In the wind production space, many credit the IRA with turning the domestic wind energy production industry around. The IRA added additional areas for lease in the eastern Gulf of Mexico and the Atlantic—off the coast of North Carolina, South Carolina, Georgia, and Florida. Reporting that “[c]ompanies are also ramping up investment in the more established US wind energy manufacturing base and in battery storage technology,” S&P Global noted “South Korea-headquartered LG Energy Solution Ltd. said it would break ground later this year on a $5.5 billion lithium-ion battery production complex in Arizona that it billed as North America's ‘single largest investment ever’ in a stand-alone battery factory.”
What about the IRA has the renewable energy sector so bullish on investment in the U.S.? There are three answers to that question. The IRA:
(i) provides for new and enhanced renewable energy tax credits under Sections 38, 45 and 48 of the Internal Revenue Code of 1986, as amended (the “Code”);
(ii) adds requirements for new projects for labor and domestic production in order to receive the full tax benefits; and
(iii) provides grants to enhance development and research projects for new solar, onshore and offshore wind projects.
While this boon of announced and planned investments in new U.S. construction may be cause for (cautious) optimism, announcements and plans are just that. The promise of the IRA is indeed exciting investors across the renewable energy space, even as the bureaucratic roll out of rules and guidance by the Internal Revenue Service has been a bit of a wet blanket. Nevertheless, the IRA may make American renewable energy projects more competitive with other international projects under similar structures.
In rest of this article, we highlight what all the excitement is about.
The Heart of the Inflation Reduction Act
A. Giving Credit Where Credit Is Due: the IRA’s Tax Incentives
Generally, the Code provides two mutually exclusive tax credits for renewable energy projects. The first is the Renewable Energy Production Tax Credit under Section 45 of the Code and the second is the Energy Investment Tax Credit under Section 48 of the Code. Each credit has been extended for beginning-of-construction activity through the end of 2024. Beginning in 2025, the Renewable Energy Production Tax Credit and the Energy Investment Tax Credit sunset and are replaced by two technology-neutral tax credits for facilities placed in service after 2024. For purposes of this article, we focus on the Renewable Energy Production Tax Credit and the Energy Investment Tax Credit.
- Renewable Energy Production Tax Credit
Section 45 of the Code establishes the Renewable Energy Production Tax Credit. This credit provides a base rate of 0.3 cents per kWh of renewable energy produced by the project for ten years beginning in the year the project is placed in service. In an industry that struggles with project delivery deadlines, contractors should immediately recognize the importance of the placed-in-service timing of this credit to their project owners.
- Energy Investment Tax Credit
Section 48 of the Code establishes the Energy Investment Tax Credit. This credit provides a base rate of 6% of the eligible costs spent on eligible renewable energy project property. As with the Renewable Energy Tax Credit, the Energy Investment Tax Credit is earned in the year the project is placed in service.
- Beginning of Construction and Continuity Requirements
Of great interest to contractors, the amount of the renewable energy tax credits can depend on the year in which construction commences. Generally, the earlier construction commences, the greater the tax credit percentage becomes available to the project owner. This means contractors can expect project owners looking to take full advantage of the IRA to be pressing hard for construction to start this year or that depending on the tax incentive to the owner. But commencing construction is not enough, as the IRA also imposes construction continuity requirements.
- Beginning of Construction Requirement
The Internal Revenue Service provides two methods for project owners to meet the beginning of construction requirements: (i) the Physical Work Test; or (ii) the Five-Percent Safe Harbor.
Under the Physical Work Test, the project owner must show that physical work of a “significant nature” has begun. The Physical Work Test is fact based and focuses on the nature of the work performed, not the amount or the costs. The Internal Revenue Service (“IRS”) does not define “significant nature,” however, the IRS states that physical work of a significant nature does not include “preliminary activities,” even if those activities add to the depreciable basis of the facility. Preliminary activities include planning or designing, securing financing, exploring, researching, obtaining permits, licensing, conducing surveys, environmental and engineering studies, or clearing a site.
