The Investment Tax Credit (ITC), embodied in Section 48 of the Internal Revenue Code (IRC), provides a substantial financial incentive designed to stimulate investment in renewable and clean energy. The ITC encourages potential investors to partake in the installation of renewable and clean energy systems, thereby promoting environmentally sustainable practices in the United States. The relevance of the ITC has surged recently, especially in the context of the current administration’s focus on sustainable energy development and practices.

The ITC has been revised multiple times since 1992, the most recent revision occurring in August 2022 under the Inflation Reduction Act (Act).¹ The first portion of this article provides an overview of the requirements to qualify for the ITC in general. The second portion takes a deeper dive into the changes to the ITC implemented by the Act and related guidance, with attention to updates recently released by the Internal Revenue Service (IRS), including those related to transferability and direct pay.

General ITC Requirements

To qualify for the ITC, eligible energy properties must satisfy three key criteria: (i) the taxpayer must own the property; (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

1. Eligible Property
   
   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, including solar energy systems, geothermal systems, fuel cells, and small wind turbines. The Act expanded the scope of applicable energy projects to include: (i) solar facilities beginning construction before Jan. 1, 2025; (ii) standalone energy storage technology; and (iii) zero-emission projects that start construction on or after Jan. 1, 2025.⁴
   
   An eligible property must meet the following criteria to qualify for the ITC:
   
   
   • Must be constructed, reconstructed, or erected by the taxpayer;
   • Depreciation or amortization must be allowable on the property; and
   • Meet certain performance and quality standards promulgated by the U.S. Secretary of the Treasury, if any, in effect at the time of acquisition.


2. Ownership & Operational Status
   
   In order to claim the ITC, the taxpayer must possess ownership of the energy property.⁵ 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.⁶ 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).⁷


3. Beginning Construction
   
   A 30% ITC is available for taxpayers who “began construction” by Dec. 31, 2019, with reduced percentages available for projects begun after this date.⁸ Two methods may be used to determine when construction begins: the “Physical Work Test” and the “5% Safe Harbor.” 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.
   
   
   1. Physical Work Test
      
      Under the “Physical Work Test,” construction is considered to have begun when physical work of significant nature has started. This test focuses on the nature of the work performed, not the amount or cost. “Physical work of a significant nature” may include any off-site or on-site physical work, such as mounting equipment, manufacturing components, or installing equipment and structures. Preparatory work or work related to the assembly of component parts of energy property would not qualify as “physical work of a significant nature.”
   
   
   2. 5% Safe Harbor
      
      The “5% Safe Harbor” stipulates that construction can be considered to have begun if the taxpayer has paid or incurred at least 5% of the total cost of the property. To qualify under the 5% Safe Harbor, taxpayers must fulfill the requirements of Section 461, which involve the three-part “All Events Test.” Under the “All Events Test,” an accrual basis taxpayer “pays or incurs” the cost when (i) all events establishing the liability have occurred, (ii) the amount of the liability can be determined with reasonable accuracy, and (iii) economic performance has occurred with respect to the liability, subject to exceptions.

Recent Act Impacts

1. Extensions & Adjustments
   
   Before the Act, owners of qualifying energy projects could claim a tax credit up to 30% of their project’s capital costs, subject to a phase-down. The Act introduced key extensions and adjustments, including:
   
   
   • Extension of ITC availability for solar facilities that commence construction before Jan. 1, 2025;
   • Expanded eligibility for standalone energy storage technology; and
   • Allowing taxpayers to opt for the ITC instead of the Production Tax Credit for some qualified facilities.
   
   The Act also extended the advanced energy project credit for investments in projects that re-equip, expand, or establish certain energy manufacturing facilities.⁹


2. Credit Amounts
   
   The ITC base rate under the IRC 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 meets criteria such as:
   
   
   • Payment of prevailing wages during the construction phase and the first five years of operation along with adherence to registered apprenticeship requirements (detailed below in Section 3);
   • Generation of a maximum net output of less than one MW of electrical or thermal energy; or
   • Construction beginning within 60 days after the IRS publishes guidance on the wage and apprenticeship requirements.
   
