligible component) produced within the United States or a US possession and sold to an unrelated person. Eligible components for this purpose would include finished equipment and component parts of both onshore and offshore wind power generation facilities, solar power generation facilities, electricity inverter equipment, and energy storage equipment. Critical minerals, including certain rare earth metals, would also be treated as eligible components.

The applicable credit rate would be based on the type of component produced and sold, and facilities that elected to apply the Section 48C investment credit would not be eligible for the Section 45X credit. The Section 45X credit would remain at its maximum rate until 2030, at which time it would step down by 25% per year until it expires in 2033. However, the credit would remain at its maximum rate without reduction for critical materials.

Monetization of Credits

Refundable Credits

The Act would provide for refundable energy, carbon capture, manufacturing, and fuel production tax credits and investment tax credits for tax years after 2022 for facilities placed in service after 2022. However, aside from limited exceptions for the Section 45Q carbon credit, the clean hydrogen production credit, and the advanced manufacturing production credit, only tax-exempt and US federal, state, local, or tribal governmental entities (including Alaska Native Corporations) would be eligible for the refundable credit.

In general, an election to claim a refundable credit would be required for the year the applicable facility is placed in service and for the entirety of a 10-year/12-year production-based credit period. But, the refundable credit for a taxable person with respect to the Section 45Q carbon credit or the clean hydrogen production credit may generally only be allowed for the placed in-service year and the next four years that end before 2033.

The amount of the refundable credit would be based on the amount of the actual tax credit for which the claimant would be eligible (without applying certain restrictions on the ownership or use of investment credit property by governmental or tax-exempt persons). However, the amount of the refundable credit would be subject to reduction based on whether the applicable facility satisfies the domestic content requirement described above.

The refundable credit generally would be at the maximum amount if it satisfies the domestic content requirement or if it begins construction before 2024 or, for applicable facilities, if it has a capacity of less than 1 MW. For facilities that begin construction after 2024 and that exceed any limitation for smaller facilities, failure to satisfy the domestic content requirement would result in the following reductions in the refundable credit:

  • 2024 beginning of construction, 10% reduction
  • 2025 beginning of construction, 15% reduction
  • After 2025 beginning of construction, 100% reduction

Notwithstanding these limitations, the Act authorizes Treasury to deem a facility to satisfy the domestic content requirement for this purpose based on either the significantly increased cost of a facility associated with satisfying the requirement or the unavailability or unsatisfactory quality of applicable US materials.

The Act would include recapture rules under which, if it is determined that a person overclaimed a refundable credit, the person (regardless of whether it is otherwise a taxable entity) would need to repay to Treasury the overclaimed amount plus a 20% penalty amount.

For US possessions, the “mirrored” code would not automatically include the refundable credit provision of the Code, but each could make an election to so apply the refundable credit.

Although tax-exempt investors have long sought a way to sidestep the “tax-exempt use” property rules and provide project development capital for renewable energy generation projects, much of this interest has been in the context of energy infrastructure fund investment and other pooled investment vehicles (at least for government pension funds). In this context, the refundable credit provisions of the Act are welcome, but do not address certain technical tax partnership matters that need to be resolved for investment to be workable. This clarity will need to be provided by Treasury and the IRS in implementing regulations and/or other guidance. For tax-exempt utility owners, however, the Act should provide immediate incentive to build, own, and operate tax credit–eligible green technology projects.

Sale of Credits

The Act would permit those persons not eligible to elect for refundable credits (in general, taxable persons) to elect to sell all or a portion of refundable energy, carbon capture, manufacturing, and fuel production tax credits and investment tax credits for tax years after 2022 for facilities placed in service after 2022. The election to sell credits would be made on an annual basis with respect to production-based tax credits. The credits would need to be sold for cash, would not be included in the gross income of the recipient taxpayer, and would not be deductible by the buyer. Credits that are carried back or carried forward from another year cannot be sold.

The purchased tax credit would be taken into account by the buyer in its first taxable year ending with, or after, the taxable year of the electing/selling taxpayer with respect to which the credit was determined. The buyer would not be able to retransfer or resell purchased credits. For an eligible facility held by a partnership or S corporation, the election would need to be made at the entity level, and the entity’s receipt of cash would be treated as tax-exempt income for partnership and S corporation tax accounting purposes. The transferor would be required to apply the ITC basis reduction rules under Section 50(c). A similar provision to the recapture of 120% of an overclaimed amount under the refundable credit rules would apply to the sale of credits.

If enacted, these provisions will no doubt revolutionize the way green technology project financing is structured and documented. Under current law, a “tax equity” investor must be a true project development joint venture “partner” (among other common law–based requirements) to effectively be compensated for capital investment with a disproportionate share of project tax credits. On their face, the tax credit sale provisions of the Act would appear to allow investors to discard this paradigm and enjoy the type of no-risk, “pure play” tax credit purchase commercial arrangement they have long desired. Market practice will no doubt take time to develop around the documentation and structures for these pure play tax credit purchases, and there remain numerous technical questions that will need to be addressed by Treasury and the IRS in implementing regulations and/or guidance for these transactions in order for a robust credit marketplace to develop.

We would query as to whether some investors will still prefer to use traditional tax equity joint venture partnership structures for project financing of green technology projects in order to access tax depreciation benefits as well as tax credits from project investment. Given the current historically low baseline corporate income tax rates and proposed corporate minimum tax provisions of the Act, however, we are skeptical that conventional joint venture partnership-based tax equity investing will remain a common feature of green technology project development practice.

Credit Carryover Rules

The Act would replace the general 1-year carryback, 20-year carryforward period for unused Section 38 business tax credits with a 3-year carryback, 22-year carryforward period for applicable energy, carbon capture, manufacturing, and fuel production tax credits and investment tax credits.