On May 29, 2024, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) published proposed regulations regarding the new “clean electricity production credit” under section 45Y (the “Tech-Neutral PTC”) and the new “clean electricity investment credit” under section 48E (the “Tech-Neutral ITC”). Beginning in 2025, these new tax credits will replace the production tax credit under section 45 (the “Legacy PTC”) and the investment tax credit under section 48 (the “Legacy ITC”). The proposed regulations adopt many principles for the new technology-neutral credits that are similar to those applicable under the legacy credits and provide guidance regarding the novel technology-neutral aspects of the new credits. The discussion below provides selected highlights of those rules.
Comments on the proposed regulations are due by August 2, 2024, and public hearings on the proposed regulations are scheduled for August 12, 2024 (in person) and August 13, 2024 (telephonic).
Statutory Background – Section 45Y and 48E
The Inflation Reduction Act of 2022 (the “IRA”) extended, increased, and expanded the Legacy PTC under section 45 and the Legacy ITC under section 48 (together, the “Legacy Tax Credits”), but only for facilities that begin construction before 2025. The IRA replaced the Legacy Tax Credits with the Tech-Neutral PTC under section 45Y and the Tech-Neutral ITC under section 48E (together, the “Tech-Neutral Tax Credits”) for facilities placed in service after 2024.
The principal difference between the Legacy Tax Credits and the Tech-Neutral Tax Credits is in the method they use to determine whether a particular technology qualifies for the credit. The Legacy Tax Credits contain lists of technologies that qualify, e.g., wind, solar and storage. The Tech-Neutral ITC retains storage and certain interconnection property as named qualifying technologies, but the Tech-Neutral Tax Credits otherwise simply require that a facility generate electricity and that its greenhouse gas emissions into the atmosphere in the production of that electricity be no greater than zero (the “Zero GHG Requirement”). The IRS is required to publish an annual list of technologies that it has determined satisfy the Zero GHG Requirement and only those technologies are generally eligible for the Tech-Neutral Tax Credits. This is a very material change to the clean energy tax credit rules. For example, projects that qualify for the Legacy ITC under section 48 but are not energy storage or electricity generation activities generally will not qualify for the Tech-Neutral ITC under section 48E.
The Tech-Neutral Tax Credits are otherwise very similar to the Legacy Tax Credits they replace. For example, the amount of credit, prevailing wage and apprenticeship requirements, and availability of credit “adders” are substantially the same. One potentially significant difference between the Legacy ITC and the Tech-Neutral ITC is that the former aggregates related energy properties into “energy projects” while the latter contains no such aggregating principle.
The Tech-Neutral Tax Credits will begin to phase out after 2032 or, if later, the year in which Treasury determines that greenhouse gas emissions from production of electricity in the United States are no more than 25% of 2022 levels.
What Happens on January 1, 2025?
The Legacy Tax Credits apply to facilities that begin construction before 2025, while the Tech-Neutral Tax Credits apply to facilities placed in service after 2024. This raises the question which credits apply to facilities that begin construction before 2025 and are placed in service after 2024. The preamble to the proposed regulations indicates that a taxpayer with such facilities may elect to apply either a Legacy Tax Credit or a Tech-Neutral Tax Credit (but not both) by claiming that credit on its tax return.
The “Categorical” Technologies That Satisfy the Zero GHG Requirement
The proposed regulations list eight technologies that satisfy the Zero GHG Requirement:
- Wind
- Hydropower
- Marine and hydrokinetic
- Solar
- Geothermal
- Nuclear fission
- Nuclear fusion
- Waste energy recovery property that derives energy from one of the sources listed above
As described above, the Tech-Neutral Tax Credits require that the IRS annually publish a list of technologies that satisfy the Zero GHG Requirement, and only the technologies on that list generally qualify for the Tech-Neutral Tax Credits. The preamble to the proposed regulations announces that taxpayers may treat the eight technologies on the list above as satisfying the Zero GHG Requirement until the IRS publishes its first annual list, which the preamble says will not occur until after the regulations are issued in final form.
