LEGAL ALERT: Solar Energy Law
Internal Revenue Service Adds Clarity to Low-Income Community Bonus Credits
On June 1, 2023, the IRS issued a notice of proposed rulemaking (Reg-110412-23)[i] related to the 10% and 20% bonus credits that will apply to certain solar and wind energy projects for low-income communities.
The new guidance, issued under the Inflation Reduction Act and Internal Revenue Code Section 48(e), provides definitions and procedural rules that the IRS and Treasury Department will likely end up using once the final regulations are written. This notice (the “Bonus Credit Guidance”) follows IRS Notice 2023-17, issued in February 2023, which provided a framework to illustrate how the IRS and Treasury Department will allocate bonus tax credits among low-income communities for projects producing up to 1.7 gigawatts of electricity in 2023 and 2024. See prior KTC Client Alert, “IRS Notice 2023-17: Initial Guidance Regarding Add-On Tax Credits for Solar and Wind Projects Serving Low-Income Communities,” February 27, 2023.
Part A of this Alert summarizes the Section 48 federal energy credit (“ITC credit”) and the special Section 48(e) add-on credits (“Bonus Credits”) for qualified solar and wind facilities. Part A considers both the Inflation Reduction Act and IRS Notice 2023-17. Part B of the Alert discusses several new points addressed in the new Bonus Credit Guidance, using a Q&A format. Note that the Bonus Credit Guidance is still proposed, which means that taxpayers will need to review and rely on final guidance once it appears.
- Background: Investment Tax Credit for Qualified Solar and Wind Facilities
Starting in 2023, many small solar and wind projects will qualify for a 30% ITC credit.[ii] The Inflation Reduction Act also sprinkles in several add-on credits – including a 10% add-on if the project is in a census tract that meets certain low-income variables, and a 20% add-on credit if the project provides energy savings to low-income consumers. If a project qualifies for both the 10% and 20% add-on credits, only the 20% one will apply.
As for stacking of credits, the baseline 30% ITC credit will stack with either the 10% or 20% add-on credits – meaning that many small solar and wind projects for low-income communities will be eligible for either a 40% or 50% overall ITC credit, starting in 2023.
The cash value of an ITC credit is calculated by multiplying the tax basis, or cost, of each energy property placed in service during the tax year by the “energy percentage”) for the project.” The energy percentage is the same as the ITC credit figure – i.e., 30% for the base credit, plus 10% or 20% for Bonus Credits. The cash value can then be realized through a new Direct Pay mechanism, which (for the first time) will allow non-profits, government units, Tribal bodies and certain other tax-exempt parties to receive a cash payment directly from the IRS once a qualifying wind/solar project is placed in service.
Before addressing the Bonus Credit Guidance, there are several key points to keep in mind. First, while the 30% baseline ITC credit will be fairly easy to obtain, the 10% and 20% add-on credits are not automatic. Instead, the IRS will award these add-on credits to solar and wind projects only after the project owner or developer goes through a rigorous (and competitive) application process. In addition, there is a possible lottery process if the add-on credits are oversubscribed. For the Bonus Credits, the Tax Code permits an aggregate credit award of only 1.7 GW for all projects in each of 2023 and 2024 (with unused amounts carrying over to the next year).[iii]
In Notice 2023-17 the IRS and Treasury signaled that they will allocate the 1.7 GW of ITC credits based on four categories of applicants. If a project is chosen, then the IRS will grant an award of “environmental justice solar and wind capacity limitation” (“Capacity Limit”) to the applicant. A Capacity Limit award is a type of permit or quasi-guaranty from the government that lets the developer work on the project knowing that, upon completion, the recipient will be able to claim a 40% or 50% total ITC credit on a tax return – or, better yet, if the taxpayer is eligible for Direct Pay, the IRS will send a direct cash payment of this ITC credit amount for that project.[iv] Below is a table outlining the allocation of Capacity Limit among the 4 project categories:
§48(e) Low-Income Communities Bonus Credit Program
Four Categories for Solar and Wind Facilities (2023)
|Category 1||Category 2||Category 3||Category 4|
Located in low-income community
Located on Indian land
Part of low-income residential building project
Part of low-income economic benefit program
|Bonus Credit Amount||10%||10%||20%||20%|
Capacity Limit reservation for 2023, 1.8 GW per year
Finally, a “qualified solar and wind facility” means a facility that (1) generates electricity solely from a solar or wind facility, (2) with a maximum net output less than 5 MW (alternating current), and (3) is described in at least 1 of the 4 categories listed in the table above.[v] The key criteria of these 4 categories are as follows:
- Category 1 (10% Bonus Credit): A facility located in a “low-income community,” where that term is defined by reference to the New Markets Tax Credit rules and is based on U.S. population census tracts. The key test defines a low-income community as a census tract where either (1) the poverty rate is at least 20%, or (2) for non-metro areas, median family income does not exceed 80% of statewide median family income.[vi]
- Category 2 (10% Bonus Credit): A facility located on Indian land.[vii]
- Category 3 (20% Bonus Credit): A facility that is installed on a qualified low-income residential building project. This category is intended to cover only those residential rental buildings that participate in a listed affordable housing programs.[viii] In addition, the building owner must demonstrate that the benefits of the electricity savings are allocated equitably among the dwelling units.
