Key Takeaways:

  • Recently enacted direct pay and transfer provisions apply to certain clean energy tax credits. These provisions will have a significant impact on how taxpayers can monetize these tax credits and, in turn, the way that clean energy projects will be financed going forward.
  • Taxpayers may not be permitted to claim multiple clean energy credits. Taxpayers will need to carefully assess whether it is more advantageous to claim one credit over another.
  • A number of open questions relating to these clean energy credits are not addressed by the statutes. To the extent you have an open question, consider contacting BakerHostetler to discuss whether it is appropriate to request future regulatory guidance to address your open questions.

Virtually every major country has placed a focus on energy resources and energy policy in 2022. Much of the focus is on the technical challenges of converting to new forms of energy, including the large capital investments required and the economic impact of a shift toward net zero carbon emissions. On August 16, 2022, President Joe Biden signed into law the Inflation Reduction Act (“IRA”), which contains a number of provisions that seek to mitigate these costs by providing tax credits (through traditional tax equity financing, direct pay and transfers) to producers, developers and investors in renewable energy and in projects that capture and sequester carbon. What follows is a discussion of these credits, including how taxpayers may monetize credits, and several considerations for taxpayers analyzing and assessing potential credits.

I. Credit Monetization and Appropriations[1]

The IRA provides alternatives to monetize credits in addition to the traditional tax equity investment structures. The first is allowing certain entities to receive a “direct pay” cash payment in the form of a tax refund from the federal government. The second is allowing entities to sell or transfer credits to third parties.

A. Direct Pay Credits

For tax years beginning after December 31, 2022, and before January 1, 2033, tax-exempt entities, state and local governments, and Indian tribal governments may elect to treat certain tax credits as refundable payments of tax. Such entities are eligible to receive a direct payment for any amount paid in excess of their tax liability for credits under Sections 30C (alternative fuel refueling property), 45 (renewable electricity production credit), 45Q (carbon oxide sequestration credit), 45U (zero-emission nuclear power production credit), 45V (clean hydrogen production credit), 45X (advanced manufacturing production credit), 45Y (clean electricity production credit), 45Z (clean fuel production credit), 48 (energy investment tax credit), 48C (qualifying advanced energy project credit) and 48E (clean electricity investment credit) of the Code. In addition, certain tax-exempt entities may elect to receive a direct payment of tax credits under Section 45W (qualified commercial vehicles).

Non-tax-exempt entities are eligible for this direct payment only for credits under Sections 45Q (carbon capture credit), 45V (clean hydrogen production credit) and 45X (advanced manufacturing production credit) of the Code. This refund election expires on December 31, 2032.

B. Transfers

For tax years beginning after December 31, 2022, taxpayers that are not tax-exempt entities are also allowed to transfer certain tax credits to taxpayers that are not related to the transferor taxpayer. Tax credits eligible for this transfer include those under Sections 30C (alternative fuel refueling property), 45 (renewable electricity production credit), 45Q (carbon oxide sequestration credit), 45U (zero-emission nuclear power production credit), 45V (clean hydrogen production credit), 45X (advanced manufacturing production credit), 45Y (clean electricity production credit), 45Z (clean fuel production credit), 48 (energy investment tax credit), 48C (qualifying advanced energy project credit) and 48E (clean electricity investment credit) of the Code. Any payments received in exchange for the transfer of credits are excluded from income, and any amounts paid to obtain a transferred credit cannot be deducted from income.

Observations:

  • The direct pay and one-time transfer provisions allow developers of clean energy projects to monetize tax credits without having to utilize traditional tax equity financing structures. These new provisions will be disruptive in the market, will provide flexibility and alternatives to developers and producers, and will likely materially change the way projects are financed going forward as potential new investors look to make investments.
  • There is an open question regarding whether all producers that receive tax credits through a transfer may elect direct pay for the credit transferred. We are hopeful that IRS guidance will make clear that direct pay elections by all producers may include tax credits acquired through transfers.
  • The transferability of credits is something that taxpayers will need to monitor going forward. It may be prudent for taxpayers engaging in transfers to carefully review any agreements relating to such transfers to ensure there are adequate contractual protections against prohibited multiple transfers.

II. Production and Investment Tax Credits

Section 13101 of the IRA extends and expands the current production tax credit framework for qualified facilities under Section 45 of the Code. The extension provides that construction of facilities for wind, biomass, geothermal, solar, landfill gas, trash, qualified hydropower, and marine and hydrokinetic power must begin before January 1, 2025. The base production tax credit amount is set at 0.3 cents per kWh. However, facilities that pay prevailing wages during the construction phase and the first 10 years of operation and meet certain apprenticeship requirements are eligible for an expanded production tax credit five times the base amount. Credits can also increase by 10 percent if certain domestic content requirements are satisfied. In general, these requirements are satisfied if (1) 100 percent of any steel or iron that is a component of the facility was produced in the United States; and (2) 40 percent of manufactured products that are components were produced in the United States.