Work performed under the contractor prior to construction, including on-site and off-site work, may be taken into account for purposes of determining whether work of a significant nature has begun. Alternatively, the project owner may satisfy the Five-Percent Safe Harbor: construction of a facility will be considered as having begun if the project owner pays or incurs 5% or more of the total cost of the facility.
- Continuity Requirement
After construction begins under either the Physical Work Test or the Five-Percent Safe Harbor, the project owner must maintain continuous construction or continuous efforts to complete construction. The Continuity Requirement may be satisfied either under a general facts and circumstances test or via the Continuity Safe Harbor. The project owner may satisfy the Continuity Safe Harbor if the renewable energy project is placed in service no more than 4 calendar years after the calendar year in which construction began. Certain projects are granted a longer time, e.g., carbon sequestration projects (6 years) and offshore wind projects (10 years). Contractors should particularly note that the Code requires the project owner to maintain sufficient records to substantiate the beginning of construction and to show that continuous construction efforts. Undoubtedly, the project owner will look to the contractor for this documentation.
B. Here’s the Kicker: the IRA’s Labor and Domestic Production Enhancements
Critically, most projects will only be economical by meeting new wage and apprenticeship enhancements under the IRA. Several pre-IRA tax credits had been scheduled to sunset until the IRA revived them in modified form. The IRA reduced the “base rate” of the various tax credits to one-fifth of the pre-IRA amounts, and only if the project meets the new wage and apprenticeship requirements is the base rate then multiplied by 5 to reach the pre-IRA credit amounts. As contractors quickly recognized, even though these IRA requirements are technically “project owner” requirements, the record-intensive tracking and documentation will necessarily flow-down to the contractors and subcontractors on these projects.
In addition to the labor enhancements, the IRA introduced enhancers to the base Renewable Energy Production Tax Credit and the Energy Investment Tax Credit through the (i) Domestic Content Bonus Tax Credit, and (ii) Energy Communities Bonus Tax Credit.
- Prevailing Wage Requirements
In general, a project owner must pay a prevailing wage to any laborers and mechanics employed by the project owner or any of the project owner’s contractors or subcontractors in the construction, alteration, or repair of the renewable energy project as published by the Department of Labor for the geographic area and type or types of construction facility. The published wages must include all labor classifications for the construction, alteration, or repair work to be done on the facility by laborers and mechanics. If there is no prevailing wage publication, the project owner will need to request a supplemental wage determination or wage rate from the Department of Labor and providing certain employee identifying information.
Separately, the Code also requires the project owner to maintain records in order to substantiate prevailing wage requirements, including, among other listed information, (i) basic employee information, (ii) location and type of qualified facility, (iii) hourly rates of wages paid for each applicable labor classification, (iv) total labor hours worked, (v) total wages paid.
The term “employed” is very broad and encompasses both employees and independent contractors. Note that only “laborers” or “mechanics” must be paid prevailing wages during the “construction, alteration or repair” of the renewable energy project. For Renewable Energy Production Tax Credits, the prevailing wages must be paid throughout the 10-year credit period. For Energy Investment Tax Credit projects, the prevailing wages must be paid throughout construction and for any alteration or repair work done 5 years beginning on the date the project is placed in service.
- Apprenticeship Requirements
Sections 45 and 48 of the Code also require project owners to meet certain apprenticeship requirements. The Code lays out three requirements: (i) a labor hours requirement, (ii) an apprenticeship ratio requirement and (iii) a participation requirement.
The Code requires that a percentage of all construction, alteration, or repair work done on a renewable energy project must be performed by qualified apprentices, measured by total labor hours (the “labor hours requirement”). For facilities that begin construction before January 1, 2024, 12.5% of the total labor hours must be performed by qualified apprentices. For facilities that begin construction after December 31, 2023, the percentage increases to 15%. The term “labor hours” is determined by the total number of hours devoted to the construction, alteration, or repair work by any individual employed by the project owner or by any contractor or subcontractor.
