New Climate Law Overhauls US Tax Code With Benefits, Flexibility

Recognizing the impact of carbon on the environment and climate, the IRA aims to support and incentivize development and investment in a broad swath of areas: green and/or clean power production; manufacturing of energy components; electrification of vehicles; and innovation. It is anticipated to spur record-setting growth in green and clean energy, driving trillions of dollars into the industry.

The Act’s Four Major Themes

Four major themes ripple through the legislation: breadth, flexibility, environmental justice, and domestic strength.

Breadth

The IRA extends subsidies (in the form of federal tax credits) through at least 2032 for a broad array of power generation facilities. This incredibly long tax credit runway should provide enterprises with the certainty they need to invest in renewable and clean energy development and innovation.

Congress sensibly recognized that carbon-intensive power production remains necessary to meet the country’s energy needs. But to mitigate carbon emissions, the IRA increases the tax credit rate available for carbon capture (the 45Q credit) and lowers the threshold to qualify for the credit.

Congress also recognized that much of our country’s green power production comes from intermittent resources, adding stand-alone storage facilities to the list of projects that are eligible for these tax benefits—extremely necessary for the stability and optimization of the country’s power grid.

Importantly, the IRA sets out a key role in reducing GHG emissions for the world’s most abundant element, providing—for the first time—subsidies for the production of clean hydrogen. The Act also includes tax credits for existing nuclear facilities, adding another clean energy source back into the mix.

Flexibility

The legislation also enacted a “technology neutral” tax credit regime for any power facilities with zero greenhouse gas (GHG) emissions—acknowledging that Congress should be focused not on picking winners and losers, but on eliminating carbon emissions across the economy. This credit kicks in for projects that are placed in service after December 31, 2024.

In another crucial piece of the puzzle, the IRA reduces the barriers to using these tax credits.  Historically, only taxpayers that had a sufficiently high tax bill—or that were able to partner with large “tax equity investors” (namely, large financial institutions)—could fully realize the benefit of tax credits. To address this, the IRA permits “monetizing” the credits by permitting “direct pay” for certain tax-exempt and governmental entities and “transferability”.

Put simply, it is possible to turn an otherwise available tax credit into either a grant from the government or an asset that can be sold for cash. This extraordinary feature should bring substantial capital into the energy transition that otherwise would not be available.

Environmental Justice

Transitioning to a lower-carbon economy will impact the U.S. workforce significantly.  In acknowledging this impact, the legislation essentially mandates that laborers and mechanics at any facility that might benefit from one of the aforementioned credits be paid “prevailing wages” and that the workforce for the development of such a facility has a robust apprenticeship program. In other words, the government will not provide the highest credit rates to developers of a renewable or clean project unless the developer pays a living wage to its workers and invests in training them.

In addition, the IRA incentivizes new power facilities and energy assets to be sited in low-income communities and/or communities that once relied on jobs in carbon-intensive industries. This feature promotes environmental justice, aiming to ensure that communities with displaced workers or who are most vulnerable to climate change are not left behind in the energy transition.

Domestic Strength

The IRA also looks to strengthen domestic security: by providing credits for producing and using U.S. manufactured energy components and by diversifying and expanding U.S. energy production to reduce reliance on international energy sources.

Credits Offset Corporate Minimum Tax

Lastly, the IRA imposes a 15% minimum tax on certain large corporations.  However,  the tax credits described above, as well as the associated accelerated depreciation, can be used to offset this minimum tax. As such, large taxpayers that were previously indifferent to investing in energy transition assets might now have a financial incentive to do so. This is a win-win: the taxpayer gets a credit and makes a responsible investment, while more capital flows to the development of renewables and clean energy.

This isn’t to say the IRA is perfect—or that it won’t present a number of challenges. One of the most notable omissions from the legislation is a tax subsidy for transmission assets and improvements. The U.S. transmission grid is already in need of upgrade and repair, and if the IRA has anywhere near the impact on the installation of energy production facilities as is projected by some, further stress will be placed on the grid. While installation of stand-alone storage (and the associated tax credit) may be a gap-fill, the benefit of the IRA may not be fully realized until the grid is upgraded.

Even as the IRA is certainly welcome by the renewable/clean energy industry, how it will be implemented—and when more detailed guidance will be provided—is still unknown. If the IRA is going to produce the level of investment that it sets out to, detailed guidance will be essential, especially for the novel concepts of direct pay and transferability.  Same for some of the labor requirements (i.e., the requirement to pay a prevailing wage and employ apprentices). We encourage Treasury to prioritize more detailed guidance for taxpayers in these areas.

Of course, the full impact of the IRA will be known only with time. But we can be certain that it overhauls a significant swath of the federal tax code—changing and adding benefits, implementing new types of taxation, and adding much-needed flexibility.

Read the article on Bloomberg Law here.