On Aug. 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022 (IRA), which includes new and revised tax incentives for clean energy projects. The IRA extends and significantly modifies the federal tax credits available for wind energy projects. This alert provides a summary for the wind industry. Additional alerts will provide summaries of the IRA focused on other clean energy technologies.
Prior Law — Production Tax Credit Phased Out for Wind Projects
Before the enactment of the IRA, the Section 45 production tax credit (PTC) for wind projects was available only to facilities that began construction before Jan. 1, 2022. The PTC rate for wind projects was subject to the phased reductions summarized below:
- Wind projects that began construction before the end of 2016 – 100 percent.
- Wind projects that began construction in 2017 – 80%.
- Wind projects that began construction in 2018 – 60%.
- Wind projects that began construction in 2019 – 40%.
- Wind projects that began construction in 2020 – 60%.
- Wind projects that began construction in 2021 – 60%.
- Wind projects that began construction after 2021 – PTC not available
Extension of PTC for Wind Projects
The IRA extends the Section 45 PTC to wind projects that begin construction before the end of 2024. This three-year extension to the PTC for wind projects comes with other qualification requirements not previously included under Section 45. The wind industry will need to adapt and accommodate these new PTC qualification requirements. The PTC for wind projects is further extended through at least 2033 under a new Section 45Y (discussed below).
Restoration of 100% PTC for Wind Projects
The IRA eliminates the PTC phaseout for any wind project placed in service after Dec. 31, 2021; however, the current PTC phaseout would continue to apply for any wind project placed in service before Jan. 1, 2022. Accordingly, wind projects placed in service after Dec. 31, 2021, are eligible to receive tax credits at full value, rather than the reduced values under the old law.
The PTC extension comes at a price. The IRA introduces new prevailing wage and apprenticeship requirements (discussed below) that must be satisfied to qualify for the full PTC for projects placed in service after Dec. 31, 2021. This is done by establishing a PTC base rate of 0.3 cents per kWh (adjusted annually for inflation after 1992) and then providing a 5x multiplier for those projects that satisfy the new prevailing wage and apprenticeship requirements. The result is a restoration of the 100% PTC for projects that satisfy the new wage and labor rules and a 20% PTC for projects that do not satisfy these new wage and labor rules.
New Section 45Y Extends PTC Through at Least 2033
The IRA introduces a new Section 45Y that replaces the traditional Section 45 for projects placed in service during 2025 or later. Section 45Y mimics old Section 45 except for one key difference. Section 45Y is technology-neutral and allows 10 years of PTCs for any electric generation facility with a zero or less greenhouse emissions rate.
Section 45Y includes the new prevailing wage and apprenticeship requirements to qualify for the full PTC (discussed below); otherwise, only a 20% PTC will be available. The two separate 10% credit adders discussed below for projects that satisfy the domestic-content requirement or are constructed in an energy community also apply under Section 45Y. The adder for projects built in low-income communities (discussed below) also apply, but those must be projects that are less than 5 MW.
The IRS eventually will publish emission rates for technologies so taxpayers can determine if their projects qualify for the PTC under new Section 45Y.
The PTC under 45Y is phased out after 2033. The phaseout is triggered when greenhouse gas emissions from the electric generation industry are reduced by at least 75% of the annual 2022 emission rate. Facilities that begin construction in the second year following the later of 2032 or the year the 75% emission reduction target is met, will qualify for a 75% PTC. A 50% PTC applies to projects that begin construction in the third year following the trigger of the phaseout, and no PTCs are allowed for projects beginning construction in the fourth calendar year or later.
Prevailing Wage and Apprenticeship Requirements
To qualify for the 100% PTC, a wind project must satisfy the prevailing wage and apprenticeship requirements for all laborers and mechanics employed by the taxpayer or for any contractor or subcontractor in the construction, alteration or repair of the facility. If these requirements are not met, the wind project would be eligible only for the base rate (i.e., 20% PTC).