The Code specifically excludes any hours worked by (i) foremen, (ii) superintendents, (iii) owners, or (iv) persons employed in an executive, administrative, or professional capacity. “Qualified apprentice” means any individual employed by the project owner or any contractor or subcontractor who is participating in a registered apprenticeship program. The percentages above are also subject to any applicable requirement requirements for apprentice-to-journey worker ratios set by the Department of Labor or any applicable State Apprenticeship Agencies (the apprenticeship ratio requirement). Finally, each project owner, contractor or subcontractor who employs more than four or more individual to perform construction, alteration, or repair work must employe one or more qualified apprentices to perform such work (the “participation requirement”).
Project owners (in reality, contractors and subcontractors) must maintain records to demonstrate their compliance with the apprenticeship requirements. The IRS’s released proposed regulations list the following recordkeeping items: (i) any written requests for the employment of apprentices from registered apprenticeship programs, (ii) any agreement entered into with registered apprenticeship programs related to the construction, alteration or repair of the facility, (iii) documents reflecting the standards and requirements of any registered apprenticeship program, (iv) the total number of labor hours worked by apprentices, and (v) records reflecting the daily ratio of apprentices-to-journeyworkers.
Like the prevailing wage requirements above, for Renewable Energy Production Tax Credits, the qualified apprenticeship requirements must be met throughout the 10-year period. For Energy Investment Tax Credit projects, the qualified apprenticeship requirements must be met throughout construction and for any alteration or repair work done 5 years beginning on the date the project is placed in service.
- Domestic Content Bonus Tax Credit
A 10% Domestic Content Bonus Tax Credit is available for projects that meet three domestic content requirements for any steel, iron or manufactured product that is a component of an “Applicable Project”. An “Applicable Project” refers to any renewable energy project that is eligible for renewable energy tax credits (solar, wind, biogas, etc.). This credit is additive to the Renewable Energy Production Tax Credit and the Energy Investment Tax Credit.
All three requirements must be satisfied for a project owner to receive the Domestic Content Bonus Tax Credit. The project must meet: (i) the Steel or Iron Requirement, (ii) the Manufactured Products Requirement, and (iii) the Certification Requirement.
- Steel or Iron Requirement
For all steel or iron used in a renewable energy project, all manufacturing processes for structural steel and iron must occur in the United States (except for metallurgical processes for refinement of steel additives). The IRS limited this requirement to “Applicable Project Components” that are construction materials made primarily of steel or iron and are structural in function. “Applicable Project Components” means any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into a renewable energy project. The IRS also categorized certain Applicable Project Components that fall under the steel or iron category, depending on the type of project. For example, for a solar energy project, steel or iron Applicable Project Components are: (i) steel photovoltaic module racking, (ii) pile or ground screws and (iii) steel or iron rebar in foundation (e.g., a concrete pad).
- Manufactured Products Requirement
For all manufactured products incorporated in a renewable energy project, the Manufacture Products Requirement will be met if not less than the adjusted percentage of the total costs of all manufactured products incorporated in the project (including components) are mined, produced, or manufactured in the United States. The adjusted percentage depends on when the project begins construction. If construction begins before 2025, the adjusted percentage is 40%. Beginning in 2025, the adjusted percentage increases by 5% each year until 55% for projects that begin construction in 2027.
- Certification Requirement
The project owner must complete the certification statement and fill out IRS Form 8835, Renewable Electricity Production Credit, or IRS Form 3468, Investment Credit, and attach the form to its tax return. The Code also requires general recordkeeping requirements to substantiate the certification statement.
