In this last of a two-part series, Judy Kwok, a Partner at Troutman Pepper, discusses key tax provisions in the recently passed Inflation Reduction Act (IRA), including those around American labor, environmental justice, and new technologies. Click here to read the first part of our conversation.
Kwok’s practice focuses on federal income tax aspects of investing in onshore and offshore wind, and solar, among other types of renewable energy, as well as general M&A tax issues for the energy industry. Intimately familiar with the unique perspectives of both developers and tax equity investors, Kwok has a deep technical and commercial knowledge of the complex tax issues and structured arrangements arising from renewable energy investments, including investment tax credit and production tax credit qualification, flip partnerships, repowerings, sale-leasebacks, debt-equity, and depreciation. She has written and spoken extensively on regulatory and legislative developments in the renewable energy tax arena.
Key tax provisions included in the Inflation Reduction Act will mean a major win for American workers and historically underserved communities, while also investing in decarbonization across all sectors of the economy via targeted federal support of innovative climate solutions.
Investment tax credit (ITC) and production tax credit (PTC) provisions are expected to provide a significant boost to younger technologies and incentivize developers to invest in projects that meet specific criteria, while also driving fair wages for American workers.
What about transmission?
The industry has long been chomping at the bit for a transmission ITC, which could unlock tens of gigawatts of wind and solar stuck in interconnection queues. In 2019, legislation was introduced that would have provided a tax credit for investment in qualifying electric transmission line properties. The provision appeared again – this time in the Build Back Better Act (BBBA) – but was ultimately eliminated in the IRA.
“The separate ITC for transmission did not make it into the current legislation,” said Judy Kwok, a Partner at Troutman Pepper. “This is a major difference between the BBBA and the IRA, which in most respects are conceptually very similar, and that came as a surprise to much of the market.”
However, certain transmission properties continue to be ITC – eligible.
“Interconnection property is now included in ITC-eligible basis under the general ITC statute, but only for projects with capacity of 5 MW (AC) or less,” Kwok said.
The long-awaited ITC for standalone storage, by contrast, did come through. The IRA expands the full 30 percent ITC to cover a broad range of qualifying energy storage technologies.
“Energy storage has historically qualified for the ITC, but only to the extent that it was part of an otherwise ITC-eligible project – typically solar or wind – and there were restrictions and credit haircuts associated with any energy that was drawn from the grid, as opposed to the solar or wind facility,” Kwok said. “The standalone storage ITC will significantly boost the energy storage industry and its ability to get large-scale projects financed.”
American labor will be a major beneficiary of this bill, with the PTC and ITC getting a reset to the full pre-phasedown amounts on condition that certain labor requirements are met.
To qualify for the pre-phasedown credit rates, a taxpayer would need to ensure that laborers and mechanics are paid wages at the prevailing local rate – as determined by the Secretary of Labor – for the construction and, within a limited time period, alteration and repair of projects; meet minimum threshold percentages for qualified apprentice headcounts; and ensure that a specified percentage of total labor hours is performed by qualified apprentices.
If these requirements are not met, the PTC and ITC generally would be subject to an 80 percent reduction.
“While the IRA does not explicitly impose requirements on the type of labor used, certain aspects of these labor requirements, including the apprenticeship requirement, may incentivize some contractors to use union labor,” Kwok said. “And if you don’t meet these requirements, then the ITC and the PTC drastically decrease. There will be a lot of emphasis on making sure these labor requirements are met, for example, in construction contracts.”
Kwok notes that although the full pre-phasedown PTC and ITC are available to projects placed in service after January 1, 2022, the IRA’s labor requirements don’t actually kick in until 60 days after the regulations on those requirements are issued—whenever that may be.
“Therefore, it is possible to get the full pre-phasedown PTC and ITC without meeting the prevailing wage and apprenticeship requirements, but you have to start construction before the 60-day window ends,” she said. “It is probably prudent for many developers to start thinking about this now, if they have not already done so.”
Carbon capture and beyond
The IRA generally extends the Section 45Q credit to qualified facilities that begin construction prior to 2033, also lowering the minimum amount of carbon oxide that must be captured for the Section 45Q credit to be available.
