By Matt Gamache, Simon Pritchard, Jesse Newton, and Jeff Endler
On August 16, President Biden signed the Inflation Reduction Act of 2022 into law. The IRA is a significant piece of legislation with impacts for a variety of industries, including expanded Medicare benefits and updates to the corporate tax code. However, the centerpiece of the Act is focused on the energy industry. To that end, the bill has been touted as the first major piece of U.S. legislation aimed at addressing climate change and reducing carbon emissions. The IRA contains expansions and extensions of tax credits available to renewable technologies, incentives for electric vehicles, and other benefits aimed at energy upgrades for households. The ramifications for the energy industry are expected to be significant, with many of these provisions in effect for 10+ years. Analysts estimate the resulting emission reduction to be roughly 40 percent by the end of the decade.
Like most everyone in the energy industry, Competitive Energy Services has spent the last few weeks parsing through each of the many energy-related aspects of the IRA. While many of the specific impacts will depend on subsequent Internal Revenue Service interpretation, administrative agency rulemaking, and industry reaction, it is clear that the bill will create substantial opportunities for renewables, battery storage, electric vehicles, and other energy technologies. Over the coming months, CES expects to closely monitor the developments and byproducts of this momentous policy and discuss specific opportunities with our clients. For now, we would like to provide a summary overview of some key provisions in the IRA.
Renewable Energy Tax Credit Overview
ITC & PTC: An Overview of Investment and Production Tax Credits
Investment and Production Tax Credits have existed for decades in various forms and serve as mechanisms of policy to subsidize the development of renewable energy in the U.S. With the signing of the Inflation Reduction Act, the existing ITC and PTC programs were both extended and expanded.
These two forms of tax credits provide alternative options for project developers to take advantage of federal incentives. An ITC is dependent upon the dollar amount of capital invested in a renewable energy project, and the credit takes form as a percent of that project’s up-front investment. On the other hand, a PTC is dependent upon the amount of energy produced – commonly expressed in kilowatt-hours – from a project over the course of several years and provides an established dollar-per-kilowatt-hour rate credit for the amount of energy produced by the project.
Given the inherent structure and form of these types of tax credits, one can be more suited to certain projects over the other. For projects where high upfront costs can be a barrier to development, an ITC will ensure that the initial capital investment requirement is reduced as much as possible; for projects expected to produce substantial amounts of energy and in which the initial capital required for development is less of a hinderance, a PTC may offer the more economical option.
ITC & CEITC
Prior to the passage of the IRA, the existing ITC was slated to phase down for solar credits and phase out entirely for other technologies. Under the IRA, the ITC was extended to projects with construction beginning before January 1, 2025. The extended ITC remains technology-specific, with qualifying technologies including solar, fuel cell, microturbine, combined heat and power systems, small wind, waste energy recovery systems, stand-alone energy storage, biogas, and microgrid controllers. For projects that went into service prior to January 1, 2022, tax credit values will be dictated by pre-IRA existing ITC phase-out protocol. The base credit available for projects coming online after January 1, 2022, is reduced from 30% down to 6%; however, if specific prevailing wage and apprenticeship requirements are met for the project, the base credit will be multiplied by a maximum factor of five, bringing the total ITC credit back up to 30%.
Starting in 2025, an updated version of the ITC kicks in, known as the Clean Energy Investment Tax Credit (CEITC). The CEITC is available for qualifying tech-neutral projects coming online after January 1, 2025, that either produce or store electricity while emitting zero greenhouse gas emissions. Like the extended ITC, the CEITC maintains a max credit of 30%. Projects that are 5 megawatts or less in size will also be able to include interconnection costs under the CEITC. The credits could begin phasing out after 2032, reaching 0% as soon as 2037. If the power sector reduces its total emissions by 75% from current 2022 levels before 2032, however, the CEITC will then be phased out ahead of schedule. Conversely, if the power sector does not reduce its total emissions by 75% from current 2022 levels by 2032, the CEITC will NOT be phased out until the 75% emissions reduction is reached. As a result, the ITC is likely to remain in place well after 2032.
PTC & CEPTC
Similar to the ITC, the existing PTC had been scheduled to phase out prior to the Inflation Reduction Act becoming law. With the IRA’s passage, the existing PTC was extended to projects with construction beginning before January 1, 2025. It remains tech-specific, with qualifying technologies including solar, wind, geothermal, biomass, and hydropower, with solar being included for the first time since 2006. Like the ITC, projects in service before January 1, 2022, are maintained under the pre-IRA existing PTC phase-out schedule. Beginning with projects that come online in 2022, the base credit available under the extended PTC is reduced; however, if prevailing wage and apprenticeship requirements are also met, the base credit can be multiplied by a maximum factor of five, returning the total PTC credit back to its full value per kWh (currently 2.6 cents). Projects that are less than 1 megawatt in size are excused from the additional requirements and can qualify for the maximum credit immediately.
Starting in 2025, the extended PTC is replaced by the Clean Energy Production Tax Credit (CEPTC). The CEPTC will provide tech-neutral credits to projects that produce electricity and zero greenhouse gas emissions coming online after January 1, 2025. Electricity from the project can be consumed or stored by the taxpaying entity or sold to an unrelated taxpayer to qualify. The CEPTC also follows the same phase out schedule to the CEITC, ending by 2036 or when the power sector’s emissions are reduced by 75% from 2022 levels.
All IRA-related tax credits described above will also be eligible for additional bonus credits if certain criteria are met. For projects that meet domestic manufacturing requirements, an additional 10% credit will be included. For projects located in energy communities – including brownfields and communities with tax revenue or employment tied to the fossil fuel industry in the past – an additional 10% credit will be included. For projects located in low-income and tribal communities, an additional 10% credit will be included. And for projects sited for low-income residential buildings, an additional 20% credit can be included.