- Energy Communities Bonus Tax Credit
The IRA added a 10% Energy Communities Bonus Tax Credit for projects that are located within an “energy community”. For the Renewable Energy Production Tax Credit, whether the renewable energy project is located in an energy community is determined separate for each taxable year during the 10-year credit period. If the project is located in an energy community for any part of a year, the project will be considered in an energy community for that taxable year. Further, the IRS provided a special rule that if a project owner begins construction of a renewable energy project in an energy community, then the project will continue to be considered in an energy community for the duration of the credit period. For the Investment Tax Credit, the renewable energy project must be placed in service within an energy community. Further, the IRS included a provision that if the project owner begins construction of the project in an energy community, then the project will be considered in an energy community on the placed in service date.
For purposes of the Energy Communities Bonus Tax Credits, energy communities include: (i) any metropolitan statistical area or non-metropolitan statistical area that has, at any time since 2009, had at least 0.17% employment or 25% local tax collection derived from the fossil fuel industry and a local unemployment rate for the previous year that exceed the national average; (ii) a Brownfield Site as defined under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980; and (iii) any census tract (or any adjacent census tract) where a coal mine has closed since 1999 or coal-fired power plant has closed since 2009.
The project owner must verify that a project is located in or placed in service within an energy community by the Nameplate Capacity Test or the Footprint Test. Under the Nameplate Capacity Test, a project will be considered located in an energy community if at least 50% of the nameplate capacity of the generating units is located in an energy community. The nameplate capacity means the maximum electrical generating out put in megawatts (MW) that the unit is capable of producing on a steady state basis and during continuous operation under standard conditions.
If the project does not meet the Nameplate Capacity Test, the project will apply the Footprint Test. A renewable energy project meets the Footprint Test if 50% or more of the project’s square footage is in an area that qualifies as an energy community.
C. Show Me the Money: the IRA’s Grant Provisions
The IRA provided grants to encourage renewable energy development in addition to the many credit changes and enhancements. To name just a few of the grant programs available under the IRA (among many others):
- Environmental Protection Agency - Greenhouse Gas Reduction Fund - $27 billion in competitive grants to States, municipalities, Tribal governments and nonprofit entities to mobilize financing and leverage private capital for clean energy and climate projects that reduce greenhouse gas emissions, with an emphasis on projects that benefit low-income and disadvantaged communities.
- Department of Energy - Advanced Industrial Facilities Deployment Program - $5.812 billion in grants to owners and operators of facilities engaged in energy intensive industrial processes to purchase advanced industrial facilities, retrofits or upgrades operational improvements at eligible facilities or studies that reduce a facility’s greenhouse gas emissions.
- Environmental Protection Agency - Methane Emissions Reduction Program - $1.55 billion in grants, rebates, contracts and other activities to States, cities, Tribal Governments, nonprofits, businesses and individuals to accelerate the reduction of methane and other greenhouse gas emissions from petroleum and natural gas systems. The funding is intended to improve and deploy equipment to reduce emissions, supporting innovation, permanently shutting and plugging wells, mitigating health effects in low-income and disadvantaged communities, improving climate resilience, and supporting environmental restoration.
- Environmental Protection Agency - Grants to Reduce Air Pollution at Ports - $3 billion in rebates and competitive grants to a port authority, state, regional or Tribal agency, air pollution control agencies or private entities that partner with a port-owning authority, for the purchase and installation of zero-emission port equipment or technology, and conduct relevant planning or permitting in connection with installation of such zero-emission port equipment or technology.
- Department of Housing and Urban Development - Green and Resilient Retrofit Program – $837,500,000 in grants and direct loans (up to $4 billion in loan authority) to owners or sponsors of HUD-assisted properties to improve energy or water efficiency; enhance indoor air quality or sustainability; implement the use of zero-emission electricity generation, low-emission building materials or processes, energy storage, or building electrification strategies; or make the properties more resilient to climate impacts.
Conclusion
The IRA incorporates key drivers of investment that clearly have the renewable energy sector in the U.S. buzzing. It remains to be seen whether all this buzz will produce honey in the way of hundreds of U.S. construction projects worth billions of dollars over the coming years. But for now, we remain (cautiously) optimistic.