On November 19, 2021, the House of Representatives passed the Build Back Better Act (the “Act”). The Act includes funding for various programs as well as significant new tax provisions intended to help offset the cost. The Act now heads to the Senate, where its passage faces significant obstacles.
While it remains uncertain whether the Act will ultimately become law (and, if so, in what form), the enactment of the Act in its current form would provide substantial benefits to the green energy sector. Subtitle F of the Act (the “Green Energy Subtitle”) provides tax incentives for renewable energy, such as wind and solar, as well as clean energy activities such as carbon capture and low-carbon hydrogen production. This alert summarizes the highlights of selected provisions of the Green Energy Subtitle.
Two-Tiered Incentives Structure
The Green Energy Subtitle structures various tax credits in two tiers: a base rate and, if certain requirements are satisfied, a higher rate that is quintuple the base rate.
The higher rate generally applies only to those projects which meet the prevailing wage and apprenticeship requirements during applicable periods or satisfy certain other exceptions. Projects which are exempted from the prevailing wage and apprenticeship requirements and, thus, also qualify for the higher rate, generally include (1) where applicable, projects with a maximum net output of less than one megawatt and (2) projects which commence construction prior to the 60th day after Treasury issues guidance regarding the prevailing wage and apprenticeship requirements. The base rate applies to all other projects.
Under the “prevailing wage requirements,” the taxpayer must ensure that laborers and mechanics employed by contractors and subcontractors working on the construction of the facility, and in many cases its alteration or repair for a period of years after construction, are paid the prevailing wages in the locality as determined by the Secretary of Labor. Under the “apprenticeship requirements,” the taxpayer must ensure that no fewer than the applicable percentage (10% for projects which begin construction in 2022, 12.5% for 2023, and 15% thereafter) of total labor hours are performed by qualified apprentices. Both requirements have certain cure provisions and the apprenticeship requirement includes a “good faith efforts” exception.
Enhanced Credits for Domestic Content, Energy Communities, and Low-Income Housing
For certain types of credits, such as the production tax credit under Section 45 (the “PTC”), the investment tax credit under Section 48 (the “ITC”), and the new tax credit for qualifying electric transmission property under Section 48D, an additional credit amount is available if the “domestic content requirements” are satisfied. Under the domestic content requirements, the taxpayer must ensure that a sufficient portion of the materials and products used in the qualified facility or energy property, as applicable, (for example, in the case of manufactured products, increasing in stages from 40% of costs for construction beginning before 2025 to 55% of costs for construction beginning after 2026) are manufactured or deemed manufactured in the United States.
In the case of the PTC, this additional credit amount equals 10% of the amount otherwise available to the taxpayer. In the case of the ITC and the tax credit under new Section 48D, this additional credit would increase the applicable credit rate by 2 percentage points for property that only qualifies for the base rate of underlying credit and 10 percentage points for property that qualifies for the higher rate of underlying credit.
There are also additional credit amount enhancements for facilities located in energy communities or low-income communities. For this purpose, an “energy community” is a census tract (or a directly adjoining census tract) where a coal mine closed after 1999 or a coal-fired electric generating unit closed after 2009. Qualification for the credit enhancement for low-income communities requires the taxpayer to meet the applicable criteria and apply to Treasury for an allocation of the capacity eligible for the credit each year.
Credit Haircuts for Tax-Exempt Financing
For most green energy credits, the available credit is reduced up to 15% to the extent the relevant facility is financed by tax-exempt debt and construction of the facility began after 2021.
Extensions of the PTC and ITC for Wind, Solar and other Energy Property
The Green Energy Subtitle extends the PTC and ITC applicable to wind, solar, and certain other energy projects.
The PTC for solar energy is revived. For solar, wind, and other PTC-eligible projects placed in service after 2021 that begin construction before 2027, the “higher rate” of PTC credit is increased to the full applicable credit rate (for example, 2.5 cents per KwH in 2021), without any haircut.
The ITC for solar energy property and most other ITC-eligible property is extended, providing a rate of 30% (in the case of projects qualifying for the higher rate) for projects placed in service after 2021 that begin construction before 2027. The credit is extended for limited classes of property for construction beginning before 2034 (with a phased-down credit amount in the final two years).
