The Inflation Reduction Act was signed into law this month. As a budget reconciliation law, it impacts federal income and spending. For 5 and our customers, this law provides increased incentives for on-site renewable projects that support the energy transition.
The detailed scope of the Act and its various provisions are subject to further clarification, however, an initial summary of what we know about this new legislation is outlined below. We expect to have additional details and clarifications in the weeks and months ahead.
Investment Tax Credit
The financial incentives for solar projects are more favorable. The law extends the Investment Tax Credit (ITC) for 10 years at 30%, which means that 30% of the total project cost will be credited back as a tax credit. The law also includes the following adders to the ITC to promote solar development in certain communities and manufacturing in the US.
An additional 10% is added to the ITC for project locations in an “energy community”, which is defined as a brownfield site, an area with significant fossil fuel employment, or a location within or adjacent to a recently retired coal mine or coal-fired power plant.
The domestic content adder makes another 10% of additional ITC available if all steel and iron, plus 40% of manufactured products used in the solar installation are made in the US. The domestic content percentage will increase in future years.
Projects under 5 MW located in low-income communities will get a 10% ITC adder. This adder jumps to 20% for projects that are located at low-income housing facilities or located where at least half of the financial benefits of the electricity produced go to low-income households.
Collectively, all these adders and incentives could amount to as much as 70% for a qualified project. Domestic content will be up to the developers to source, but clients who have locations in energy communities or low-income communities should consider on-site solar for their facilities.
Other changes to the ITC include:
The ITC will cover energy storage projects, including those that are not tied to solar projects. While previously, storage projects had to be associated with a solar project to qualify, now stand-alone storage projects will be eligible for the ITC.
For solar projects under 5 MW, interconnection costs will be included in the project costs eligible for the ITC starting in 2023. This will help fund the cost of grid upgrades needed to put distributed generation projects in service. Some projects that were canceled due to interconnection costs may be able to proceed now.
A potential issue for projects is that the 30% ITC is contingent on project developers meeting specific wage and labor guidelines. These requirements will be in place for projects over 1 MW and begin 60 days after the IRS releases further guidance on the matter. For projects in high-wage areas, the requirement to meet prevailing wage guidelines could increase project costs significantly.
The Inflation Reduction Act also broadens solar and storage financing mechanisms by creating new options for how the ITC can be paid. Until now, only taxable organizations with sufficient taxable income could take advantage of the ITC since it was paid as a credit against taxes due. The Inflation Reduction Act adds a direct pay option that allows tax-exempt organizations to directly receive the ITC as a refund beginning with projects placed in service in 2023. Entities eligible for direct pay include tax-exempt entities, state or local governments, the Tennessee Valley Authority, Indian tribal governments, or an Alaska Native Corporation. This is a big change for tax-exempt organizations that previously relied on third-party ownership of solar projects to make the most of the tax benefits. 5 is actively following this provision in the new law to determine what qualifications are placed on tax-exempt groups and how direct pay plays out.
For taxable organizations, the Inflation Reduction Act introduces an option to transfer the ITC to another party, which essentially provides the ability to sell the tax credit for cash. This provision will open financing options for developers and may make financing easier, although tax-equity financing is expected to stay relevant to take advantage of the accelerated depreciation benefits from these projects.
Manufacturing and Production Tax Credit
On a larger scale, the Inflation Reduction Act provides a big boost to renewable energy, both in manufacturing and utility-scale development. US manufacturing of renewable energy components will receive significant tax credits to promote domestic manufacturing and jobs. The Production Tax Credit (PTC) was extended for 10 years as well and opened to solar projects in addition to wind projects that have historically received the PTC. While it is yet to be seen which solar projects will choose the PTC and which will choose the ITC, it seems that the PTC will be favorable for larger utility-scale projects in the southwest while the ITC will be favorable for smaller projects in the northeast.
The Inflation Reduction Act also extended tax credits for individuals who purchase electric vehicles (EVs). However, there are limitations on this $7,500 tax credit for new EV purchases. Limitations include a maximum income for the purchaser, limits on the price the of vehicle, and requirements that the vehicle is assembled in North America and that battery components are sourced from countries with free trade agreements with the US. This law also creates a tax credit for individuals purchasing used EVs, and for commercial electric vehicles.
These investments are likely to result in increased adoption of EVs. Organizations should evaluate the potential of increasing EV charging needs at their facilities as part of budgeting and energy forecasting.
The Inflation Reduction Act also has implications for existing power plants and oil, gas, and nuclear industries. It ensures that federal land will remain open to oil and gas development both directly and by requiring renewable energy auctions to be preceded by oil and gas leases. It provides funding to oil and gas companies to reduce methane emissions, while also enacting a penalty for excess methane emissions. A tax credit for electricity generation from existing nuclear power plants is included in the law. Carbon capture and storage tax credits are increased as well. The carbon capture provision may be a lifeline for some fossil fuel power plants that otherwise would struggle to meet emissions requirements.