   A bonus credit of 2% is available for projects that (a) meet domestic content requirements, or (b) are located in an energy community.¹⁰ This bonus credit increases to 10% for projects meeting the prevailing wage and workforce requirements described below in Section 3. To earn the domestic content bonus credit amount, the taxpayer must certify to the U.S. Secretary that any steel, iron, or manufactured product that is a component of such facility was produced in the United States.¹¹ A project is located in an energy community if it is located in a brownfield site, a statistical area that depends on fossil fuels and has high unemployment, or a census tract, or adjoining census tract, where a coal mine or coal-fired electric generating unit has closed or been retired after certain dates.


3. Prevailing Wage & Apprenticeship Requirements
   
   In accordance with IRS Notice 2022-61, to qualify for the 30% ITC and be eligible for the 10% bonus credit amount, the energy project must satisfy the prevailing wage and apprenticeship requirements.¹² These requirements are highly detailed; this Section 3 provides a high-level summary of such requirements.
   
   All laborers and mechanics involved in the project—whether they are employees of the taxpayer, contractor, or subcontractor—must be compensated at least the prevailing wage rates as determined by the U.S. Department of Labor under the Davis-Bacon Act for similar work within the project’s locality. The “prevailing wage” is listed for a particular classification of laborer or mechanic on the applicable wage determination for the type of construction and geographic area as determined by the U.S. Secretary of Labor. Such rates apply to hourly wages and contributions made pursuant to a fringe benefit plan, with such fringe benefits to include medical or hospital care, pensions, unemployment benefits, life insurance, vacation pay, etc.¹³ This not only applies during construction but also extends five years post-construction.
   
   Apprentices, recognized within a registered apprenticeship program, must carry out a defined percentage of total labor hours. This begins at 12.5% for projects initiating construction in 2023, increasing to 15% for projects starting from 2024 on. Taxpayers must adhere to the U.S. Department of Labor’s prescribed apprentice-to-journeyworker ratios.
   
   Taxpayers must also fulfill specific recordkeeping requirements concerning wage and apprenticeship data. It should be noted that IRS Notice 2022-61 does not modify the “good faith” exception, which permits taxpayers to benefit from the ITC if they can demonstrate they made an honest attempt to comply with these requirements, or the Act’s remedial provisions, which offer solutions for non-compliance.


4. Credit Transferability & Direct Pay
   
   IRC Section 6418 permits transferring the ITC, among other certain energy credits. On June 14, 2023, the U.S. Treasury Department and IRS released proposed regulations expanding on energy credit transferability under IRC Section 6418. This Section 4 provides a high-level summary of these proposed regulations.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:
   
   
   • The transfer must be a one-time event;
   • The transfer must be a cash purchase;
   • The income from the transfer is not included in the seller’s income;
   • The cost of the transfer is not deductible by the transferee; and
   • The transferee cannot further transfer any part of the credit.
   
   The taxpayer can transfer all or part of the credit to multiple taxpayers, as long as the total tax credits transferred do not exceed the project’s eligible total. Tax-exempt entities and other entities defined for direct-pay purposes are prohibited from electing to transfer credits, with an additional 20% penalty applying to “excessive credit transfers.” Taxpayers electing to transfer must complete a prefiling registration process through an online portal and obtain unique registration numbers for each eligible property.
   
   Similarly, direct pay (sometimes referred to as elective pay) allows eligible entities, such as nonprofits, governmental agencies, and the like, to apply to the IRS to claim a refund of the tax credit amount, which is then paid directly to such applicant. A credit that is transferred to the eligible entity is then ineligible for direct pay.
   
   Note that the foregoing Section 4 reflects proposed regulations and guidance, which are subject to comment and further change by the U.S. Department of Treasury and the IRS.

Conclusion

The ITC serves as a key financial incentive to boost investment in renewable energy projects. Eligibility for the ITC rests upon various requirements, including property ownership, operational status, and commencement of construction within specified timelines. As the recent Act has broadened the scope of eligible properties and deadlines, acquiring a thorough understanding of these evolving regulations is crucial for determining whether one is eligible for the ITC and to what extent.

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.