Future Replacement of ITC and PTC with Similar Technology-Neutral Credits
For projects that begin construction after 2026, the traditional ITC and PTC generally no longer apply. They are replaced by a new technology-neutral clean electricity production tax credit and a new clean energy investment tax credit. Eligibility for these credits generally requires that the facility’s greenhouse gas emissions be no greater than zero. These credits would begin to phase out in 2031 or, if later, the year in which Treasury determines that greenhouse gas emissions from production of electricity in the United States are no more than 25% of 2021 levels.
Extension and Increase in Section 45Q Tax Credit for Carbon Capture and Sequestration
The tax credit under Section 45Q for carbon capture and sequestration (the “45Q Credit”) is extended for facilities that begin construction before 2032. Section 45Q, as revised by the Green Energy Subtitle, would provide a credit at a rate of $85 (in the case of facilities qualifying for the higher rate) per metric ton of carbon oxide captured for geological storage and a credit at a rate of $60 (in the case of facilities qualifying for the higher rate) per metric ton of carbon oxide captured and used by the taxpayer for enhanced oil recovery or other allowable use. These rates, which would be effective starting in 2022, represent an increase over the current credit amounts of $50 and $35 per ton for sequestration or enhanced oil recovery, respectively, scheduled to apply in 2026 and later years.
With respect to qualified direct air capture facilities, the Green Energy Subtitle also provides an enhanced 45Q Credit at a rate of $180 (in the case of facilities qualifying for the higher rate) per metric ton of carbon oxide captured for geological storage and a credit at a rate of $130 (in the case of facilities qualifying for the higher rate) per metric ton of carbon captured and used by the taxpayer for enhanced oil recovery or other allowable use.
While the proposal does not increase the credit period from the existing 12 years, it does reduce the minimum annual capture thresholds that must be met in order to be a qualified facility to 12,500 tons for non-electricity producing facilities and to 18,750 tons (coupled with a 75% of emissions capture requirement) for electricity producing facilities.
Although the amendments to section 45Q contained in the Act are generally applicable only to facilities that begin construction after 2021, the Act also offers an election into the increased credit amounts of amended section 45Q to facilities currently in service and as to which no section 45Q credits have previously been claimed if the facility is located in a federally-declared disaster area and the disaster resulted in a cessation of operation of the facility.
Expansion of the ITC
The Green Energy Subtitle expands the ITC to include:
- energy storage technology, which generally includes property that receives, stores and delivers energy for conversion to electricity and has a minimum capacity of 5 kilowatt hours,
- qualified biogas property, which converts biomass into a gas which consists of (or is concentrated by such system to consist of) not less than 52% methane and captures such gas for productive use,
- microgrid controllers, which are part of, and monitor and control the energy resources and loads on, qualified microgrids capable of generating not less than 4 kilowatts and not greater than 20 megawatts of electricity,
- linear generator assemblies, which generate electricity through electromechanical means without using rotating parts and have a minimum capacity of at least 1 kilowatt, and
- dynamic or electrochromic glass, which uses electricity to change its light transmittance properties in order to heat or cool a structure.
“Direct Pay”: Elective Refund for Deemed Payment of Tax
The Green Energy Subtitle allows taxpayers to elect to be treated as having made a payment of tax equal to the value of eligible tax credits and to request a tax refund for the deemed payment of tax rather than carrying forward such credits, implementing what is referred to as “direct pay” with respect to the credits. This provision allows entities with little or no tax liability (including tax partnerships and tax-exempt entities) to obtain the economic benefit of these credits.
The types of credits eligible for such election include, among other things, the ITC, the PTC, the 45Q Credit, the Section 48D credit for transmission property, and the Section 45X clean hydrogen production credit. This provision applies to projects placed in service after 2021.