General Rules Regarding the Zero GHG Requirement for Non-C&G Facilities
The proposed regulations provide that the relevant greenhouse gas emissions are limited to those that directly occur from the process that transforms the input energy source into electricity and exclude emissions from backup generators, maintenance activities, step-up transformers, construction or manufacturing of the facility or related infrastructure, or distribution of electricity to customers. Special rules, discussed below, apply to facilities that produce electricity through combustion or gasification (“C&G Facilities”). In the case of all other facilities (“Non-C&G Facilities”), certain types of emissions from hydropower reservoirs and operations, geothermal reservoirs, and off-site activities are also excluded from the determination of greenhouse gas emissions. The determination of whether the technology employed by a Non-C&G Facility satisfies the Zero GHG Requirement must be made through a technical and engineering assessment of the fundamental energy transformation into electricity that considers all input and output energy carriers and chemical reactions of chemical processes taking place at the facility in the production of electricity. As described above, the proposed regulations identify eight types of Non-C&G facilities that satisfy the Zero GHG Requirement.
Combustion and Gasification (C&G) Facilities
The Tech-Neutral Tax Credits expressly contemplate that C&G Facilities may satisfy the Zero GHG Requirement and allow the sequestration or qualifying use of carbon oxide resulting from combustion to be taken into account in making this determination. The proposed regulations include detailed rules interpreting these provisions and the means of determining the greenhouse gas emissions rates for a C&G Facility, including the emissions that may be excluded in making the determination.
The proposed regulations would require a lifecycle emissions analysis for C&G Facilities that includes emissions not just from the combustion of fuel to produce the electricity but also from generation, production and extraction of feedstock, transportation of feedstock and fuel, and handling, processing, upgrading and storing feedstock, intermediate products, and fuel. The proposed regulations solicit comments on a host of issues, including the proper application of these rules to biogas, renewable natural gas (RNG), and fugitive methane.
The preamble to the proposed regulations notes that the IRS anticipates requiring that in order for biogas, RNG, or fugitive methane to receive a reduced emissions value, the gas used to produce electricity must originate from the first productive use of the relevant gas. As a result, if such gas had been productively used in a prior taxable year, it would receive an emissions value consistent with natural gas, i.e., it would not satisfy the Zero GHG Requirement.
In categorizing C&G Facilities the proposed regulations define fuel cells as C&G Facilities, with the result that no fuel cells (even hydrogen fuel cells) would qualify for the credits unless the fuel used in the fuel cell has zero emissions from its combustion or in its creation. Since fuel cells previously have been eligible for the Legacy ITC, this is an example of a technology that would suffer under the Tech-Neutral ITC.
As in the case of Non-C&G Facilities, only technologies included in the IRS’s annual list are generally eligible to claim the Tech-Neutral Tax Credits. None of the eight categories listed by the proposed regulations as satisfying the Zero GHG Requirement are C&G Facilities.
Provisional Emissions Rates
If the IRS and Treasury have not determined a greenhouse gas emissions rate with respect to a technology, a taxpayer that owns such a facility may petition the IRS for determination of an emissions rate. The taxpayer petitions the IRS by claiming the Tech-Neutral Tax Credit on its tax return and attaching the petition. The petition must include an emissions value that is supported by either a letter from the Department of Energy (DOE) or a lifecycle analysis (LCA) model approved by the IRS. The petition is deemed approved upon the IRS’s acceptance of the tax return in which it is included, and the taxpayer may rely on the emissions rate included in the petition if the information provided to DOE or included in the LCA model is accurate.
Section 45Y Metering Rules for Electricity Production Not Sold to Unrelated Parties
The Legacy PTC generally requires that electricity produced by a facility be sold to an unrelated party in order to be eligible for the credit. The Tech-Neutral PTC extends the credit to electricity consumed or stored by the taxpayer or sold to a related party, provided that the facility is equipped with a metering device which is owned and operated by an unrelated person. The proposed regulations provide details regarding the operation of the third-party metering requirement.
Facility Expansions
Electricity Generation. In the case of an electricity-generating facility placed in service before 2025, a new unit or an addition to capacity placed in service after 2024 will qualify as a new facility under the Tech-Neutral Tax Credits. The proposed regulations provide rules for determining the extent to which expansions qualify for the credit that generally look to the effect of the expansion upon the nameplate capacity of the facility as a whole. To the extent the new unit or added capacity increases the nameplate capacity, rather than replacing pre-existing nameplate capacity, it can be treated as a new facility qualifying for a Tech-Neutral Tax Credit. For purposes of applying the one-megawatt exception to the prevailing wage and apprenticeship rules (discussed by us here), the expansion is viewed together with the pre-2025 facility. The proposed regulations provide a special rule for restarts of decommissioned facilities.
