The Investment Tax Credit (ITC) and Production Tax Credit (PTC) provide substantial financial incentives designed to promote renewable energy investment and production in the United States. Section 38 allows a federal income tax credit equal to the sum of various business credits, including the ITC and PTC. The ITC, embodied in Section 48 of the Internal Revenue Code (Code), encourages potential investors to partake in the installation of renewable and clean energy systems. The PTC, detailed in Section 45 of the Code, provides a per-kilowatt-hour tax credit for electricity generated from qualified renewable resources. Together, these credits drive environmentally sustainable practices and support the growth of clean energy.

This article revisits the general ITC and PTC requirements and provides an overview of recently published final and proposed regulations related to such credits.

General ITC & PTC Requirements

A. General ITC Requirements

To qualify for the ITC, eligible energy properties must satisfy three key criteria: (i) the taxpayer must own the property;¹ (ii) the property must reach operational status within the year the credit is first claimed; and (iii) the property and project must comply with specific federal and state guidelines.² The ITC applies primarily to energy properties, including solar, wind, and geothermal energy properties.³ Applicable energy properties include a wide range of equipment and systems, such as solar energy systems, geothermal systems, fuel cells, and small wind turbines.

The ITC base rate under the Code stands at 6% for specific energy properties (including solar, fuel cells, waste energy recovery, combined heat and power, and small wind), and 2% for microturbine property. These rates can increase to 30% for specific energy properties and 10% for microturbine property, if the project satisfies the prevailing wage and apprenticeship requirements. ⁴

The energy property must be “placed in service,” meaning it must be ready and available for use, in the year the tax credit is claimed.⁵ However, for property that satisfies the “beginning of construction” requirement, the ITC can be claimed if the property is placed in service by a specific deadline (usually within four years after the construction began).⁶

A 30% ITC is available for taxpayers who “began construction” by Dec. 31, 2019, with reduced percentages available for projects begun after this date.⁷ There are two methods to determine when construction begins: the “Physical Work Test” and the “5% Safe Harbor.”⁸ Continual progress towards completion is mandatory for both methods, generally requiring the project to be “placed in service” within the fourth calendar year after commencement of construction.

B. General PTC Requirements
To qualify for the PTC, eligible energy properties must satisfy three criteria: (i) electricity must be produced from a qualified energy resource (including wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy); (ii) the project must be a qualified facility; and (iii) the electricity produced must be sold to an unrelated person.⁹

A Qualified Facility is an energy property that is: (i) owned by the tax payer; (ii) placed in service after 1992; and (iii) construction of which begins before Jan. 1, 2025.¹⁰ The PTC, like the ITC, also uses the “Physical Work Test” or the “5% Safe Harbor” method to determine the beginning of construction date.

Lastly, the electricity must be sold to an unrelated person, generally requiring that the energy is not sold to an entity under common control or ownership, such as a parent-subsidiary, brother-sister corporation, or combined groups of corporations.¹¹

The PTC is equal to the product of 0.3 cent multiplied by the kilowatt hours of electricity (a) produced by the taxpayer from qualified energy resources and at a qualified facility during the 10-year period beginning on the date the facility was originally placed in service, and (b) sold by the taxpayer to an unrelated person, increased by an inflation factor.¹² If an energy project meets the prevailing wage requirements set forth in the Code, the amount of the credit can increase further.¹³

Final Regulations for Transferability and Direct Pay

Transferability allows eligible taxpayers to transfer all or a portion of their eligible tax credits to unrelated taxpayers in exchange for cash payments, beginning after Dec. 31, 2022.¹⁴ These cash payments are excluded from the gross income of the eligible taxpayers and are not deductible by the transferee.¹⁵ Direct pay, also referred to as elective pay, allows “applicable entities,”¹⁶ to receive a direct payment from the IRS in lieu of a tax credit.¹⁷
On April 25, 2024, the Treasury and the IRS issued final regulations (T.D. 9993) related to the election to transfer certain tax credits. This follows the recent issuance of final regulations (T.D. 9988) on March 6, 2024, concerning the direct pay of certain tax credits.