Assuming that prevailing wage and apprenticeship requirements are met, the IRA generally increases the dollar amount of the credit relative to the changes to Section 45Q included in the BBBA. These developments may help accelerate the incipient tax equity market for carbon capture projects even though the Section 45Q credit is now eligible for direct pay – even for taxpaying entities.
“Major carbon capture projects are starting to become financeable,” Kwok said. “Right before the IRA, investors were beginning to consider very seriously the possibility of large-scale tax equity investments for carbon capture projects that rely on sequestration or enhanced oil recovery.”
While the long-term impact of direct pay and transferability on this market is not yet clear, Kwok notes that it is critical to remember that both the market and the technology are still in their very early stages.
“Some of the most exciting aspects of carbon capture that really ignite the public imagination—including the stories about innovative carbon capture technologies that use direct air capture and repurpose captured carbon oxide into consumer or agricultural products—are still a long way off from large-scale implementation,” Kwok said. “So, it’s too early to make sweeping predictions about the future of the Section 45Q credit and how carbon capture projects will be financed.”
The technology-neutral tax credits included in the IRA are also a push for innovation. The credits would apply to projects used for the generation of electricity that are placed in service in 2025 or later– but only if they have greenhouse gas emissions rates at or below zero.
Taxpayers would have the option to choose between a technology-neutral ITC or PTC. Each technology-neutral credit has an open-ended beginning of construction deadline that is the third calendar year after the year in which the U.S. electric power sector emits 75 percent less carbon than in 2022, which would not occur earlier than 2032.
“Innovation is clearly the intent,” Kwok said. “At this point, we can’t say what the big winners from the technology-neutral approach will be down the line. Wind and solar are here to stay, but these credits open up the field for new technologies. From a process perspective, there will be a lot of emphasis on measuring greenhouse gas emissions rates accurately in order to demonstrate eligibility for the credits.”
Low-income and Energy Community enhancements
The IRA builds on investments in the Biden administration’s Bipartisan Infrastructure Law, like spurring wind and solar project development in underserved communities via a 20 percent ITC enhancement for wind and solar projects (with nameplate capacity of 5MW or less) on federally subsidized affordable housing projects, and a 10 percent ITC enhancement for such wind and solar projects in specified low-income communities, including tribal lands.
Both enhancements are subject to the projects being allocated an “environmental justice solar and wind capacity limitation” by the government, which is capped at 1.8 GW nationwide for each in 2023 and 2024.
The IRA also includes 10 percent ITC and PTC enhancements for projects built in certain “energy communities” with ties to traditional energy resources.
An energy community includes brownfield sites; certain areas that meet specified thresholds demonstrating economic ties to the coal, oil, or natural gas industries; and any census tract or adjoining tract in which a coal mine closed after Dec. 31, 1999, or a coal-fired electric power plant retired after Dec. 31, 2009.
But getting these enhancements will be harder than it looks, in part because meeting these criteria – similar to the domestic content enhancement and the labor requirements – requires fundamental changes to the planning of renewables projects.
“Very detailed technical hurdles have to be met in order for an area to qualify as a low-income community or an energy community,” Kwok said. “On the other hand, it’s very rewarding if you can meet these requirements, and they are additive –the base credit is separately increased by each of meeting labor requirements, meeting the domestic content thresholds, locating the project in a low-income community, and locating the project in an energy community.”
As an example–a developer could, in theory, receive up to a 70 percent ITC. Practically speaking, however, it could be challenging to get all of these enhancements, says Kwok, since creating these enhancers will take real work.
“These requirements are not just administrative–you really need some substance to locate a project in a low-income community or an energy community, or make sure a project meets domestic content requirements,” she said. “These requirements, along with labor requirements, will incentivize major changes in the way developers build their projects. In many cases, certain rules are still very ambiguous, particularly in the domestic content area, and there are a lot of open questions about their application that require further clarification from the IRS.”
Explore previous installments in our Pulse on Policy series.
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