The Section 48 energy credit, also known as the Investment Tax Credit (“ITC”), is a federal tax credit that provides a financial incentive for individuals and businesses to invest in certain types of renewable energy systems. Congress created the ITC as part of a broader set of policies aimed at promoting investment in renewable energy systems and reducing greenhouse gas emissions. The credit was first introduced in 1978 as a 10% tax credit for investments in renewable energy sources such as solar, wind, geothermal, and hydroelectric power. Congress has repeatedly amended the credit since originally passed.
Until 2022, the ITC was equal to 30% of the taxpayer’s basis in § 48 Property. § 48 Property covered qualified wind energy technologies, solar energy technologies, geothermal energy technologies, fuel cells, microturbines, and combined heat and power systems. The basis in § 48 Property includes the taxpayer’s expenses incurred acquiring, developing, constructing, and installing renewable energy technologies, and connecting the system to the power grid. The ITC was scheduled to enter a phase-down starting in tax year 2022.
The Inflation Reduction Act of 2022 (“IRA”), however, comprehensively amended the ITC. Namely, the IRA:
The amendments, taken as a whole, are taxpayer favorable and provide new opportunities and incentives for taxpayers involved in renewable energy technologies.
1. New systems qualify for the ITC
The IRA expanded the types of renewable energy systems eligible for the ITC. All systems that qualified as § 48 Property before the IRA continue to qualify. Energy storage technologies, qualified biogas property, and microgrid controllers now also qualify as § 48 Property. Energy storage technologies are those that can receive, store, and later deliver energy. Qualified biogas property includes all property included in a system that converts biomass to energy with waste products consisting of less than 52% methane. A microgrid controller is any property used to monitor and manage the load on an electrical grid producing between 4 kilowatts and 20 megawatts of electricity.
2. Two-tiered rate depending on taxpayer satisfaction of labor requirements
The IRA established a new base rate of 6% of the taxpayer’s basis in the § 48 Property. The taxpayer, however, may claim a 30% rate if any one of the below requirements are met:
On November 30, the IRS published guidance on the beginning of construction and the prevailing wage and apprenticeship requirements. We discussed this guidance in more detail in a prior article. The initial question is whether the maximum net output of the project is less than 1 MW. If so, then the project defaults to the increased 30% credit. If not, then the taxpayer must determine if construction began on or before January 29, 2023, which can be satisfied by either showing physical work on the project or that 5% of the project’s costs were incurred by that date.
If the taxpayer does not meet either of the first two criteria, the only avenue for the increased credit is to meet prevailing wage and apprenticeship requirements. The prevailing wage requirement requires the taxpayer pay laborers a prevailing market wage for construction and for maintenance for the first five years the property is in service. Second, the apprenticeship requirement requires the taxpayer to fulfill a specified percentage of the labor with qualified apprentice hours. In effect, these amendments create an 80% credit penalty for energy projects over 1 megawatt where construction started after 1/29/23 and that fail to meet the prevailing wage and apprenticeship requirements.
3. New bonus incentives and monetization opportunities available
The IRA created three bonus incentives that increase the applicable ITC rate. First, taxpayers can claim a Domestic Content Bonus for projects that source all steel and iron from the United States and include only manufactured products containing at least 40% US-sourced components. Second, projects located in a qualified energy community are eligible for an Energy Bonus. Qualified energy communities include brownfield sites, metropolitan areas, and non-metropolitan areas that meet certain conditions. Both the Domestic Content Bonus and the Energy Community Bonus are equal to an additional 10% for projects that meet the 1MW, beginning of construction, or prevailing wage and apprenticeship requirements. Otherwise, the bonuses are worth an additional 2% each.
Third, projects under 5 megawatts located in low-income communities can claim one of the Low-Income Bonuses. A 10% bonus is available to projects built in low-income communities, as defined by the New Markets Tax Credit, or on an Indian reservation. Meanwhile, a 20% bonus is available to systems that are part of a low-income residential building project and low-income economic benefit project.
In addition to the bonuses, the IRA also created new monetization opportunities for tax-exempt entities. A taxpayer could only use an ITC to offset tax liability before tax year 2023. The IRA, however, amended the Code to allow certain applicable entities to receive a direct payment of the ITC starting in tax year 2023. The applicable entity is treated as making a payment against tax equal to the amount of such credit. Organizations exempt from tax under Subtitle A and political subdivisions, such as states and municipalities, are among the applicable entities allowed to seek a direct payment. Entities other than applicable entities (mainly for-profit companies), can also make a one-time transfer of some or all of the ITC starting with property placed in service in tax year 2023. Payments made by transferees for ITC credits must be made in cash and cannot be deducted or included in gross income.
4. Extended phase-down schedule and switch to technology neutral framework
The IRA modified an ongoing phase-down of the ITC. The ITC credit rate was meant to progressively decrease from 30% to 10% over the course of four years, but the IRA eliminated the current phase-down.
The IRA, however, eliminated the ITC from 2024 onwards and replaced it with the Clean Electricity ITC. The Clean Electricity ITC is subject to the same rate structure, bonuses, and monetization opportunities discussed in Parts 2-3. The Clean Electricity ITC, however, applies generally to zero emission power facilities and storage technologies, rather than to a specified list of technologies like the ITC. The credit’s scope thus will expand when the Clean Electricity supplants the Energy ITC in 2024. Once active, the Clean Electricity ITC will be subject to a phase-down schedule that depends on U.S. progress towards emissions targets.
Overall, the IRA created new opportunities for taxpayers and tax-exempt entities to subsidize their renewable energy investments. The IRA also created a new bonus framework that allows taxpayers to claim up to 70% of the energy property’s cost basis as a credit to be applied against tax liability, or in the case of a tax-exempt entity, a direct payment from the Internal Revenue Service.
If you or a client has a project that you believe may qualify for the ITC, please contact BRAYN to schedule a consultation. Our team of experts is available to provide personalized guidance and support. To schedule a consultation, please call us at (888) 773-8356 or email us at email@example.com.