Section 13102 of the IRA extends and expands the current investment tax credit framework for qualified facilities under Section 48 of the Code. In addition, the list of qualifying properties has been expanded to include stand-alone storage, qualified biogas property, electrochromic glass and microgrid controllers. The investment tax credits extend the beginning-of-construction deadline to before January 1, 2025. The base investment tax credit for solar, fuel cells, waste energy recovery, combined heat and power, and small wind property is set at 6 percent, but may be expanded to up to 30 percent if wage and workforce requirements are met. An additional bonus credit of up to 10 percent (i.e., expanding the credit to up to 40 percent) is available for projects that use certified steel, iron and manufactured products that are domestically produced (similar to the domestic content requirements noted above). However, the bonus credit is only 2 percent if both of the following are true: (1) construction of the facility does not begin prior to 60 days after the IRS releases guidance regarding wage and apprenticeship requirements; and (2) the prevailing wage and apprenticeship requirements are not satisfied.

Observations:

  • No credits can be claimed under either of these provisions to the extent that credits are claimed under certain other sections. Thus, taxpayers will need to assess whether it is more advantageous to claim one credit over another.
  • Taxpayers may have the option to claim the production tax credit or the investment tax credit. The additional bonus credit for certified steel, iron and manufactured products that are domestically produced may impact this decision.

III. Clean Electricity Production and Investment Credits

Section 13701 creates a new clean electricity production credit under Section 45Y relating to the sale of domestically produced electricity with a greenhouse gas emissions rate not greater than zero. To qualify, electricity must be produced at a qualifying facility placed in service after December 31, 2024. Meanwhile, Section 13702 creates a new clean electricity investment tax credit under Section 48E for investments in qualifying zero-emissions electricity generation facilities or storage technologies for facilities placed in service after December 31, 2024.

These new credits are intended to be technology neutral and will replace the current production and investment tax credits found in Sections 45 and 48, respectively, of the Code. These new credits largely mirror the current production and investment tax credits discussed above.

Observations:

  • No credits can be claimed under either of these provisions to the extent that credits are claimed under certain other sections. Thus, taxpayers will need to assess whether it is more advantageous to claim one credit over another.
  • Facilities that are constructed before the end of 2024 may consider qualifying for the production tax credits or investment tax credits under Sections 45 and 48 instead of these credits. This is because credits under Sections 45 and 48 are not required to satisfy the zero greenhouse gas emission requirement.

IV. Carbon Capture Credits

Carbon capture credits under Section 45Q were first introduced on October 3, 2008, as part of the Energy Improvement and Extension Act of 2008 (P.L. 110-343), and that provision has since been amended several times. In general, taxpayers that (1) own carbon capture equipment that captures qualified carbon oxide from an industrial facility and (2) sequester or use carbon for certain purposes are entitled to a credit for each metric ton of qualified carbon oxide captured and sequestered.

The IRA significantly increases the Section 45Q tax credit value to $85/metric ton for captured qualified carbon oxide stored in geologic formations, $60/metric ton for the use of captured carbon emissions, and $60/metric ton for qualified carbon oxide stored in oil and gas fields if certain wage and apprenticeship requirements are met.

The IRA expands eligibility for carbon capture and sequestration credits under Section 45Q by extending the beginning-of-construction deadline from before January 1, 2026, to before January 1, 2033. Thus, tax credits can now be claimed for qualified carbon oxide during the 12-year period following the qualifying facility being placed in service. The amount of qualified carbon oxide that must be captured at a qualifying facility is reduced from 100,000 metric tons to 1,000 metric tons annually for direct air capture facilities, from 500,000 metric tons to 18,750 metric tons annually for an electricity-generating facility, and from 100,000 metric tons to 12,500 metric tons for any other facility.

Observations:

  • This increased credit further incentivizes incorporating carbon capture equipment into industrial facility projects with a specific focus on meeting the wage and apprenticeship requirements.
  • The IRA reduces the threshold amount of carbon oxide required to be captured in order to qualify for the credit. Thus, taxpayers that would not have previously qualified for these credits may find that they now qualify.
  • These credits are eligible for direct pay for the first five years. This combined with the increase of the credit will likely affect financing structures for carbon capture projects. But given the five-year limitation, it is not likely that traditional tax equity structures will disappear completely.

V. Advanced Manufacturing Production Credit

Section 13502 of the IRA creates a new production tax credit under Section 45X for the domestic production and sale of solar and wind components in the course of a taxpayer’s trade or business. The credits apply to an array of components, with the amount of the credit varying depending on the eligible components. Eligible components include specifically listed items used in wind, solar and battery projects, such as blades, wind turbine towers, PV cells, solar grade polysilicon, solar modules, torque tubes, structural fasteners, electrode active materials, battery cells, battery modules and certain critical minerals.

These credits will phase out for components sold after December 31, 2029, with any components sold thereafter being reduced by 25 percent per year. There will be no credit offered beyond 2031. These tax credits do not apply to facilities that are already receiving a credit under Section 48C.

Observations:

  • A number of components qualify for this credit. But there is uncertainty regarding the definition of “produce” and “producer” and what constitutes a domestically produced component. Taxpayers that may be eligible should review their manufactured products and operations and monitor any future guidance provided by the IRS or Treasury regarding these topics.
  • Taxpayers that qualify for this credit and make a direct pay election (as described above) may not also make an election to transfer any portion of their advanced manufacturing credits. Taxpayers should accordingly analyze their current situation and determine whether direct pay is better than the alternative of using credits pursuant to Section 38 without direct pay refundability, with the flexibility of being able to also transfer certain credits for cash.