Storage. In the case of energy storage technology, section 48E incorporates the expansion rule under section 48 that treats most increases in nameplate capacity of a storage system as new property eligible to claim the ITC. The proposed regulations include rules interpreting this provision that track the rules contained in the proposed regulations under section 48 (discussed by us here).
Basic Operating Rules
Generally. The proposed regulations define many of the terms used in Sections 45Y and 48E and interpret many of the basic operating rules of those statutes. Since, as discussed above, the Tech-Neutral Tax Credits are very similar to the Legacy Tax Credits, the rules provided by the proposed regulations are generally consistent with existing or proposed guidance under the Legacy Tax Credits. Among other things, these rules:
- Identify the core facility by reference to “functionally interdependent components;”
- Add to the facility any property that is an “integral part” of the facility;
- Allow “integral” property to be split between different facilities;
- Provide a detailed definition of “qualified interconnection property”; and
- Apply traditional 80/20 principles to facility retrofits.
No “Energy Project” Concept. The application of the Legacy PTC and the Tech-Neutral PTC is determined on a qualified facility-by-qualified facility basis, e.g., each wind tower in a wind farm is tested separately for eligibility for credits under section 45 or section 45Y. By contrast, the Legacy ITC is determined on the basis of an “energy project” that includes all closely related generation and storage assets. Section 48E appears to test each “qualifying facility” and “energy storage technology” separately, which suggests that the aggregation principles of the Legacy ITC under section 48 will not apply to the Tech-Neutral ITC under section 48E. The IRS and Treasury reserved the issuance of regulations on this point for a future date, so it is possible they will seek to insert the “energy project” concept into the Tech-Neutral ITC, but that seems unlikely given the express language of section 48E and the long history of not applying that concept to the Legacy PTC.
No ”Dual Use” or “Incremental Cost” Concept. The proposed regulations under section 48E do not include rules for “dual use property” or “incremental cost” similar to those included in the proposed regulations under section 48. The preamble does not comment on the non-inclusion of these rules, so the significance of this omission is not clear.
Section 761 Elections. Under proposed regulations released in March 2024, a tax partnership whose members are otherwise eligible to elect into the “direct pay” regime under section 6417 may elect out of the Subchapter K rules under section 761 if certain requirements are met. The proposed regulations under the Tech-Neutral Tax Credits recognize that under those circ*mstances the partners will be treated as directly owning their share of the underlying assets of the tax partnership.
Phaseout Rules
As described above, Tech-Neutral Tax Credits will begin to phase out after 2032 or, if later, the year in which Treasury determines that greenhouse gas emissions from production of electricity in the United States are no more than 25% of 2022 levels. The proposed regulations include proposed rules for use by the IRS in determining when greenhouse gas emissions have reached the level required to trigger the phaseout.
Avoid Application of the Tech-Neutral Tax Credit Rules by Beginning Construction Before 2025
As described above, the Legacy Tax Credits will continue to apply to facilities that begin construction before 2025. Some taxpayers would be well advised to begin construction before 2025 to avoid the shift to the Tech-Neutral Tax Credits. For example, biogas property, fuel cells and microgrid controllers qualify for the Legacy ITC but either do not qualify for the Tech-Neutral ITC or face a difficult path to qualification. Another example is projects for which a developer plans to claim both the ITC and the section 45Q credit for carbon capture and sequestration; a taxpayer may claim both the Legacy ITC and the section 45Q credit but may not claim both the Tech-Neutral ITC and the section 45Q credit. Taxpayers can rely on the safe harbor guidance that the IRS has provided with respect to “beginning of construction” (see, e.g., Notice 2018-59), to avoid application of the Tech-Neutral Tax Credits by beginning construction before 2025. For a discussion of the safe harbor guidance on “beginning of construction,” see our client alert here.
***************
We will continue to monitor the Inflation Reduction Act guidance initiatives from the IRS and Treasury and will provide further updates as guidance is released. In the meantime, Baker Botts would be pleased to assist you in your analysis of the Inflation Reduction Act and clean energy tax incentive matters.
ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm whose lawyers practice throughout a network of offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy, technology and life sciences sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.
