The major legislation passed by Congress this month is nothing short of transformational.
The Inflation Reduction Act (which I’ll nickname as the “Climate Tax Bill”), if passed by the House, would expand the use of Federal tax credits to advance climate stabilization goals and attempt to curb global warning. In doing so, this bill lays bare the power and reach of the U.S. Tax Code to harness renewable energy as a tool to achieve economic security.
This post will focus on the provisions of the bill that relate directly to the Investment Tax Credit ITC and, specifically, how it pertains to the financing of commercial and industrial or utility-scale solar projects.
Section 48 of the Internal Revenue Code currently allows an ITC of 26% of the eligible costs of a solar project which was to be reduced to 22% in 2023 and 10% in 2024. The new Climate Tax Bill extends the ITC until 2035 and will actually increase the ITC to 30% for projects that are placed in service in 2022. Accordingly, a project which had $10 million in eligible costs would have, in the recent past, generated a $2.6 million
ITC. Under the new bill, for many projects the ITC would be increased to $3 million.
For a project that has commenced construction prior to December 31, 2024 (and is placed-in-service after December 31, 2022) the Climate Tax Bill creates a clean electricity investment credit in Proposed Code Section 48D (the “new ITC”). The new ITC, which will phase out the current ITC for projects that begin construction after 2024, has a base rate of 6% that can increase to 30% for taxpayers who pay local prevailing rates and utilize registered apprenticeship programs. This credit value can be further increased:
- if the facilities meet domestic-content requirements;
- for projects in energy communities; and
- for projects located in low-income communities.
Accordingly, under proposed new Code Section 48D the new ITC would be as
- 6% base ITC that could increase to 30% if labor and wage requirements are satisfied;
- + 10% if meet domestic content usage and prevailing wage requirements are met;
- + 10% if the project is located in an “Energy Community” (certain Brownfields sites are included); and
- + 10% if the project is located in a low-income community or + 20% if the project is included with certain qualified low-income buildings.
Let’s add this all up: for a project that complies with all of the above elements, the new ITC could be up to 70%.
That’s a figure that will attract the attention of any astute developer or investor.
The Senate Finance Committee issued these comments to further describe the benefits
of the Climate Tax Bill:
- Any qualified property or grid improvement property described in the new ITC will be treated as five-year property under the General Depreciation System (“GDS) for tax purposes of Code Section 168. 1 This expanded depreciation provision shall apply to facilities and property placed in service after Dec. 31, 2024.
- The credit carry-back period is extended from one to three years for any credit eligible to be transferred.
- The applicable percentage for facilities which satisfy domestic content requirements and have a maximum net output of less than one megawatt shall be 100%. 2
- New Section 48D applies to taxable years beginning after Dec. 31, 2022.
- A provision of the Climate Tax Bill, i.e., Section 6418, allows for the transfer of the new ITC from the eligible taxpayer3 to an unrelated taxpayer — which greatly differs from current law and practice, and would certainly revolutionize the ITC marketplace. For transfers of the New ITC, (i) any amount paid in consideration of a transfer must be paid in cash; and (ii) this payment for any credit is not deductible by the purchaser, nor is the payment included in income of the seller. 4
- Any election to transfer new ITCs by a partnership or S corporation must be made at the entity level and is not allowed at the partner or shareholder level.
- This transfer of a new ITC may be for all, or a portion of, a credit, but any credit (or portion thereof) may only be transferred once.
Should this Climate Tax Bill become law, the IRS is expected to publish rules pertaining to the transfer of the new ITC which we hope will address issues such as whether taxpayers subject to the Passive Loss Rules and the At-Risk Rules would be able to receive and utilize the new Section 48D ITC, and whether the purchaser would be taxed on their use of the new ITC. We at the Cherrytree Group will be closely
monitoring those and other further developments.
Clearly, the Inflation Reduction Act is the most significant tax legislation in years — and has the potential to reform and revitalize the solar energy industry. Hopefully, in the coming weeks and months the IRS will publish guidance on the open issues and we can begin to digest these changes and how they will affect valuation, transfer, and transactional structuring of the new ITC. Keep reading as we update this post!
1 Amends Code Section 168(e)(3)(B) to allow any facility described in Proposed Code Section 48D to be treated as five-year personal property under the GDS.
2 Measured in alternating current (AC). These projects are exempted from the prevailing wage and apprenticeship requirements.
3 Section 6417(c)(1)(A) defines eligible taxpayer (which includes individuals, corporation, trusts, i.e., the taxpayers generally seeking the transfer of the ITC).
4 Currently, the ITC is not transferable, but a taxpayer that enters into a partnership with the eligible taxpayer (usually an entity) and conforms to the requirements of Revenue Ruling 2007-65 (i.e., the Safe Harbor) could be allocated the ITC in proportion to its ownership interest.