A. Transferability
A taxpayer can elect to transfer all or a portion of an eligible credit to an unrelated transferee taxpayer. However, the following requirements, attributes, and impacts apply:

• • Partnerships and entities with tax-exempt partners may qualify as transferors, if the entity has not made a direct pay election for eligible credits;
  • Energy storage technology is eligible credit property;
  • The transfer must be a one-time event, but transferors may transfer to multiple transferees;
  • Bonus credit amounts, additional credits earned from meeting specific requirements such as prevailing wage and apprenticeship requirements, cannot be transferred separately from the base credit amounts;
  • Grantor trusts can make transfer elections for eligible tax credits;
    There is an automatic six-month extension from the original due date of the tax return, excluding any other extensions, for making a transfer election;
  • The initial transfer election cannot be made on an amended return; however, adjustments to the amount of the credit can be made on an amended return if the election was made timely on the original or superseding return; and
  • Transferees may carry forward any unused credit amounts by applying the rules of Code Section 39(a)(4).

B. Direct Pay
An eligible business may elect for direct payment in lieu of a tax credit. However, the following requirements, attributes, and impacts apply:

• • “Applicable entities” include all organizations exempt from tax under Section 501(a) of the Code. Federal agencies and state-law non-profits without federal tax‑exempt status are not “applicable entities” for Section 6717. Additionally, partnerships and S corporations are not “applicable entities,” regardless of whether their partners or shareholders are applicable entities;
  • The initial transfer election cannot be made on an amended return; however, adjustments to the amount of the credit can be made on an amended return if the election was made timely on the original or superseding return;
  • There is an automatic six-month extension from the original due date of the tax return, excluding any other extensions, for making a direct pay election;
  • Applicable entities can choose their taxable year based on calendar or fiscal year, if they maintain adequate books and records to support making a direct payment election based on the chosen taxable year; and
  • Regarding the excess benefit rule, the purpose of a tax‑exempt grant is determined at the time of the award, and grants awarded post-acquisition are generally not restricted tax amounts. Additionally, only forgivable loans are treated as tax exempt under the excess benefit rule.

Energy Property Proposed Regulations

Section 48 provides that the ITC is available for “energy property.” On Nov. 17, 2023, the IRS issued proposed regulations for the ITC, specifically addressing what qualifies as energy property. This section highlights some of the major changes and clarifications from the proposed regulations.

A. Definition of Energy Property
The term “energy property” generally means a “unit of energy property.” A unit of energy property includes all functionally independent components of property owned by the taxpayer that operate together and can function independently from other energy properties within a larger project.

B. Qualifying Energy Property
The proposed regulations provide much-needed guidance on certain newer technologies including energy storage and qualified biogas property.

C. Integral Part of Energy Property
Any property that is an “integral part” of the energy property is considered energy property for ITC purposes. To qualify as an integral part, the property must be used directly in the intended function of the energy property and be essential to its completeness.

D. Exclusions
The proposed regulations specify that the power purchase agreements, goodwill, going concern value, and renewable energy certificates are not energy property.

E. The 80/20 Rule
Energy property qualifies as “acquired by the taxpayer” if the “original use” of such property commences with the taxpayer.¹⁸ The proposed regulations provide that for retrofitted energy property, the 80/20 Rule applies. If the fair market value of the used components is not more than 20% of the total value of the unit of energy property, then the rule is met and the property qualifies as “acquired by the taxpayer.”¹⁹

Conclusion

The ITC and PTC are key financial incentives that boost investment in renewable energy projects. Transferability and direct pay expand access and enhance investment, promoting broader participation in the renewable energy sector. Recent final and proposed regulations aim to clarify the implementation and provide compliance guidance for these credits. Understanding these evolving regulations is crucial for determining eligibility and the extent of benefits under both the ITC and PTC.

As every energy project is unique, the specific legal and tax implications can vary. As such, this article should be used as a guide and not as a definitive source of advice. We recommend consulting with a Baird Holm LLP attorney and a qualified accountant for advice regarding the specific tax implications of a project.