- Category 4 (20% Bonus Credit): A facility installed anywhere in the U.S. where at least 50% of the financial benefits from the electricity project are provided to households (1) with income of less than 200% of poverty line applicable to a family of the size involved, or (2) with income that is less than 80% of area median gross income.
- Key Points from the Bonus Credit Guidance (Code Section 48(e))
Facility aggregation rule.
Q1: How will the IRS treat an applicant’s project that contains multiple facilities?
The IRS intends to apply an aggregation rule to combine the electric capacity of wind and solar projects that are spread across multiple linked or integrated facilities. This rule is intended to curtail a potential abuse that would occur if a large project over 5 MW refashioned itself into several smaller projects of less than 5 MW to maximize total ITC credits. Based on the facts of each case, the IRS plans to aggregate multiple facilities or energy properties that are “operated as part of a single project.” This rule will draw on the “single project” standards that the IRS has previously used in its guidance regarding construction starting dates for the ITC credit and Production Tax Credit.[ix]
Batteries and Storage.
Q2: How does an applicant gain comfort that an additional investment in battery and storage technology will be included when calculating the total Bonus Credit amount?
Under the Inflation Reduction Act a taxpayer can now claim Bonus Credits for battery and storage technology “installed in connection with” a qualified wind or solar project. The Bonus Credit Guidance clarifies the “installed in connection with” standard by creating a 2-part test. To be treated as an eligible cost for ITC credit purposes, the storage technology must be (1) owned by the same legal entity that owns the solar/wind facility, located on the same contiguous piece of land, have a common interconnection point, and be described in one or more common regulatory permits; and (2) charged not less than 50% by the qualifying wind/solar facility. The IRS and Treasury Department propose a safe harbor rule for the second test. This involves treating storage as meeting the 50% charging requirement if the power rating of the storage is less than 2 times the capacity rating of the qualifying wind/solar facility.
Financial Benefit testing
Q3: For a Category 3 or 4 project, how does an applicant show that the “financial benefits” of the project will be allocated equitably among tenants?
For a standalone building, the owner or manager of a Category 3 project must ensure that the electricity produced by the attached wind or solar facility is “allocated equitably among the occupants.” This sounds easy, but in fact the allocation rule is inherently complex due to the varied fact patterns for measuring the net value of electricity and allocation of benefits. Generally, the Bonus Credit Guidance indicates that a covered housing project will meet the equitable allocation test if at least 50% of the financial value of net energy savings is passed on to building occupants (excluding common area allocations). The guidance provides several rules used to calculate the “financial value of net energy savings,” depending on the presence of billing credits, whether the project and building owner are the same party, and whether dwelling units are separately-metered or covered by a single meter (master metered).[x]
For Category 4 projects, the guidance similarly requires a showing that at least 50% of the facility’s total output is distributed to qualifying low-income households, where the applicant and project owner are responsible for verifying household income levels. In applying this test, the IRS and Treasury plan to reserve all of the Category 4 Credit Limit for applicants that can show at least a 20% “bill credit discount” on the tenants’ electricity bills – i.e., to qualify, a project owner will need to show that the aggregate monetary savings received by a tenant, net of required fees and participation costs, must be at least 20% of the total monetary savings.
