Three potential bonus tax credits in the Inflation Reduction Act could take investment tax credits on some projects as high as 70%.

Production tax credits could increase by as much as 20%.

The bonus credits only apply to projects placed in service in 2023 or later. Developers whose projects qualify have an incentive to delay completing year-end projects until early next year.

Some developers report difficulty persuading tax equity investors to accept that their projects qualify before the Treasury issues guidance to implement the bonus credits.

Energy Community

An extra 10% investment tax credit can be claimed on any project in an “energy community,” assuming the project complies with, or is exempted from, wage and apprentice requirements. (For more detail, see “Wage and Apprentice Requirements” in the October 2022 NewsWire.) Otherwise, the additional investment tax credit is only 2%.

A project claiming production tax credits would multiply the base tax credit for which the project qualifies by 1.1.

A project in any of three locations qualifies.

One is a project on a “brownfield site,” defined as “mine-scarred land” or a site whose use “may be complicated by the presence or potential presence of a hazardous substance, pollutant, or contaminant.”

The site cannot already have been cleaned up.

Locations that have already been listed as Superfund cleanup sites, added or proposed to be added to the national priorities list, or are subject to a court or administrative order or consent decree requiring cleanup do not qualify.

Mine-scarred land includes not only a former mine, but also nearby waters and watersheds that were affected by processing of ore and other minerals.

Another location that qualifies as an energy community is any census tract where a coal mine closed after 1999 or a coal-fired generating “unit” retired after 2009 or a directly adjoining census tract.

The third location is any metropolitan or non-metropolitan statistical area that has currently, or had at any time after 2009, at least 0.17% direct employment or at least 25% local tax collections tied to extracting, processing, transport or storage of coal, oil or natural gas and that has an unemployment rate at or above the average national rate “for the previous year.”

It is unclear to what year the phrase “for the previous year” refers. The Treasury will have to explain in guidance. However, developers have been getting comfortable with some locations by checking local unemployment rates against the national rate back multiple years and taking comfort if the local rate is consistently higher than the national rate.

A bigger challenge is while the Office of Management and Budget publishes the statistical areas, it is hard at this stage to say definitively whether projects outside the obvious coal and oil & gas regions qualify. One issue is what to treat as the relevant area for projects in rural areas. It is unclear whether it is the single county where the project is located or also one or more neighboring counties. The Senate version of the Inflation Reduction Act had other language describing the third type of energy community as a placeholder until shortly before the Senate vote. The two Senate sponsors were given only 36 hours to reframe the provision. There was no time to consult with OMB about how best to describe the eligible areas.

The Bureau of Labor statistics keeps local employment data. BLS staff believe that 12 NAICS codes should be used to add up the amount of direct employment in coal, oil and natural gas. NAICS codes — for North American Industry Classification System — are used by the government to classify businesses.

It is proving a bigger challenge to determine local tax collections. Calls to local tax authorities and economic development agencies rarely turn up the information.

Companies have been asking what happens if part of the project is in an energy community — for example, where the project substation is on a brownfield site or a gen-tie line crosses a census tract where a coal-fired generating unit retired — or whether a temporary spike in employment to build gas-fired power plant or gas pipeline counts. The Joint Committee on Taxation staff said that employment with the local gas distribution company probably does not count. The Treasury will make the final call in guidance.

In the meantime, various groups, including the American Clean Power Association and the Solar Energy Industries Association, have published maps showing probable energy communities.

Domestic Content

An additional 10% investment tax credit can be claimed on projects that satisfy domestic content requirements. However, the additional tax credit is only 2% unless the project complies with, or is exempted from, the wage and apprentice requirements. Production tax credits on projects that qualify would be multiplied by 1.1 (or 1.2 if both the energy community and domestic content adders apply).

All iron and steel and at least 40% initially (increasing over time to 55%) of the cost of all manufactured products used to build the project would have to be produced in the United States.

The Inflation Reduction Act says to look to the Buy America regulations used for federally-funded transit projects for guidance.

 Separate materials brought to the project site for incorporation into the project into two categories: construction materials and manufactured products.

Construction materials are materials that are made primarily of iron or steel. They must be entirely US made, meaning all of the manufacturing processes, but not mining of raw ore, must take place in the United States, except for metallurgical processes involving refinement of steel additives. Examples of construction materials are rebar, steel uprights and probably torque tubes that hold up solar arrays and offshore wind monopiles.

“Manufactured products” are products that are not primarily iron or steel.

Set up a fraction. The numerator is the cost of the manufactured products manufactured in the US. The denominator is the cost of all the manufactured products used to build the project. The fraction must be at least 40% for projects on which construction starts by the end of 2024, 45% for projects starting construction in 2025, 50% in 2026 and 55% thereafter. It starts at 20% for offshore wind projects, increasing to 55% for such projects that start construction in 2028 or later.