With regard to a production or investment-based tax credit, taxpaying entities will be allowed to claim credits for one option or the other, but not both. Tax credits received for a project will also be considered transferable to entities that do not need to have a direct investment stake in the project. Lastly, certain qualifying entities will have the ability to select a direct-pay option wherein the generated tax credits are instead treated as a payment to the entity. The direct-pay option will, in most cases, only apply to tax-exempt entities, along with state, local, and Indian tribal governments.
Electric Vehicle Tax Credits
The IRA creates the most significant incentives to date to support the electrification of the transportation fleet and electric vehicle (“EV”) charging infrastructure in the U.S. The new law extends the popular existing tax credit while also implementing some new eligibility requirements. These requirements dovetail with other funding to support domestic sourcing and production of EVs.
Residential Tax Credits
On the residential side, the law modifies and expands the existing $7,500 electric vehicle tax credit. The most significant change is for light duty EVs, extending the existing $7,500 credit through 2032 and removing the 200,000 vehicles per manufacturer cap that had ended eligibility for Tesla and GE vehicles under the previous program. The new eligibility requirements include a maximum suggested retail price (“MSRP”) cap of $55,000 for sedans and $80,000 for trucks, and an income cap of $150,000 for individuals and $300,000 for joint filers. Finally, for the first-time used vehicle purchases will be eligible for a credit of the lesser of $4,000 or 30% of the sales price, if the vehicle is at least two years old.
The IRA also establishes sourcing requirements meaning eligible vehicles will need to use increasing amounts of critical materials and battery components produced in North America or from countries with whom the U.S. has a free trade agreement. By 2026, 80% of critical materials will need to comply with sourcing requirements for a vehicle to qualify. This requirement will be implemented once IRS guidance is complete, but no later than the end of 2022. Lastly, effective immediately following the law’s passage, any vehicle purchased after August 16, 2022 must have final assembly occur in the U.S. to be eligible for the credit.
Commercial Tax Credits & Chargers
Commercial vehicles for the first time are eligible for a federal tax credit, calculated to be the lesser of 30% of the sales price or the incremental cost of the commercial EV over a comparable internal combustion engine vehicle. The credit value is capped at $7,500 for vehicles with a gross weight of up to 14,000 lbs. and $40,000 for vehicles over 14,000 lbs. For charging infrastructure, the existing credit has been extended through 2032 and for residential purposes is capped at 30% of the installation cost, up to $1,000. For commercial purposes, the tax credit is increasing from $30,000 per business, to 6% of the installation cost up to $100,000. In order to incentivize targeted charging infrastructure build out, chargers must be located in low income or non-urban areas to be eligible.
Beyond tax credits, the law also allocates $3 billion for the electrification of the USPS service fleet and $1 billion to states, municipalities, indigenous tribes, and schools to replace heavy duty trucks with EVs. For these projects, rebates for up to 100% of vehicle and charging infrastructure cost are available. The law also makes billions of dollars available to support domestic EV manufacturing, advanced vehicle technology research, a diesel emissions reduction program, and an extension of the advanced manufacturing production tax credit. Taken together with the tax credits, the IRA is the first comprehensive effort by the federal government to electrify transportation in the U.S., while also promoting domestic manufacturing and robust supply chains in North America.
Other Tax Credits & Consumer Benefits
While the IRA’s support for renewable energy generation technologies and electric vehicles has rightly gained significant attention, the law also expands energy efficiency and building decarbonization funding for both commercial and residential property owners. The Commercial Buildings Energy-Efficiency Tax Deduction, originally enacted in 2006, previously allowed commercial building owners and the designers of government-owned buildings to claim a tax deduction of up to $1.88/square foot for energy efficiency lighting, HVAC, and building envelope improvements in new construction and renovations, that met a minimum 50% savings in energy costs compared to ASHRAE standards from 2 years prior to construction. Starting in 2023, the IRA reduces the savings threshold for the energy savings deduction to 25%, shifts relevant ASHRAE standards from 2 years to 4 years prior to construction. It then adds bonuses to a base deduction of $0.50/sq ft for energy savings up to 50% as well as labor requirements like those in the ITC and PTC, to increase the maximum possible deduction to $5/sq ft. Further, the IRA expands the eligibility of the deduction for projects owned to all tax-exempt and also allows real estate investment trusts (REITs) to claim the deduction. Lastly, the IRA adjusts the cap on deductions that one building may take, from one deduction per lifetime to a maximum deduction every 4 years.
On the residential side, the expanded Energy Efficient Home Improvement Credit is slated to provide tax credits starting in 2023 for heat pumps (up to $2,000), heat pump water heaters ($2,000), home electrical system upgrades ($600), and weatherization projects ($600). Additional funding available for low- and moderate-income households, through point-of-sale rebates that may be stacked with the tax credits, will cover 50-100% of the costs for many projects, significantly expanding the accessibility of residential energy efficiency and electrification measures.
The IRA provides game-changing investment to accelerate the long-term development of renewable energy and decarbonization in the United States. In the weeks since the IRA’s passage, there has been a host of announcements from companies planning to add large domestic manufacturing facilities to scale production of batteries, electric vehicles, and solar modules. However, just as the administration of the IRA’s funding provisions and specific tax codes and guidance will take time to develop, so too will the impact on markets and project development. Near-term constraints due to material costs, permitting, labor, and regulatory hurdles remain. Transmission upgrades and interconnection bottlenecks will require further attention. The IRA may mitigate these challenges to some extent, but it will not solve them. For some projects, the IRA provides immediate benefits while others may await industry and regulatory developments. Moving forward, CES will be prepared to help our clients understand the impacts of the IRA and identify opportunities to pursue their energy and sustainability goals.