Federal Regulators Propose to Clarify the Scope of the ITC and Who Qualifies for Increased Credit Amounts

The proposed regulations clarify what property qualifies for the credit, which taxpayers qualify for increased credit amounts and several other key aspects of the ITC.

The Department of the Treasury (“Treasury”) and Internal Revenue Service (“IRS”) proposed regulations on November 17, 2023, that would clarify key components of the Investment Tax Credit (the “ITC”).  Originally enacted in 1962, the ITC provides valuable economic incentives to investors in energy, transportation and communications.  See 26 U.S.C. Section 48.

The proposed regulations are online here.  They address two main topics in particular: (1) the scope of “energy property” and (2) who qualifies for increased credit amounts.  This guidance is vital for energy producers across the country including those entities newly eligible for IRA Direct Payments in-lieu-of credits.[1]

1. Expansion of Eligible “Energy Property”

The proposed regulations address what qualifies as eligible “energy property” under 26 U.S.C. section 48(a)(3)(A)(i)-(xi).  Among other changes, the proposed regulations would expand eligible energy property to include portions of facilities.  Previously, if a portion of a facility received the Section 45 Tax Credit, the entirety of the facility could not claim the ITC.  Under the proposed rules, however, energy storage facilities and technologies that share their location with facilities receiving Section 45 Tax Credits would no longer lose their ITC eligibility. 

The proposed regulations will also allow for fractional owners to qualify for the ITC.  Previously, if a tax-exempt entity owned any portion of otherwise eligible energy property, the entire property was ineligible.  In alignment with Revenue Ruling 78-268, the proposed regulations will now permit all owners of the otherwise eligible energy property to claim the ITC to the extent of their basis in the property.  This, paired with the now-available payment in lieu of tax credit for tax-exempt owners, expands eligibility to include multi-owner properties (e.g., where owners are private companies or municipal entities). 

Another notable change is the “80/20 Rule.”  Under the rule, retrofitted systems that qualify as “energy property” can still qualify for the ITC.  Ordinarily, the ITC only applies in the year the “energy property was placed in service.”  26 U.S.C. section 48(a)(1).  Used components and materials may still qualify for the ITC so long as the used property’s fair market value does not exceed 20 percent of the entire facility’s fair market value.

The last notable change is the inclusion of energy storage technology as part of the definition of eligible energy property.  Energy storage technology currently includes “property (other than property used in the transportation for goods or individuals and not for the production of electricity) that receives, stores, and delivers energy for conversion into electricity and has a nameplate capacity of not less than 5 kWh.”  26 U.S.C. section 48(c)(6)(A)(i).  The proposed regulations, however, would add hydrogen energy solely used for production of energy and not an end-user product like fertilizer. 

The proposed regulations acknowledge it is “impossible to list all the types of technologies that could qualify . . . [a]n the importance of leaving the language broad enough to allow future technological advances in energy storage technologies.”  Thus, the proposed regulations would add two-tests to aid in determining eligibility: 

(i) 80-20 Rule: property that consists partially of energy storage technologies can qualify for the ITC so long as the non-storage components are less than 20 percent of the property’s fair market value; and

(ii) Functional Interdependence Test: the energy storage technology must not be functional except with the other components of the facility.  Stated differently, if the components of the energy storage technology cannot operate without the entirety of the energy storage “unit” are in working order, they are independent and thus are not part of the entire facility. 

2. Increased Tax Credit Amounts

Currently, section 48(a)(9)(A)(i) entitles a qualified “energy project” to an ITC increase by a multiplier of five.  Qualification requires an owner to satisfy any of three elements: (1) Prevailing Wage (“PWA”) Requirements, (2) One-Megawatt Exception, or the (3) Beginning of Construction Requirements.  26 U.S.C. section 48(a)(9)(B)(i)-(iii).  The proposed regulations would clarify:

• • An ITC transferee that receives the PWA-based increased credit amount bears the same liability of recapturing income;
  • For taxpayers claiming a PWA-based increased tax credit, annual informational reports must go to the IRS; and
  • The recapture percentage in the five years following the energy project commencing use reduces annually by 20 percent.

The proposed regulations involve highly technical and nuanced changes and clarifications of the ITC.  Public comments close on January 22, 2024, and final publication of the regulations will proceed in early 2024.

Attorneys at Baird Holm LLP have extensive experience in clean energy tax credit matters, renewable energy, and other general corporate and taxation matters.  If you have any questions about these proposed regulations or would like to discuss the potential eligibility of your entity, please do not hesitate to contact the firm.

[1] See this article analyzing which tax-exempt entities qualify for direct pay.