The federal transit regulations that are supposed to serve as a precedent distinguish among the end product, manufactured components and subcomponents. Manufactured components must be US made. It does not matter under the transit regulations where subcomponents are made.

This creates tension between local transit agencies and the federal government over what is the “end product.” For example, the Metropolitan Transportation Authority in New York City said the end product for its construction of a new Second Avenue subway station was the subway station. However, the Federal Transit Administration treated the fire suppression system as a separate end product, with the result that pipes and valves for it could not be imported from Finland since they would be manufactured components rather than subcomponents if the end product is the fire suppression system rather than the entire subway station.

The Inflation Reduction Act treats the end product as the “facility,” meaning a standalone battery or power plant.

The numerator of the manufactured products fraction is the cost of manufactured products that were manufactured in US factories. Mere final assembly in the US by welding together parts brought from overseas is not manufacturing. Manufacturing involves altering the form or function of the components by “adding value and transforming” the components into “a new product functionally different from that which would result from mere assembly.”

“Cost” for this purpose should be the contract price paid by the customer rather than the cost to the manufacturer. Manufacturers are usually unwilling to disclose their actual costs.

Labor costs at the project site probably do not count. The aim of the manufactured products fraction is to identify how much of the equipment was made in US factories.  

The origin of subcomponents probably does not matter, but a Senate Finance Committee staff summary left this unclear. The summary released soon after the bill was signed says, “Manufactured products are deemed to have been manufactured in the United States if the adjusted percentage [e.g., 40%] of the total cost of the components and subcomponents of the project is attributable to components that are mined, produced, or manufactured in the United States.” (Emphasis added.) The Treasury will have the final say in guidance.

Manufacturers who are able to offer products that help developers qualify for the domestic content bonus credit have been asking for premiums.

Developers are asking such manufacturers not only to certify that their products were manufactured (as opposed to assembled) at US factories, but also to recertify to the domestic content after any IRS guidance is issued or else return any premium paid for the equipment.

The domestic content requirements have waiver provisions for cases where use of US-made components would increase the project cost by more than 25% or US-made components are not available in sufficient quantity or quality.

A project cannot waive into a bonus credit, according to the Congressional tax committee staffs. Their view is the waivers are relevant only for avoiding a domestic content penalty, meaning inability for tax-exempt and state and local government entities, the Tennessee Valley Authority, Indian tribes and rural electric cooperatives “Searching for Opportunities in the Inflation Reduction Act”, and private parties with PTCs for clean hydrogen, carbon capture or domestic manufacturing, to receive full direct cash payments from the IRS for tax credits on projects on which construction starts after 2023. (For more about the direct-pay option, see “Searching for Opportunities in the Inflation Reduction Act” in the August 2022 NewsWire.)

LMI Credit

Finally, an additional 10% or 20% investment tax credit can be claimed on some small solar and wind projects with maximum net outputs of less than 5 MWac and related batteries.

The extra credit is 10% for such projects on Indian land or in low-income communities that qualify for new markets tax credits.

It is 20% for such projects that are placed on low-income residential buildings whose tenants qualify for rent subsidies or that provide at least half the “financial benefit of the electricity” to households with incomes below 200% of the poverty line or 80% of the area median gross income.

However, developers must apply to the IRS for an allocation of up to 1,800 megawatts of generating capacity that the IRS has to allocate each year. Any project receiving an allocation must be placed in service within four years.

The Treasury will have to decide what it means to share the financial benefits of the electricity. One way to handle this would be to require that at least half the electricity go to households below the thresholds and that such households not be charged more than other subscribers.

Community solar developers and rooftop solar companies will end up competing for the 1,800-megawatt annual volume cap.

Tax Equity

Some tax equity investors are unwilling to fund based on bonus credits until the IRS issues guidance.

However, despite some uncertainties, there may be some projects for which qualification is clear. An example is a project in a clear oil and gas area with above-average unemployment. Another is a project in a census tract or adjoining tract where a coal mine shut after 1999 or a coal-fired generating unit was retired after 2009.

  In cases where an investor will not fund yet, the deal documents should require an additional investment after the guidance is issued if qualification is then clear. The tax equity investor may require a legal opinion.

Insurance companies are eager to write tax insurance on qualification.

Another idea that has been discussed in some deals is leaving the bonus credits for the sponsors in the same way that state tax benefits or renewable energy credits often remain with the sponsor because the tax equity investor is unwilling to take them into account in pricing. However, the tax credits would have to be sold by the tax equity partnership and then the cash distributed to the sponsor. Proceeds from selling tax credits do not have to be reported as income. However, the tax-exempt income bumps up partner capital accounts in the same ratio as tax credits would have had to be allocated by the partnership. Thus, 99% of this tax-exempt income would be added to the tax equity investor’s capital account, giving it more capacity to absorb depreciation on the project. The sponsor would have to fund any tax indemnity that must be paid to the tax credit buyer in the event the IRS disallows the bonus credits.