Specifically, a taxpayer must (1) pay prevailing wages at the local rate (as most recently determined by the secretary of labor, in accordance with Subchapter IV of Chapter 31 of Title 40 of the United States Code) for the construction of the facility and any repair or alteration of the facility during the entire 10-year PTC period, and (2) ensure that no less than the applicable percentage of total labor hours is performed by qualified apprentices. For purposes of the apprenticeship requirement, the applicable percentage is (i) 10% for projects that begin construction in 2022, (ii) 12.5% for projects that begin construction in 2023, and (iii) 15% for projects that begin construction in 2024 or later.
Section 45 does contain mechanics for correcting failures to comply with these new wage and labor rules, so the 100% PTC can be preserved. These corrective measures include payments to the laborer for the difference between the prevailing wage and the wage paid, plus interest, and a $5,000 per-laborer penalty to be paid to the IRS. The penalty is increased to $10,000 per laborer if the failure was an intentional disregard of the new rules. Failure to employ apprenticeship laborers has similar corrective provisions, including a $50 per-labor-hour penalty paid to the IRS, or $500 per-labor-hour penalty if the failure was an intentional disregard.
Notable Exceptions to Wage and Labor Requirements
There are two notable exceptions to the prevailing wage and apprentice labor requirements, thus allowing these projects to qualify for the 100% PTC regardless:
- Projects with less than 1 MW of nameplate capacity.
- Projects that begin construction prior to the date that is 60 days after the IRS publishes guidance with respect to the prevailing wage and apprentice labor requirements.
The apprenticeship labor requirements have a good-faith exemption that applies if the taxpayer requests qualified apprentices from a registered apprenticeship program and the request is denied or goes without response for more than five business days.
A key matter for the new PTC will be when a project begins construction for purposes of the prevailing wage and apprentice labor requirements. This could mean the difference between a 20% PTC and a 100% PTC. The wind industry should closely monitor the IRS’ publication of guidance on these new labor and wage requirements.
Refundable PTC for Tax-Exempt Entities
The PTC now is a refundable credit for tax-exempt entities, state and local governments, tribal governments, Alaska Native Corporations, the Tennessee Valley Authority and rural electric cooperatives. Projects that are 1 MW or larger must satisfy the domestic content requirements if they begin construction after 2023; otherwise, the refundable credit amount will be reduced by 10% for projects that begin construction in 2024 and by 15% for projects that begin construction in 2025. No refundable credit will be permitted for projects that begin construction in 2026 or later if they do not satisfy the domestic-content requirements.
An exception to the domestic-content requirement applies if those components are not produced in the United States in sufficient available quantities, or if the inclusion of domestic content would increase the overall project costs by more than 25 percent.
Wind projects owned by the tax-exempt entities described above and placed in service after 2022 can qualify for the refundable credit.
Wind projects owned by taxable entities are not eligible for a refundable PTC, but instead can take advantage of the new transferability rules (discussed below).
Direct Transfer of the Tax Credits
The IRA added a provision to permit project owners (other than tax-exempt entities) to make an election to transfer the PTC or the ITC to a third party. The amount the third party paid for the tax credit must be in cash, is not included in the gross income of the transferee and is not deductible to the transferor. An election to transfer the tax credits must be made on or before the due date for the tax return in the year the credits were determined, so credits that are carried forward cannot be later transferred. Also, once a credit is transferred, the credit cannot be further transferred by the transferee.
The election to transfer PTCs to a third party applies to credits determined after 2022, regardless of when the wind project was placed in service. This means operating wind farms with remaining years of PTC eligibility could take advantage of the PTC transfer rules for operating years 2023 and later.
These direct transfer rules likely will have a significant impact on wind project financing, as sponsors might elect to simply monetize the PTC each year rather than bringing in tax equity partners. The simplified transfer rules could avoid cumbersome governance and ongoing compliance matters that affect operating wind farms. However, the tax credit market may seek indemnities from sponsors and parent guaranties related to the tax credits’ original determination and qualification. This could have a separating effect in a tax credit market between creditworthy sponsors and the rest of the industry. Expect tax insurance to play a large role in the new tax credit transfer market.
10% PTC Adder for Wind Projects With Domestic Content
A 10% PTC adder applies for wind projects placed in service after Dec. 31, 2022, that satisfy a new domestic-content requirement. To qualify for this new 10% bonus to the PTC for domestic content, the taxpayer must certify that any steel and iron, or any manufactured product that is a component of the facility, was produced in the United States.