Q4: For the 10% Bonus Credit (which is tied to geography), where is a project deemed to be located?
For Category 1 or 2 applicants, a project is “located” in a relevant census tract or geographic area if 50% or more of its nameplate capacity is physically situated in the applicable area. This test only considers the nameplate capacity of energy-generating units, while ignoring the location of storage and other non-generation equipment.
Placed in Service and cut-off issues.
Q5: Can a project receive a Capacity Limit award if it has already been placed in service?
No. An award of Capacity Limit will only be made to a project that is not yet placed in service, where the placed in service definition and date will be critical to determine eligibility. Projects are placed in service before the Capacity Limit allocation program is implemented (or before an award is made) will not be eligible.
“Additional Selection Criteria” – a new process to allocate Credit Limit.
Q6: How is the IRS/Treasury going to handle the likely oversubscription of Capacity Limit in 2023? Which applications will be favored?
In Notice 2023-17, the IRS stated that it will accept 2023 applications for Capacity Limit in phases, using a series of rolling 60-day application windows. Now the IRS has apparently changed course. To address expected high demand, the Bonus Credit Guidance calls for a new approach in which the IRS will evaluate all applications reached by a certain date as one group. Capacity Limit awards will be made within this group. If there is Capacity Limit remaining after this initial allocation, then a rolling application window will begin.
Certain applications will be favored. It is proposed that at least 50% of the Capacity Limit for each of the four categories will be ear-marked for facilities that meet either or both of two new tests: (1) the “specified ownership” test or (2) the “geographic criteria” test (together, the “Additional Selection Criteria”). Specified ownership means that the project is owned by a Tribal Enterprise, an Alaska Native Corporation, a renewable energy cooperative, a qualified renewable energy company, [xi] or a qualified tax-exempt entity.[xii] The geographic criteria test applies a more focused map than what is used generally to determine low-income census tracts under Category 1. Under the new geographic test, a facility is favored if it is located either in a Persistent Poverty County[xiii] or in a census tract that is designated in the Climate and Economic Justice Screening Tool as disadvantaged.[xiv]
Separately, the IRS/Treasury announced that it will allocate Capacity Limit to Category 1 applicants in a manner that will favor residential roof-top applicants over business and non-residential projects. Of the 700 MW of Capacity Limit under Category 1, the IRS/Treasury plan to allocate 540 MW to residential behind-the-meter facilities, and 140 MW to front-of-the meter and non-residential facilities.[xv]
Q7: What sort of documents and attestations will be required for a Capacity Limit application, both at the initial filing stage and later when the project is placed in service?
The Bonus Credit Guidance provides a useful chart to illustrate the various documents and attestations that each project leader will need to submit with a Capacity Limit application. Among other requirements, the applicant will need to attest that it has executed contracts to acquire the facility, and that it has permits, site control and project size confirmations.[xvi]
After Capacity Limit is awarded, the applicant is required to place the project in service within four years. At that point, the Bonus Credit Guidance requires the applicant to make a second filing, with further attestations, to show that the project ultimately meets all requirements for the Bonus Credit (including, for example, to show that the financial benefit test was met, including the 20% bill credit for low-income consumers and lists of households who are recipients of the project energy).
Compliance Issues: Disqualification and Recapture Risks
Can a project with Capacity Limit be disqualified? What is recapture risk?
Once Capacity Limit is awarded, any subsequent changes to the project run the risk that the Capacity Limit will be disqualified. For example, per the Bonus Credit Guidance disqualification will occur if, before or upon the placed in service date, the project changes its location or the nameplate capacity increases to exceed 5 MW or decreases by the greater of 2 kW or 25%. In addition, disqualification will occur if the “financial benefits” requirement is not met, if there is a change to the required ownership of the project, or the project misses the 4-year completion date.
