LEGAL ALERT: Solar Energy Law

Inflation Reduction Act Low Income Community Bonus Credits

IRS Notice 2023-17:  Initial Guidance Regarding Add-On Tax Credits
for Solar and Wind Projects Serving Low-Income Communities

BACKGROUND

The Inflation Reduction Act, signed into law in August of 2022, is expected to provide significant new tax incentives for solar and wind projects that serve low-income communities. On February 13, 2023 the IRS issued Notice 2023-17, which states initial guidance regarding the new 10% and 20% tax credits for certain qualifying solar and wind projects. These special credits are additive to the basic 30% Investment Tax Credit for alternative energy projects, which means a qualifying low-income solar or wind project may be eligible for tax credits accounting for 40% or even 50% of the total project cost.

Furthermore, under the new “direct pay” regime that is now in place under the Inflation Reduction Act (per Code Section 6417), certain solar and wind project owners who do not pay tax (such as electricity cooperatives, tax-exempt entities, Tribes and local government units) will be eligible for cash refunds from the IRS equal to the applicable project credit amount. In effect, many mutual and consumer owned utilities, along with Tribes, non-profits and government units who want to develop and own solar and wind projects, will soon be roughly on the same footing as for-profit developers when it comes to monetizing the value of federal energy tax credits. More guidance will be needed. But Notice 2023-17 provides a few details about how this program will likely operate, as outlined below.

Basic 30% Investment Tax Credit for Solar and Wind Projects.  

The Inflation Reduction Act re-instated the prior 30% Investment Tax Credit (“ITC”) for solar and wind projects with a net capacity under 1 Megawatt (alternating current).  This category covers homeowner roof-top systems. It also includes larger roof-top projects serving government, apartments and commercial buildings, along with smaller array grid installations serving non-urban communities. The ITC is a “front-end” credit, which means it is generally equal to 30% multiplied by the total upfront equipment and construction costs needed to build the project. Projects of 1 MW or more qualify for a basic 6% ITC credit, but this amount is increased to 30% if the project meets new prevailing wage and apprenticeship requirements. Also, certain shovel-ready projects will receive the 30% ITC without meeting wage and apprenticeship projects if construction begins no later than 60 days after the IRS issues applicable guidance.  The new 30% ITC will be in place up to 2032, subject to phase-out rules after that year.

10% and 20% Add-On Credits.

The Inflation Reduction Act adds a special 10% add-on ITC credit for solar and wind projects under 5 MW capacity located in certain low-income communities or on Indian land. This is a geographic test. In general, the locations that are eligible for this tax incentive are based on household income levels within U.S. census tracts, as determined under the same rules that were used for the New Markets Tax Credit (Code Section 45D(e)). Qualifying Tribe locations are determined under the Energy Policy Act of 1992.

A new 20% add-on ITC credit applies if the qualifying solar or wind project (under 5 MW) is installed on a residential rental building where the tenants receive affordable housing benefits (a “Low Income Residential Building Project”).  An installation can also qualify for the 20% credit if the solar or wind facility is installed off-site but where more than 50% of the economic benefits of the generated power are realized by lower income households in the served community (a ” Low Income Economic Benefit Project.”)

Both the 10% and 20% add-on credits are offered on an application basis, under a newly formed Low Income Community Bonus Credit Program. Therefore, these credits are not automatic. For any given project, the owner will need to apply first to the IRS and receive an allocation of credit.  Also, these two credits do not stack, so if both credits apply to a particular case, only the higher 20% one will be awarded.

IRS Low Income Community Bonus Credit Program.

Project owners will need to apply directly to the IRS to obtain the additional 10% or 20% ITC credits. As described in Notice 2023-17, the new Low Income Community Bonus Credit Program will include these elements:

• Capacity Limit. For 2023 and 2024, the IRS will allocate up to 1.8 gigawatts of capacity per year to all U.S. applicants. This 1.8 GW ceiling is referred as the “Capacity Limit.” Thus, a successful applicant will receive an award of a certain amount of Capacity Limit that – in an ideal case—will equal the capacity size of the applicant’s project. If the program has unused Capacity Limit in 2023 or 2024, the excess will carry over to be eligible for award in the next year.
• Four Categories. The 1.8 GW Capacity Limit in 2023 will be allocated to four categories of project: (1) 700 MW for low income community projects (based on geography), (2) 200 MW for Indian Land projects, (3) 200 MW for Low Income Residential Building Projects, and (4) 700 MW for Low Income Economic Benefit Projects. The IRS may re-allocate these figures to address under or over subscription in any given category.
• Other Criteria. Notice 2023-17 points out that the IRS will apply “additional criteria” in making awards of Capacity Limit to applicants. These criteria include a focus on facilities that are (1) owned or developed by community-based organizations and mission-driven entities, (2) have an impact on encouraging new market participants, (3) provide substantial benefits to low income communities and individuals marginalized from economic opportunities, and (4) have a higher degree of commercial readiness. If the total Capacity Limit is over-subscribed, the IRS may end up using a lottery to make the awards. The Department of Energy will be assisting the IRS in administering the program.
• Application Timing and Process. Applications will be accepted on a phase in basis. Thus, in Q3 of this year, the IRS and Treasury Department will begin to accept applications for the 20% add-on credit for both Low Income Residential Building Projects and Low Income Economic Benefit Projects. The exact timing of applications for the 10% credit (for low income communities and Indian Land applicants, Categories (1) and (2) above) is not specified in the notice, but will presumably be after the start of Q3. Once an award of Capacity Limit is made, the recipient receives a right to claim the additional 10% or 20% ITC and has four years from the date of the award notice to place the property in service. Note that the award of Capacity Limit is not itself a credit, and cannot be separately monetized.  An award of Capacity Limit it is just a right to claim the credit if the underlying project is eventually completed. The project must still meet all other requirements for ITC eligibility (including the placed-in-service test and the applicable low income and qualified facility tests). The IRS has audit rights over these projects for a period of at least three years following the relevant tax return filing date.

Observation Regarding Timing and Direct Pay Benefit.

Notice 2023-17 does not describe details of the new Direct Pay mechanism. But, one can begin to see the outlines of how the new Investment Tax Credit will interact with the Direct Pay program for projects involving tax-exempts, Tribes and government units. Below is an example, based on the information that is available to date. (Note: The dates and timing assumptions below are subject to change, based on additional IRS guidance.)

Example.  Assume Developer, a tax exempt entity, begins construction on a 500 KW solar project in Q2 of 2023. Assume the project meets all requirements for the basic 30% ITC tax credit. On July 1, 2023 (the first day of Q3), Developer submits an application to the IRS and Treasury Department and makes a request for a 20% add-on ITC credit under Category 4 (the Low Income Economic Benefit Project category). Assume that the IRS and Department of Energy accept the application and make a Capacity Limit award of 500 kW in Q4 of 2023. Therefore, Developer’s potential ITC on this project is 50% (i.e.,  a 30% base ITC plus the 20% add-on credit).

Developer completes the project in Q4 and the project is “placed in service” (in accordance with IRS standards – e.g., Notices 2018-59 and 2019-41) in December of 2023. It appears that Developer would file a tax return or tax form with the IRS by March 15, 2024 (the normal tax return due date for tax exempt entities) to claim the 50% credit, and would be eligible to receive a cash refund under the Direct Pay statute, at the earliest, on March 15, 2024. Actual receipt of these funds would arise later, probably weeks or months later.

Although the Inflation Reduction Act will provide significant benefits to non-profit and low income community developers, this examples illustrates several timing challenges. For example, Developer here still need to “gap fund” the upfront construction and equipment purchase costs (absent an IRS change that would effectively prepay the credit amounts prior to the final return due date). Also, note that a critical point is the date on which the project is “placed in service.” Under the tax code, the Investment Tax Credit can only be claimed in the year in which the facility is placed in service. If the construction in this example were delayed and the placed-in-service date was deferred to January of 2024, then presumably the “placed in service” tax year would fall in 2024 and – absent a change in the law or regulations — the Direct Pay date would be delayed a year to March 15, 2025.

The timing issues related to Direct Pay and other Inflation Reduction Act benefits represent a significant outstanding issue. Timing and filing mechanics will be clarified as the IRS issues more guidance.

For more information or questions, please contact Chris Brown at 206.224.8008, cbrown@karrtuttle.com, or the KTC attorney with whom you typically work.