IRS Guidance for Using Energy Tax Credits
As you likely know, last year’s Inflation Reduction Act (IRA) provided several new tax incentives for developing clean energy projects to benefit so-called “energy communities.” One of these incentives is a tax credit adder for a production tax credit (PTC), and another is an investment tax credit (ITC). To further explain how developers and investors can take advantage of these options, the IRS provided Notice 2023-29 on April 4, 2023. It outlines the requirements—per Internal Revenue Code Sections 45, 45Y, 48, and 48E—for claiming the energy community enhanced tax credits.
How the Energy Community Adder Works
The energy community adder increases a project’s PTC value by giving it a 10% multiplier. In addition, it can potentially provide a 10% addition to the ITC rate. To take advantage of the energy community adder, businesses must comply with the IRA’s apprenticeship (PWA) and prevailing wage requirements. Nevertheless, the effect has a separate application to the different credits. Whether a PTC project has followed the PWA requirements or not, the energy community adder still provides a 10% multiplier to its PTC value. However, if the PWA requirement is not followed, the PTC value will decrease by 80%. That means the energy credit multiplier will apply to the lower PTC amount. In contrast, when used for an ITC project, the energy community adder will apply to the credit itself. So if the PWA requirements are not followed, the adder and the ITC are both decreased by 80%. For example, without PWA compliance, a 10% bonus for a 30% ITC would be reduced to a 2% bonus for a 6% ITC. Some projects have a PWA exemption because they started construction before January 29, 2023, or their output is less than 1 MW. For those cases, the total 10% energy community adder applies.
How an Energy Community Is Defined
These tax incentives were created specifically for projects within energy communities, which are defined as these:
- Brownfield sites—property that has been impacted by pollution or mining, designated under federal law at 42 U.S.C. § 9601(39)(A)
- Coal closures—census tracts with coal mines closed since 1999 or coal-fired power plants closed since 2009 (or tracts that adjoin those areas)
- Statistical areas—metropolitan statistical areas (MSAs) or non-metropolitan statistical areas (non-MSAa) that have high unemployment (based on statistics for prior years) or high fossil fuel industry activity
Projects claiming a PTC must be “located in” an energy community, while projects claiming an ITC must be “placed in service” in an energy community. The critical date for an ITC project is at or near its commercial operations date (namely, when it was placed in service for tax purposes). For a PTC project, the energy community designation must be made each taxable year over the ten-year PTC period.
For both cases, 50% or more of a facility’s generating output or storage capacity must be in the given area (the Nameplate Capacity Test). But if that can’t be measured, 50% or more of the facility’s square footage must be in the given area (the Footprint Test). Offshore energy projects not located in a census tract can attribute their generation to the location of the land-based power-generating equipment. Therefore, some projects may choose to carefully locate their onshore substations so they qualify for the 10% energy community bonus.
Treasury, the IRS, and the Interagency Working Group on Energy Communities created a mapping tool to help identify energy communities. However, the applicable categories can change from year to year and over time.
The Begin-Construction Rule
Since the categories of energy communities can change, a location that qualifies this year may not be eligible a few years from now. The IRS realized the difficulty such revisions could present for projects with multiyear schedules, so it created a begin-construction rule.
If a project is located in what is considered an energy community on its begin-construction date, that location will remain an energy community for that project. If the project maintains the begin-construction standards released and refined by the IRS, this determination will continue for the ten-year credit PTC period or until the project’s ITC placed-in-service date.
These guidelines help clarify the requirements of the tax incentives and define the energy communities. However, since such definitions may be fluid in the years ahead, developers and investors are advised to monitor changes before committing to new projects. If you have any questions regarding tax credits or need assistance drafting contracts for customers, please do not hesitate to reach out to me at email@example.com.