The Inflation Reduction Act, Public Law 117-168 (the “Act”), was signed into law by President Joe Biden on August 16, 2022, but the impact of some of its provisions is just beginning to be felt. Among those are the substantial federal subsidies the Act provides for state and local government investments in clean energy projects. These subsidies are provided through a change in the rules for clean energy tax credits, which will allow state and local governments to take a direct payment in lieu of the tax credit. While the amount of the direct payment for a qualifying project will vary, there is potential for some projects to qualify for a direct payment equal to 70% of the project cost.
Before the passage of the Act, clean energy tax credits could only be used to offset a credit recipient’s federal income tax liability. State and local governments were ineligible for credits, as they do not pay federal income tax, and therefore would be required to pay the full cost of any clean energy project. A common workaround was for the government to partner with a tax-paying business to obtain essentially a pass-through of the economic benefit of the tax credit.
With the passage of the Act, which applies to projects placed in service after December 31, 2022, a state or local government can directly receive the economic benefit of the credit. Eligible entities include states, their political subdivisions, and their agencies and instrumentalities, as well as public school districts.
An eligible entity must own the project for which it is seeking a direct payment. This may be a departure for governmental entities that have undertaken clean energy projects in the past. Prior to the passage of the Act, the tax-paying business partner, as the recipient of the tax credit, would own the project. Under this structure the governmental entity would be absolved of the liabilities of ownership of the project and the related installation and maintenance costs. Going forward, the governmental entity will have to assume these responsibilities as part of its ownership of the project in order to qualify for a direct payment.
While the Act authorizes a variety of clean energy tax credits, we anticipate that most governmentally-owned clean energy projects will seek to take advantage of the tax credits under Code section 45 (section 45Y after December 31, 2024), which provides for a production tax credit for electricity generated from renewables (the “Production Tax Credit”), or Code section 48 (section 48E after December 31, 2024), which provides for a clean energy investment tax credit (the “Investment Tax Credit”).
The Production Tax Credit is an annual tax credit based on the amount of electricity generated by a clean energy project. The credit is limited to ten years. In contrast, the Investment Tax Credit is taken completely up front and is received in a lump sum, based on the cost of the project. Direct pay recipients must elect which of these credits to take; they may not take both. We believe the Investment Tax Credit will be the more popular of the two credits – particularly when considering the various direct-pay, tax advantaged bond programs and the impact that sequestration cuts had on them. Governmental entities that issued such bonds may be hesitant to assume that the value of the Production Tax Credit will not be cut by Congress in the future.
Clean energy projects eligible for direct pay credits include solar, geothermal, biogas, wind, and landfill gas facilities. After December 31, 2024, any project which is used for the generation of electricity and which has a greenhouse gas emissions rate of not greater than zero is eligible; the project need not fit within the parameters of a specified technology (wind, solar, etc.).
Direct pay recipients may finance these projects using tax-exempt bonds, so long as they otherwise qualify for tax-exempt status under Code sections 103 and 141-150. We anticipate that many projects will qualify to be financed with tax-exempt bonds due to the governmental ownership requirement. If tax-exempt bonds are used to finance the project, the amount of the direct pay credit generally will be reduced by 15%. Current market conditions suggest that the benefit of using tax-exempt bonds will outweigh the reduction in the direct pay credit.
There are a number of additional provisions in the Act that may impact the value of a direct pay credit under the Act. Most importantly, to obtain the minimum 30% Investment Tax Credit or 2.75 cents/kW Production Tax Credit, a project must either be small (generate less than 1 megawatt) or meet prevailing wage and apprenticeship requirements. Public entities in Pennsylvania will be familiar with the prevailing wage requirement, but may be unfamiliar with the apprenticeship requirement. A limited good faith exception to the apprenticeship requirement may apply.
The Act also has escalation provisions, which if activated will increase for the value of the direct pay credit over the minimum level. Bonuses are offered for projects using certain minimum levels of “domestic content,” as well as projects located in “energy communities” and “low-income communities.” These bonuses are stacking, such that a single project could potentially qualify and receive all of them.
A project will qualify for a “domestic content” bonus if it uses certain minimum amounts of domestically produced steel or iron, and manufactured products. If the minimum thresholds are met, a project receiving the Production Tax Credit will receive a 10% increase in the 2.75 cents/kW credit rate, and a project receiving the Investment Tax Credit will receive a 10 percentage point increase in the 30% credit rate.
A project will qualify for an “energy community” bonus if it is located in a brownfield site or near a coal mine or coal-fired power plant. Locating in a community with high concentrations of economic activity related to coal, oil or natural gas development and which currently has higher-than-average unemployment will also qualify the project for the “energy community” bonus. A qualifying project will receive a 10% bonus similar to the “domestic content” bonus discussed above.
A project will qualify for a “low-income community” bonus if it is located in a community that either has (1) a poverty rate equal to or greater than 20%, or (2) median family income not greater than 80% of the state’s income (or city income, if the community is located in a city). A qualifying project will receive a 10% bonus similar to the “domestic content” bonus discussed above. The bonus may even be doubled to 20% if the project is part of a qualifying affordable housing program. Allocations for the “low-income community” bonus are limited and require a special pre-application process and award.
Eligible entities that wish to apply for direct payment of clean energy credits must complete a special pre-filing registration application with the IRS to obtain a special registration number for each particular project. The pre-filing registration application web tool is now live, and eligible entities that intend to apply for direct payment are encouraged to complete that application as soon as possible.
As busy as the IRS has been over the last year with implementing the Act, many questions remain about the direct pay credit program. In particular, there are unresolved issues regarding the tax character of any direct payments received by the recipient when a project is financed with tax-exempt bonds. We anticipate that the IRS will issue guidance on this question this year. As projects get underway, we can anticipate additional questions and (hopefully) timely answers from the IRS.
Reprinted with permission from the February 6, 2024 edition of The Legal Intelligencer © 2024 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.