However, in the case of a facility for which ITCs, PTCs, or Section 48D credits are claimed and which has a maximum net output of at least one megawatt, the domestic content requirements are imposed to potentially limit such payments. If the facility claiming such credits fails to meet the domestic content requirements, the amount of direct payment would generally be subject to a phasedown schedule: the amount of such payment would be 100% of the credits the taxpayer would otherwise be eligible for if the facility commences construction before 2024, 90% if the facility commences construction in 2024, 85% if the facility commences construction in 2025, and 0% if the facility commences construction in 2026 and thereafter. Treasury is authorized to provide exceptions to the domestic content requirement where domestic products are not available in sufficient quantity or quality or their use would increase the overall cost of the facility by more than 25%.
Expansion of Publicly Traded Partnership Qualifying Income to Include Green Energy Income
The Green Energy Subtitle expands the definition of “qualifying income” for publicly traded partnerships to include certain income derived from green energy. Such income includes, among other things, income from the generation of energy eligible for the PTC, income from the operation of energy property eligible for the ITC, income from certain activities related to renewable fuels, and income from facilities eligible for the 45Q Credit.
New Tax Credit for Electric Transmission Property
The Green Energy Subtitle creates a new tax credit, in new Section 48D, for the basis of qualifying electric transmission property placed in service by the taxpayer after 2021 and before 2032, at a credit rate of 30% (in the case of projects qualifying for the higher rate). Qualifying electric transmission property includes transmission lines capable of transmitting electricity at a voltage of not less than 275 kilovolts, or that are superconducting lines, in either case with capacity of not less than 500 megawatts, as well as certain related transmission property.
New Tax Credit for the Production of Clean Hydrogen
The Green Energy Subtitle creates a new tax credit, in new Section 45X, for the production of clean hydrogen (“Clean Hydrogen Production Credit”) by a taxpayer at a qualified facility beginning in 2022 during the ten-year period beginning on the date such facility is placed in service. The credit applies to hydrogen produced after 2021.
The amount of the Clean Hydrogen Production Credit is equal to the “applicable percentage” of $3.00 (in the case of projects qualifying for the higher rate), indexed to inflation, multiplied by the volume (in kilograms) of clean hydrogen produced by the taxpayer at a qualified facility during such taxable year. The “applicable percentage” depends on the reduction in lifecycle greenhouse gas emissions as compared to the production of hydrogen using steam-methane reforming, with the highest applicable percentage being 100% (if lifecycle greenhouse gas emissions are less than 0.45 kilograms of CO2e per kilogram of hydrogen) and the lowest being 15% (if lifecycle greenhouse gas emissions are between 4 and 6 kilograms of CO2e per kilogram of hydrogen).
A taxpayer may elect to treat a qualified clean hydrogen facility as energy property for purposes of the ITC in lieu of the Clean Hydrogen Production Credit, in which case the ITC shall equal the applicable percentage multiplied by the energy percentage, meaning that the credit rate would reflect the extent of the reduction in lifecycle greenhouse gas emissions, and the rate of 30% (in the case of projects qualifying for the higher rate) would only apply if the facility emitted less than 0.45 kilograms of CO2e per kilogram of hydrogen. Under the Act, the Clean Hydrogen Production Credit would not be available for hydrogen produced at a facility which includes carbon capture equipment for which the 45Q Credit is allowed to any taxpayer.
The Green Energy Subtitle extends through 2026: (1) the income and excise tax credits for biodiesel and biodiesel mixtures at $1.00 per gallon, (2) the $0.10-per-gallon small agri-biodiesel producer credit, (3) the $0.50 per gallon excise tax credits for alternative fuels and alternative fuel mixtures, and (4) the second generation biofuel income tax credit. It also creates a new sustainable aviation fuel income and excise tax credit, applicable to sale or use of qualified mixtures after 2022 and before 2027.
The Green Energy Subtitle creates a new technology-neutral clean fuel production credit that applies after 2026. Fuels may qualify for the credit if their lifecycle emissions are sufficiently below the U.S. average. These credits would begin to phase out in 2031 or, if later, the year in which Treasury determines that greenhouse gas emissions from the transportation sector are no more than 25% of 2021 levels.
As the Act now moves to the Senate for consideration and potential modification, we will continue to monitor developments and will provide further updates on the green energy tax incentives package. In the meantime, Baker Botts would be pleased to assist you in your analysis of the Act and other green energy tax incentive matters.
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