For this purpose, construction material made primarily of steel or iron must be 100% produced in the United States. This does not apply to steel or iron used as components or subcomponents of other manufactured products. Manufactured products will be deemed to have been produced in the United States if not less than the “adjusted percentage” of the total costs of all such manufactured products is attributable to manufactured products (including components) that are mined, produced or manufactured in the United States.
The adjusted percentage is generally 40% for wind projects (or 20% in the
case of offshore wind facilities) that begin construction before 2025. The
domestic content requirement is increased to 45% for wind projects (or 27.5% in
the case of offshore wind facilities) that begin construction during 2025, 50%
for wind projects (or 35% in the case of offshore wind facilities) that begin
construction during 2026, 55% for wind projects (or 45% in the case of offshore
wind facilities) that begin construction during 2027 and 55% for all wind
projects (including offshore wind facilities) that begin construction during
2028 or later.
10% PTC Adder for Wind Projects Located in Energy Communities
Another new 10% PTC adder is included for wind projects that are placed in service after Dec. 31, 2022, and located within an “energy community.”
An energy community is defined to include (i) a brownfield site; (ii) a census tract or any adjoining tract in which a coal mine closed after Dec. 31, 1999, or a coal-fired electric power plant was retired after Dec. 31, 2009; or (iii) a statistic area that has (or, at any time during the period beginning after Dec. 31, 1999, had) at least 0.17% direct employment or at least 25% local tax revenues related to the extraction, processing, transport or storage of coal, oil or natural gas, and currently has an unemployment rate at or above the national average.
Certain qualified solar and wind facilities with a maximum output of less than 5 MW may be eligible for an additional credit if the facility received an allocation of environmental justice solar and wind capacity limitation. Stand-alone energy storage is not eligible for this credit, but energy storage associated with wind and solar projects may be eligible.
Projects receiving an allocation of environmental justice solar and wind capacity limitation can receive an additional 10% credit if located in a low-income community or on Indian land, or an additional 20% credit if such project is part of a qualified low-income residential building project or qualified low-income economic benefit project.
Election Into the Investment Tax Credit
The ability to elect the investment tax credit (ITC) in lieu of the PTC was extended to wind projects that begin construction before the end of 2024; however, the current ITC phaseout would continue to apply for any wind project placed in service before Jan. 1, 2022.
The ITC has similar domestic content and energy community adders; however, those are not percentage increases like the PTC. Alternatively, the adders under Section 48 are 10% basis point increases to the tax credit; thus, projects with domestic content that are also located in energy communities could be eligible for a 50% ITC.
Finally, the IRA introduces a new ITC under Section 48E that is technology-neutral and mimics old Section 48 for projects placed in service after 2024. The ITC under Section 48E includes the prevailing wage and apprenticeship labor requirements to receive the full ITC; otherwise, only a 20% ITC will be available. Wind projects will be able to elect into the ITC under new Section 48E in lieu of the PTC under new Section 48Y if they were placed in service after Dec. 31, 2024, thus extending the ITC for wind projects through at least 2033.
Reduction for Tax-Exempt Bond Financing
The rules for reducing the PTC for projects utilizing tax-exempt or subsidized financing are modified. First, the reduction to the PTC now applies only to tax-exempt financing utilized by the project. Federal, state and local grants are no longer a reduction to the PTC. Second, the maximum reduction to the PTC decreases, from 50% to 15%, if tax-exempt financing is used to finance a wind project.
The IRA did not codify any of the IRS begin-construction requirements relating to the 5% expenditure test, the physical work test or the continuous efforts continuity requirement. Those will continue to apply to wind projects unless updated by the IRS separately in further notices. Given the long extension of the PTC and ITC through at least 2033, these begin-construction rules will not have much impact until closer to the PTC and ITC phaseout under new Sections 45Y and 48E; however, the begin-construction requirements will become important for determining when projects must comply with the new wage and labor rules.
McGuireWoods lawyers are experienced in energy, project finance and tax equity structures. Do not hesitate to reach out if you would like to discuss any of the above information.