The guidance also states that the IRS can recapture Bonus Credit benefits if projects ultimately do not meet the Section 48(e) requirements. The recapture rules indicate that the IRS will apply a 5-year statute of limitations on certain items (e.g., the measurement of financial benefits delivered under Category 3 and 4 projects). The IRS will also permit a one-time cure right – so, in practice, a project that fails to meet Section 48(e) requirements will have one chance to cure the situation over a 12-month period following discovery.
What’s next in terms of additional IRS guidance?
The IRS/Treasury are running a short review period. The Bonus Credit Guidance is open to public comments only up to June 30, 2023. Presumably, the IRS/Treasury will need to release final or temporary regulations, and other guidance, in the coming months to facilitate the launch of the Capacity Limit allocation program in 2023.
For more information or questions, please contact Chris S. Brown, 206.224.8008 or firstname.lastname@example.org, or the KTC attorney with whom you typically work.
[i] The Notice can be found at https://public-inspection.federalregister.gov/2023-11718.pdf
[ii] While the 30% credit under Section 48 will require large projects to comply with strict prevailing wage and apprenticeship requirements, facilities under 1 MW capacity (alternating current) are able to sidestep these rules – which means that a 30% ITC credit is generally the starting point for sub-1 MW projects.
[iii] The Bonus Credits of Section 48(e) (limited to qualified wind and solar projects) will roll into a broader bonus credit program starting in 2025 that is based on any carbon reduction technology, per Code Section 48E(h).
[iv] And, of course, for a rigorous development of small wind and solar, developers and project owners will need to employ creative financing methods to obtain up-front cash to pay for construction costs followed by pay-off with ITC credit cash from the direct pay program. Funding structures will be covered in a future KTC Client Alert.
[vi] For a census tract within a metropolitan area, the second test is met if median family income does not exceed 80% of the greater of statewide median family income or the metropolitan area median family income. Special rules apply under Section 45D(e) for tracts with low population, high migration and areas not within census tracts.
[viii] Qualifying programs include a covered housing program (per section 41411(a) of the Violence Against Women Act of 1994 (34 USC 12491(a)(3)), a housing assistance program administered by the Dept. of Agriculture under title V of the Housing Act of 1949, a housing program administered by a tribally designated housing entity (per section 4(22) of the Native American Housing Assistance and Self-Determination Act of 1996 (25 USC 4103(22)), or other programs chosen by the Secretary of Treasury.
[xi] A qualified renewable energy company is a new category that generally includes an entity that is majority owned by individuals, cooperatives, Tribal entities, a Community Development Corp, or a Native Hawaiian organization that serves low-income communities in developing green energy projects. The entity needs to have less than 10 employees and under $5 million of gross receipts. See Bonus Credit Guidance at II.C.1.d.
[xii] Tax-exempts include 501(c)(3) organizations, Tribal governments, Section 501(c)(12) cooperatives and government entities. The government entity category uses the common definition, comprising a State, the District of Columbia, or any political subdivision thereof, along with any territory of the U.S. or any agency or instrumentality of the foregoing.
[xiii] A Persistent Poverty County is generally a county where 20% or more of residents have experienced high rates of poverty over the past 30 years. See https://www.ers.usda.gov/data-products/county-typology-codes/
[xiv] Under the Climate and Economic Justice Screening Tool, a census tract is disadvantaged based on whether the tract is either (a) greater than or equal to the 90th percentile for energy burden and greater than or equal to the 65th percentile for low income, or (b) greater than or equal to the 90th percentile for PM2.5 exposure and greater than or equal to the 65th percentile for low income.
[xv] “Behind-the-meter” means that the qualified wind/solar facility(1) is connected with an electrical connection between the facility and the panelboard or sub-panelboard of the site where the facility is located; (2) it is to be connected on the customer side of a utility service meter before it connects to a distribution or transmission system (ie, before it connects to the electricity grid), and (3) the primary purpose is to provide electricity to the utility customer of the site where the facility is located. A “front-of-the-meter” facility is one that is directly connected to a grid and its sole purpose is to provide electricity to one or more offsite locations through the grid. Bonus Credit Guidance, at II.D.